The Solar Panels Business CaseI. Introduction Central Arizona Storage has 850 stores. As part of the CEO’s low-cost supply chain strategy, $0.5bn of capital has recently been invested in a warehouse t

The Solar Panels Business CaseI. Introduction

Central Arizona Storage has 850 stores. As part of the CEO’s low-cost supply chain strategy, $0.5bn of capital has recently been invested in a warehouse transformation program. The objective of the strategy is to reduce costs to increase profits. However, news and financial analyst reports have viewed the recent performance of this transformation program as unsatisfactory because cost reductions are less than expected.

Central Arizona Storage has also received negative news reports and customer backlash about its lack of sustainability practices. While Central Arizona Storage has been preoccupied with the warehouse transformation program, its two main competitors have developed strong reputations for sustainability practices. The competitors’ annual reports are filled with discussions and performance measures about the successes of their sustainability strategies—especially concerning their switching to sustainable energy sources. Central Arizona Storage is lagging behind and customers are switching to the competitors.

Realizing that this is an issue that needs to be addressed, Central Arizona Storage is evaluating projects that incorporate sustainability practices. One project under consideration is the installation of solar panels on the roofs of the North and South warehouses. Here is an excerpt from a conversation between the Senior Management Accountant (Beth) and his talented Junior Management Accountant (you):

Beth: ‘‘I need you and your management accounting team to prepare the solar panels business case. The more warehouse roofs we put solar panels on, the more carbon dioxide greenhouse gas emissions and electricity costs we can save.’’

You: ‘‘What information do we have?’’

Beth: ‘‘There are the North and South warehouses and two solar panels sourcing scenarios: outsourced and insourced. If outsourced, external contractors would supply and install the solar panels. If insourced, we would purchase solar panels from the manufacturer and install them with internally managed projects. The business case needs to quantify carbon dioxide greenhouse gas emissions and public grid electricity cost savings, with net present values and internal rates of returns for the six alternatives.’’

You: ‘‘There are six alternatives?’’

Beth: ‘‘Yes, six alternatives. For the insource scenario, there are three potential solar panels quantities: North only, South only, and North and South combined. The larger the quantity, the lower the price per panel from the manufacturer. For the outsourced scenario we have three quotes from external contractors: North only, South only, and North and South combined.’’

You: ‘‘Do we have the solar panel prices for the insource scenario?’’

Beth: ‘‘Not yet. The CEO and CFO will negotiate the prices for the three quantities with the manufacturer. Your Excel model needs to use Goal Seek to calculate the three maximum prices that give net present values and internal rates of returns that equal those of the corresponding outsource alternatives. If the CEO and CFO end up negotiating prices lower than those maximums, then we can insource those projects and achieve better financial outcomes.’’

You: ‘‘But what if the projects do not meet our 8.0 percent hurdle rate?’’

Beth: ‘‘The Board of Directors will only approve capital expenditures that meet the 8.0 percent hurdle rate. Ideally, we end up with solar panels on both warehouses to save the most carbon dioxide emissions. Only after the price negotiations will we be able to calculate all the final net present values and internal rates of return to know which insource alternatives are approvable and whether any are better than the corresponding outsource alternatives. When we get the negotiated prices, I will update the business case myself and pass it on to the CEO, CFO, and Board of Directors.’’

You: ‘‘Thank you for giving me this exciting opportunity to broaden my strategic management accounting skills.’’  

Beth: ‘‘For you to do this business case successfully, your calculations must be correct and concisely communicated. The CEO and CFO need clear and easily understandable information for their negotiations with the solar panels manufacturer and to communicate with the Board of Directors. Eventually, Central Arizona Storage would want to inform the investor and stakeholder communities about the electricity costs and greenhouse gas emissions saved.’’

II. Outsourced and Insourced Scenarios

For the outsourced scenario, Exhibit 1 shows the best quotes from external contractors. No additional capital expenditure (capex) would be required beyond the quoted costs.

