BrightSource: Challenges and Prospects for a Concentrated Solar Power Plant Net Present Value (NPV) / MBA Resources

Introduction to Net Present Value (NPV) - What is Net Present Value (NPV) ? How it impacts financial decisions regarding project management?

NPV solution for BrightSource: Challenges and Prospects for a Concentrated Solar Power Plant case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. BrightSource: Challenges and Prospects for a Concentrated Solar Power Plant case study is a Harvard Business School (HBR) case study written by Debra Schifrin, Donald Kennedy. The BrightSource: Challenges and Prospects for a Concentrated Solar Power Plant (referred as “Brightsource Solar” from here on) case study provides evaluation & decision scenario in field of Leadership & Managing People. It also touches upon business topics such as - Value proposition, .

The net present value (NPV) of an investment proposal is the present value of the proposal’s net cash flows less the proposal’s initial cash outflow. If a project’s NPV is greater than or equal to zero, the project should be accepted.

NPV = Present Value of Future Cash Flows LESS Project’s Initial Investment

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Case Description of BrightSource: Challenges and Prospects for a Concentrated Solar Power Plant Case Study

The case presents the challenges confronting BrightSource, a company building a commercial-scale concentrated solar power plant in California in 2013: 1) environmentalists wanted to protect a threatened species at the site of the new plant, 2) competing solar power technology had become much cheaper in recent years, and 3) the company had been unable to get investors for its new thermal storage technology, which could be a game changer for the industry. When BrightSource was in the planning stages of Ivanpah, a 400-megawatt solar power plant in the Mojave Desert, the company encountered opposition from environmentalists because the federal land specifically set aside for the facility was also the habitat of the desert tortoise, a threatened species under the Endangered Species Act. While solar energy was a positive step toward increasing renewable energy resources, and Ivanpah would power 140,000 homes during peak hours, local environmentalists were equally concerned about the survival of the desert tortoise. The case describes the steps BrightSource took to respond to the concerns raised by the environmentalists and build the plant, addressing both climate change and protecting local habitats. Company management also faced challenges from the changing economics of generating solar power due to developments in competing systems and technologies. Students are asked to consider whether the technology that BrightSource is using, Concentrated Solar Power (CSP), is the right choice for the future of the industry, given that the cost of competitors' technology, Photovoltaics (PV), had dropped dramatically in the previous few years. BrightSource also had a new thermal storage technology that would allow it to provide electricity on cloudy days, thereby significantly increasing output and the profitability of future power plants, but investors so far had not come on board, citing the risk and expense of the building out the technology.

Case Authors : Debra Schifrin, Donald Kennedy

Topic : Leadership & Managing People

Related Areas :

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Calculating Net Present Value (NPV) at 6% for BrightSource: Challenges and Prospects for a Concentrated Solar Power Plant Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10005122)	-10005122	-	-
Year 1	3467294	-6537828	3467294	0.9434	3271032
Year 2	3979026	-2558802	7446320	0.89	3541319
Year 3	3945798	1386996	11392118	0.8396	3312968
Year 4	3249172	4636168	14641290	0.7921	2573649
TOTAL			14641290		12698968

The Net Present Value at 6% discount rate is 2693846

In isolation the NPV number doesn't mean much but put in right context then it is one of the best method to evaluate project returns. In this article we will cover -

Different methods of capital budgeting

What is NPV & Formula of NPV,
How it is calculated,
How to use NPV number for project evaluation, and
Scenario Planning given risks and management priorities.

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Capital Budgeting Approaches

Methods of Capital Budgeting

There are four types of capital budgeting techniques that are widely used in the corporate world –

1. Internal Rate of Return
2. Net Present Value
3. Profitability Index
4. Payback Period

Apart from the Payback period method which is an additive method, rest of the methods are based on Discounted Cash Flow technique. Even though cash flow can be calculated based on the nature of the project, for the simplicity of the article we are assuming that all the expected cash flows are realized at the end of the year.

Discounted Cash Flow approaches provide a more objective basis for evaluating and selecting investment projects. They take into consideration both –

1. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Brightsource Solar shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.
2. Timing of the expected cash flows – stockholders of Brightsource Solar have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.

