The management council must make an immediate decision that will affect the profitability of this company for the next 25 years. In response to the Clean Air Act, instead of purchasing and installing new scrubbers, I recommend that the Southern Company elect to buy allowances to meet this new standard for the remaining years to come. This strategy will not only minimize costs, it'll allow Southern the needed capital to invest in other projects in the future.
In my analysis, I looked at the possibility of purchasing and installing scrubbers as pollution control equipment, which would create a 90% reduction in your generated sulfur dioxide emissions. Initially, this appears to be an excellent strategy; however, there exists many constraints. The first constraint is the cost. The scrubbers would cost over $719 million over a three year span. And even though you could depreciate the scrubbers over the years, they would have no salvageable value. The second constraint is that there is a 2% revenue reduction due to power for the scrubbers. This cost is enormous, but it is not as substantial as the increase in operating cost for the scrubbers. If you produced our expected 21,551 million kilowatt-hours and had an operating cost of 13 cents per kilowatt-hour, you could expect an increase in operating costs of $2,800 million. This cost weighs heavily on your expected returns and inevitably, leaves you operating at a net loss. Even though you can generate some positive cash flow from selling off the excess allowances, it is not enough to offset the large operating costs due to the scrubbers.
However, there is a scenario where installing the scrubbers would be a good strategy. If the additional operating cost of the scrubbers was .32 cents per KWh instead of 13 cents per KWh, you could expect a lower cost.
As you can see, by doing nothing, you will have to pay a substantial amount for the adequate allowances to bring Southern Company into compliance, but since...
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