EXHIBIT 1: Quotes for the Outsourced Scenario

Warehouse

Supply and Installation Quoted Costs

North

$6,000,000

South

$5,000,000

North & South combined

$10,000,000

For the insourced scenario, Exhibit 2 shows the estimated installation costs—provided by the Central Arizona Storage Warehouse Design Manager. These costs exclude the (yet to be negotiated) purchase costs for buying solar panels from the manufacturer.             

EXHIBIT 2: Installation Costs for the Insourced Scenario

Warehouse

Installation Cost Estimate

North

$225,000

South

$175,000

North & South combined

$400,000

III. Electricity, Solar Panels, and Emissions Savings

Installing solar panels would save electricity costs and greenhouse gas emissions. Solar-generated electricity would reduce what Central Arizona Storage would need to purchase from the public electricity grid. Because the solar panel systems would be synchronized with the public electricity grids, any surplus solar-generated electricity not used by the warehouse would feed into the public grid for which Central Arizona Storage would receive a corresponding purchase cost credit. Purchase cost credits would be offset against electricity purchased from the public grid to supplement solar panel-generated power (for example, for electricity sourced from the public grid at night). Exhibit 3 shows the Year 1 purchase cost/credit amounts for electricity off/into the public grid—Central Arizona Storage would purchase electricity at the same price for which it would receive credits. Exhibit 3 also includes total electricity usage for each warehouse.

EXHIBIT 3: Electricity Purchase Costs/Credits and Total Electricity Usage

Project

Year 1 Public Electricity Grid: Purchase Cost/Credits per kWh

Year 1 Total Electricity Usage kWh

North

$0.34

12,000,000

South

$0.32

10,000,000

Exhibit 4 concerns how kilo Watt hours (kWh) of electricity produced by a solar panel system depends on system capacity and sun exposure:

1. System capacity differs by warehouse because each has a different roof size. Each solar panel is 1 square meter (sqm) and has the capacity to produce up to 170 Watts (or 0.17 kW) at any point in time given optimal sun exposure. A system capacity of 100kW can produce 100kW of power per hour in conditions of optimum sun exposure; that is, under optimum sun exposure the system can produce 100kWh.
2. Sun exposure differs by warehouse due to technical and geographical factors: orientation and tilt of the panels, number of daylight hours, full sun versus cloudy days, and sunlight intensity.

EXHIBIT 4: Solar System Sizes and CapacitiesProjectSolar System Size: Panels (each 1 sqm)System Capacity kWSun Exposure: Average Daily kWh Produced per kW of CapacityNorth6,0001,0208.9South4,0006806.6

Solar panels would save carbon dioxide (CO2) greenhouse gas emissions. The electricity utility companies would reduce the kWh they would generate by the amount of kWh solar generated by Central Arizona Storage. Exhibit 9 shows the carbon dioxide emissions factors for the electricity generated by the electricity utility companies. Carbon dioxide emissions factors depend on how the electricity is generated. Higher emission factors occur where the electricity generation process uses ‘‘dirtier’’ forms of fuel such as low-grade brown coal, as opposed to ‘‘cleaner’’ forms such as wind-generated electricity. Higher emission factors also occur where the electricity generation process has higher heat loss. Lower emission factors are achieved where the fuel is converted more efficiently into electricity with less heat loss. Electricity generated by solar panels on the roofs of Central Arizona Storage warehouses would have an emissions factor of zero.