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Formula and Steps to Calculate Net Present Value (NPV) of BrightSource: Challenges and Prospects for a Concentrated Solar Power Plant

NPV = Net Cash In Flowt1 / (1+r)t1 + Net Cash In Flowt2 / (1+r)t2 + … Net Cash In Flowtn / (1+r)tn
Less Net Cash Out Flowt0 / (1+r)t0

Where t = time period, in this case year 1, year 2 and so on.
r = discount rate or return that could be earned using other safe proposition such as fixed deposit or treasury bond rate. Net Cash In Flow – What the firm will get each year.
Net Cash Out Flow – What the firm needs to invest initially in the project.

Step 1 – Understand the nature of the project and calculate cash flow for each year.
Step 2 – Discount those cash flow based on the discount rate.
Step 3 – Add all the discounted cash flow.
Step 4 – Selection of the project

Why Leadership & Managing People Managers need to know Financial Tools such as Net Present Value (NPV)?

In our daily workplace we often come across people and colleagues who are just focused on their core competency and targets they have to deliver. For example marketing managers at Brightsource Solar often design programs whose objective is to drive brand awareness and customer reach. But how that 30 point increase in brand awareness or 10 point increase in customer touch points will result into shareholders’ value is not specified.

To overcome such scenarios managers at Brightsource Solar needs to not only know the financial aspect of project management but also needs to have tools to integrate them into part of the project development and monitoring plan.

Calculating Net Present Value (NPV) at 15%

After working through various assumptions we reached a conclusion that risk is far higher than 6%. In a reasonably stable industry with weak competition - 15% discount rate can be a good benchmark.

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 15 %	Discounted Cash Flows
Year 0	(10005122)	-10005122	-	-
Year 1	3467294	-6537828	3467294	0.8696	3015038
Year 2	3979026	-2558802	7446320	0.7561	3008715
Year 3	3945798	1386996	11392118	0.6575	2594426
Year 4	3249172	4636168	14641290	0.5718	1857725
TOTAL					10475904

The Net NPV after 4 years is 470782

(10475904 - 10005122 )

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Calculating Net Present Value (NPV) at 20%

If the risk component is high in the industry then we should go for a higher hurdle rate / discount rate of 20%.

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 20 %	Discounted Cash Flows
Year 0	(10005122)	-10005122	-	-
Year 1	3467294	-6537828	3467294	0.8333	2889412
Year 2	3979026	-2558802	7446320	0.6944	2763213
Year 3	3945798	1386996	11392118	0.5787	2283448
Year 4	3249172	4636168	14641290	0.4823	1566923
TOTAL					9502995

The Net NPV after 4 years is -502127

At 20% discount rate the NPV is negative (9502995 - 10005122 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Brightsource Solar to discount cash flow at lower discount rates such as 15%.

Acceptance Criteria of a Project based on NPV

Simplest Approach – If the investment project of Brightsource Solar has a NPV value higher than Zero then finance managers at Brightsource Solar can ACCEPT the project, otherwise they can reject the project. This means that project will deliver higher returns over the period of time than any alternate investment strategy.

In theory if the required rate of return or discount rate is chosen correctly by finance managers at Brightsource Solar, then the stock price of the Brightsource Solar should change by same amount of the NPV. In real world we know that share price also reflects various other factors that can be related to both macro and micro environment.

In the same vein – accepting the project with zero NPV should result in stagnant share price. Finance managers use discount rates as a measure of risk components in the project execution process.

Sensitivity Analysis

Project selection is often a far more complex decision than just choosing it based on the NPV number. Finance managers at Brightsource Solar should conduct a sensitivity analysis to better understand not only the inherent risk of the projects but also how those risks can be either factored in or mitigated during the project execution. Sensitivity analysis helps in –

Understanding of risks involved in the project.

What will be a multi year spillover effect of various taxation regulations.

What are the uncertainties surrounding the project Initial Cash Outlay (ICO’s). ICO’s often have several different components such as land, machinery, building, and other equipment.

What can impact the cash flow of the project.

What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

Some of the assumptions while using the Discounted Cash Flow Methods –

Projects are assumed to be Mutually Exclusive – This is seldom the came in modern day giant organizations where projects are often inter-related and rejecting a project solely based on NPV can result in sunk cost from a related project.

Independent projects have independent cash flows – As explained in the marketing project – though the project may look independent but in reality it is not as the brand awareness project can be closely associated with the spending on sales promotions and product specific advertising.

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Negotiation Strategy of BrightSource: Challenges and Prospects for a Concentrated Solar Power Plant

References & Further Readings

Debra Schifrin, Donald Kennedy (2018), "BrightSource: Challenges and Prospects for a Concentrated Solar Power Plant Harvard Business Review Case Study. Published by HBR Publications.