The Charvon oil company is planning to make a large investment in coal-to-liquids (CTL) gasoline. The end product will be a perfect substitute for gasoline made from petroleum, but the feedstock will be coal instead of oil. Two technologies are available to the Charvon company. The first is called indirect CTL, where the coal is gasified prior to being liquefied. The second is called direct CTL, where the coal is dissolved in a solvent, and the resulting liquid is processed into gasoline. The Charvon company has hired you as a consultant to help them decide which technology they should choose.
Charvon expects to produce 1.5 million gallons of CTL gasoline in each of the next twenty years, and they can sell the gasoline for $2.5 per gallon. The capital cost of indirect CTL is $10 million and operating costs for indirect CTL (labor, fuel, and maintenance) are $400,000 per year. The capital cost of direct CTL is $12 million and operating costs for direct CTL are $300,000 per year.
One problem with indirect CTL is that the coal gasification process releases large amounts of CO2 into the atmosphere. Assume that for every gallon of gasoline produced with indirect CTL, 0.02 tons of CO2 are released. You have learned that starting in Year 1 the government will implement a tax of $15 per ton of CO2, which is applied as increase in the operating cost. Assume that if you choose direct CTL you will not be subject to the tax on CO2.
Assume capital cost for both technologies can be depreciated using straight line with project life time of 20 years, starting from year 1 to year 20. Consider income tax rate of 40% for the taxable income and discount rate of 12% for all costs and revenues.
Perform a sensitivity analysis of the Expected NPV of direct and indirect CTL on the probability of a $15/ton carbon taxthat is implemented in Year 1. On a single set of axes, plot the Expected NPV for each of the two technologies as a function of the probability of the carbon tax, and identify the threshold probability of the tax where an expected-value decision-maker would change their decision about what plant to build.