IV. Financial Modeling Parameters and Assumptions

Parameters and assumptions to be applied in the business case are as follows:

1. All capital expenditure (capex) would be in Year 0 (this year), and solar panel systems would start generating electricity and be depreciated from the beginning of Year 1.
2. The useful life of solar panels for financial reporting is 10 years (depreciated straight line) and 5 years for company tax (depreciated straight line).
3. After 10 years, a solar panel recycling firm would remove the solar panel systems with 0 make good costs to Central Arizona Storage.
4. Other than public electricity cost savings and depreciation, the only other relevant ongoing costs from installing and using solar panels would be annual maintenance expenses (for example, cleaning the solar panels) of $1.00 per panel—this is a Year 1 figure and needs to be inflated for subsequent years.
5. Assume an electricity inflation rate of 7 percent per year for electricity over the public grid including purchase cost credits.
6. Assume a 3.0 percent per year general inflation rate where applicable for all relevant costs other than electricity.
7. Assume that the cash flow for an item occurs in the accounting period incurred.
8. The tax rate is 30.0 percent.
9. If, hypothetically, there was a taxable loss in a given year(s) from solar panels, there would be a positive tax effect on cash flows in that year (Central Arizona Storage is very profitable overall). Thus, there would be no deferred tax assets from a taxable loss from solar panels.
10. The hurdle rate (or ‘‘discount rate’’) is 8.0 percent—this is a nominal (as opposed to real) rate, and so you need to inflate the undiscounted cash flows each year.
11. The solar panels would be in use 365 days per year.

V. Business Case Requirements

Download the Financial Model Template File Download Financial Model Template FileExcel workbook. Build on what is already in the workbook—do not change the worksheet names or tables. All worksheets needed are already in the workbook—see Exhibit 5. Build your financial model with formulas that link to Input Tables 1 to 4.

EXHIBIT 5: Contents of the Financial Model Template File Excel WorkbookWorksheet NameWorksheet Contents/PurposeInput Tables 1 to 4Exhibits 1 to 4 aboveParameters and Electricity Calcs

Parameters (e.g., inflation, tax, discount rate)

Electricity Calculations (solar-generated kWh, use percent for solar)

Outsourced Cashflow ModelsCapex, EBITDA, EBIT cashflows—for each of the three alternatives Insourced Cashflow Models Capex, EBITDA, EBIT cashflows—for each of the three alternativesRequirement 1aSee Exhibit 6 (below)Requirement 1bSee Exhibit 7 (below)Requirement 1cSee Exhibit 8 (below)Requirement 1dSee guidance (below)

Apply relevant costing principles: only include the incremental costs and cash flows that would differ from installing solar panels. Electricity usage will not differ if solar panels are installed. What will differ is cost and carbon dioxide savings because Central Arizona Storage will not need to purchase the portion of electricity generated by solar panels from the public grid. Depreciation expenses and maintenance expenses will also differ if solar panels are installed. The net of these incremental costs will sum to Earnings Before Interest and Tax (EBIT). Work out EBIT as a base for calculating the incremental cash flows in Year 1 and onwards. Discount the incremental cash flows with the 8.0 percent hurdle rate. Include Year 0 capital expenditure to calculate a net present value (NPV) or to evaluate an internal rate of return (IRR).

The financial model has no size limit, but it should be simple and easy to use. A new user of your financial model (for example, the senior management accountant, the CFO, or the CEO) must be able to quickly and easily understand where the specific parts of the financial model are located.

Design your financial model to clearly present information to answer potential discussion questions such as:

1. How do the solar panels save electricity costs and greenhouse gas emissions?
2. How much of the electricity needs of the warehouses would solar panel systems produce?
3. What are the individual expense items and amounts that make up EBIT each year?
4. What happens to the cash flows in Year 6 when the solar panels no longer have a tax effect from depreciation?
5. Should instructions be included in the model to guide the CFO to easily run extra Goal Seek scenarios?
6. What is the purpose of the business case?
7. How much capital expenditure would the Board of Directors need to approve?
8. After the CEO and CFO have negotiated with the solar panels manufacturer, how should Central Arizona Storage respond to those prices?

Requirement 1a: Outsourced

For each of the three alternatives, calculate:

• EBIT
• EBITDA
• Relevant cash flows for the discounted cash flow model
• NPV of the relevant cash flows
• IRR of the relevant cash flows

Summarize the results in the Excel table provided for Requirement 1a (see Exhibit 6).

