Capital Budgeting Analysis

Capital Investment Review Memorandum
Solara Energy Arizona Solar Farm Expansion

Executive Directive

As part of our capital allocation and long-term growth strategy, we are evaluating a proposed investment in a 100-acre utility-scale solar farm in Arizona. This project will support a five-year Power Purchase Agreement (PPA) and may position the company for future expansion.

You are hereby directed to conduct a comprehensive financial evaluation of this investment consistent with the standards applied in a professional corporate finance environment. This analysis will be reviewed at the executive and board levels. The quality, transparency, and defensibility of your work must reflect that reality.

Your responsibilities include:
Estimating the firms cost of capital from first principles
Constructing a fully integrated pro forma free cash flow model
Performing a complete capital budgeting evaluation
Conducting sensitivity and risk analysis
Presenting a concise executive-level investment recommendation

Under no circumstances may you assume or rely on a provided discount rate. You must independently estimate Solara Energys Weighted Average Cost of Capital (WACC) using current, real-world market data. All assumptionsincluding peer group selection, beta adjustments, capital structure targets, risk-free rate, market risk premium, and cost of debtmust be analytically justified and clearly documented.

The credibility of your recommendation depends directly on the rigor of your cost of capital estimation. Your analysis must demonstrate disciplined financial judgment and professional standards appropriate for a multi-million-dollar capital commitment.

Company Overview

Solara Energy is a mid-sized renewable energy operator with solar and wind assets across the southwestern United States. Our primary revenue model consists of long-term Power Purchase Agreements, supplemented by spot market electricity sales.

We are evaluating the construction of a new 100-acre solar farm in Arizona to fulfill a five-year PPA.

Project Parameters

• Equipment Investment: $28,000,000 (5-year MACRS depreciation)
• Land Opportunity Cost: $5,800,000 (after-tax realizable value)
• Salvage Value: 50% of equipment cost at end of Year 5
• Production Forecast (MWh): 70,000; 72,000; 75,000; 68,000; 65,000 PPA Commitment: 60,000 MWh annually at $85 per MWh
• Spot Market Price: $75 per MWh
• Variable Operating Cost: $20 per MWh
• Fixed Operating Cost: $2,500,000 per year
• Net Working Capital: 5% of annual revenue (invested one year prior and fully recovered at termination)
• Environmental Reclamation: $1,200,000 in Year 6
• Charitable Deduction from Land Donation: $4,000,000 in Year 7
• Corporate Tax Rate: 25%

Part I Cost of Capital Determination

You are required to estimate Solaras project-specific Weighted Average Cost of Capital.

Cost of Equity (CAPM Framework):
Re = Rf + L (Rm Rf)

Required steps:
Identify and justify a relevant peer group (For example: NextEra Energy, First Solar, Enphase Energy, Brookfield Renewable)
Obtain levered betas and capital structure data
Unlever each beta: U = L / [1 + (1 T)(D/E)]
Average unlevered betas
Relever to Solaras target capital structure (assume 40% debt unless justified otherwise)
Clearly document assumptions for risk-free rate and market risk premium

Cost of Debt:
Estimate project borrowing cost based on Treasury yield plus appropriate credit spread.
Compute after-tax cost of debt: Rd(1 T)

WACC Calculation:
WACC = (E/V)Re + (D/V)Rd(1 T)

Assess whether an 11% required return is reasonable relative to your estimate.

Part II Free Cash Flow Model Construction

Develop a detailed pro forma model including:
PPA and spot market revenues
Variable and fixed operating expenses
Depreciation (5-year MACRS)
Taxes and tax shields
Net working capital investment and recovery
Initial capital expenditures and land opportunity cost
After-tax salvage value
Reclamation costs and donation-related tax effects

The model must clearly separate operating and investment cash flows.

Part III Capital Budgeting Evaluation

Using your estimated WACC, compute:
Net Present Value (NPV)
Internal Rate of Return (IRR)
Profitability Index (PI)
Payback Period
Discounted Payback Period

Interpret results and reconcile any conflicts among decision metrics.

Part IV Sensitivity and Risk Analysis

Conduct sensitivity analysis on:
Electricity price (10%)
Variable cost ($5 per MWh)
Production volume (10%)
Discount rate (9%13%)

Present findings in summary tables. And include a tornado chart (optional) .

Required Deliverables

1. Excel Financial Model (audit-ready and clearly structured)
2. Executive Decision Memorandum (maximum one page) covering:
Base case valuation results
Interpretation of metrics
Risk and sensitivity findings
Strategic considerations
Clear investment recommendation

Submission Instructions:

1. Excel Worksheet: Submit a complete Excel file containing all quantitative analyses.

2. Decision Memo: Include your one-page Decision Memo in a text box on a separate worksheet within the same Excel file.