EXHIBIT 6: Panel A: Requirement 1aOutsourcedPanels (each 1 sqm)Cost per panel installed ($000)Capex ($000)NPV ($000)IRRYear 1 EBIT ($000)NorthSouthNorth + South

Requirement 1b: Insourced

For each of the three alternatives, use Goal Seek (explained below) to calculate:

• EBIT
• EBITDA
• Relevant cash flows for the discounted cash flow model
• NPV of the relevant cash flows
• IRR of the relevant cash flows

Summarize the results in the Excel table provided for Requirement 1b (see Exhibit 7).

EXHIBIT 7: Requirement 1bOutsourcedPanels (each 1 sqm)Installation capex ($000)Purchase cost per panel ($000)Capex ($000)NPV ($000)IRRYear 1 EBIT ($000)NorthSouthNorth + South

For Requirement 1b, use Goal Seek (under What-If analysis in Excel) to calculate the three maximum prices that give net present values and internal rates of returns that equal those of the corresponding outsource alternatives. The CEO will use the ‘‘Purchase cost per panel’’ information from the Requirement 1b table to negotiate with the solar panels manufacturer. When the negotiations are finished, the senior management accountant will use that information to update your financial model and business case.

Exhibit 8 provides a view on how to set up your financial model with Goal Seek. The ‘‘Purchase cost per panel’’ cells are values that are calculated by Goal Seek and those values are inputs into other cells in other worksheets in the financial model. The cells with formulas (partly shown) feed from outputs from other cells in other worksheets in the financial model.

Requirement 1c: Greenhouse Gas Emissions

To populate the Excel table for Requirement 1c, calculate the greenhouse gas emissions that would be saved. The ‘‘hypothetical example’’ (see Exhibit 9) cells contain formulas that you can easily copy from (after you have finished, delete the hypothetical example from your model). For calculating solar-generated kWh as a percentage of total electricity usage by a warehouse, the case only contains enough information to do this for Year 1.

EXHIBIT 9Year 1NorthSouthHypothetical ExampleSolar-generated electricity kWh100,000CO2 emissions factor0.871.170.87CO2 emissions (kg CO2) saved87,000CO2 emissions (tonnes CO2) saved87

Requirement 1d: Executive Summary Table

In the separate worksheet included, design an Executive Summary table that feeds from other worksheets in your financial model. Design your Executive Summary table to clearly present the following information:

• The maximum solar panel prices negotiable for insource alternatives.
• The sizes of the warehouse installations and total size of all installations.
• A comparison of each of the three insource alternatives with the respective outsource alternatives in terms of:
  • capital expenditures
  • cost per solar panel
  • EBIT and cash flow impacts
  • NPVs and IRRs
  • carbon dioxide (tonnes) savings in Year 1
  • warehouse electricity percent solar generated.

Requirement 2: Communication of the Modeling

Business cases provide information for decision makers about potential capital expenditures projects. Approvable projects typically must be financially justified by a positive NPV and acceptable IRR (although a Board of Directors can sometimes override this requirement). Qualitative issues involving strategic alignment are also important information in business cases. Your draft business case should concisely communicate if, and how, different alternatives would align with the strategic need to adopt sustainability practices. If applicable, analyze and communicate trade-offs between alternatives.

The senior management accountant and the CFO will be the immediate audience for your draft business case. They will need to be confident that it adequately presents and discusses the qualitative factors, and that the calculations are correct and concisely communicated. When they are confident, they will pass it on to the CEO and the Board of Directors.

Requirement 3: Written Report

• Clearly present the financial information and discuss how the projects would achieve sustainability benefits.
• Do not include detailed discount cash flow models.
• Do not design new tables that would supplant the Requirement 1 tables.
• Include an Executive Summary with your Executive Summary table. The Executive Summary should concisely and comprehensively summarize the report.
• Summarize the operational issues and electricity grid synchronization.
• Discuss issues or assumptions made in the financial modeling.
• Conclude with the next steps for finalizing the business case.