Skip to main content
Engineering LibreTexts

12.4: Subsidies and Incentives in the Pro Forma

  • Page ID
    47822
  • \( \newcommand{\vecs}[1]{\overset { \scriptstyle \rightharpoonup} {\mathbf{#1}} } \)

    \( \newcommand{\vecd}[1]{\overset{-\!-\!\rightharpoonup}{\vphantom{a}\smash {#1}}} \)

    \( \newcommand{\id}{\mathrm{id}}\) \( \newcommand{\Span}{\mathrm{span}}\)

    ( \newcommand{\kernel}{\mathrm{null}\,}\) \( \newcommand{\range}{\mathrm{range}\,}\)

    \( \newcommand{\RealPart}{\mathrm{Re}}\) \( \newcommand{\ImaginaryPart}{\mathrm{Im}}\)

    \( \newcommand{\Argument}{\mathrm{Arg}}\) \( \newcommand{\norm}[1]{\| #1 \|}\)

    \( \newcommand{\inner}[2]{\langle #1, #2 \rangle}\)

    \( \newcommand{\Span}{\mathrm{span}}\)

    \( \newcommand{\id}{\mathrm{id}}\)

    \( \newcommand{\Span}{\mathrm{span}}\)

    \( \newcommand{\kernel}{\mathrm{null}\,}\)

    \( \newcommand{\range}{\mathrm{range}\,}\)

    \( \newcommand{\RealPart}{\mathrm{Re}}\)

    \( \newcommand{\ImaginaryPart}{\mathrm{Im}}\)

    \( \newcommand{\Argument}{\mathrm{Arg}}\)

    \( \newcommand{\norm}[1]{\| #1 \|}\)

    \( \newcommand{\inner}[2]{\langle #1, #2 \rangle}\)

    \( \newcommand{\Span}{\mathrm{span}}\) \( \newcommand{\AA}{\unicode[.8,0]{x212B}}\)

    \( \newcommand{\vectorA}[1]{\vec{#1}}      % arrow\)

    \( \newcommand{\vectorAt}[1]{\vec{\text{#1}}}      % arrow\)

    \( \newcommand{\vectorB}[1]{\overset { \scriptstyle \rightharpoonup} {\mathbf{#1}} } \)

    \( \newcommand{\vectorC}[1]{\textbf{#1}} \)

    \( \newcommand{\vectorD}[1]{\overrightarrow{#1}} \)

    \( \newcommand{\vectorDt}[1]{\overrightarrow{\text{#1}}} \)

    \( \newcommand{\vectE}[1]{\overset{-\!-\!\rightharpoonup}{\vphantom{a}\smash{\mathbf {#1}}}} \)

    \( \newcommand{\vecs}[1]{\overset { \scriptstyle \rightharpoonup} {\mathbf{#1}} } \)

    \( \newcommand{\vecd}[1]{\overset{-\!-\!\rightharpoonup}{\vphantom{a}\smash {#1}}} \)

    \(\newcommand{\avec}{\mathbf a}\) \(\newcommand{\bvec}{\mathbf b}\) \(\newcommand{\cvec}{\mathbf c}\) \(\newcommand{\dvec}{\mathbf d}\) \(\newcommand{\dtil}{\widetilde{\mathbf d}}\) \(\newcommand{\evec}{\mathbf e}\) \(\newcommand{\fvec}{\mathbf f}\) \(\newcommand{\nvec}{\mathbf n}\) \(\newcommand{\pvec}{\mathbf p}\) \(\newcommand{\qvec}{\mathbf q}\) \(\newcommand{\svec}{\mathbf s}\) \(\newcommand{\tvec}{\mathbf t}\) \(\newcommand{\uvec}{\mathbf u}\) \(\newcommand{\vvec}{\mathbf v}\) \(\newcommand{\wvec}{\mathbf w}\) \(\newcommand{\xvec}{\mathbf x}\) \(\newcommand{\yvec}{\mathbf y}\) \(\newcommand{\zvec}{\mathbf z}\) \(\newcommand{\rvec}{\mathbf r}\) \(\newcommand{\mvec}{\mathbf m}\) \(\newcommand{\zerovec}{\mathbf 0}\) \(\newcommand{\onevec}{\mathbf 1}\) \(\newcommand{\real}{\mathbb R}\) \(\newcommand{\twovec}[2]{\left[\begin{array}{r}#1 \\ #2 \end{array}\right]}\) \(\newcommand{\ctwovec}[2]{\left[\begin{array}{c}#1 \\ #2 \end{array}\right]}\) \(\newcommand{\threevec}[3]{\left[\begin{array}{r}#1 \\ #2 \\ #3 \end{array}\right]}\) \(\newcommand{\cthreevec}[3]{\left[\begin{array}{c}#1 \\ #2 \\ #3 \end{array}\right]}\) \(\newcommand{\fourvec}[4]{\left[\begin{array}{r}#1 \\ #2 \\ #3 \\ #4 \end{array}\right]}\) \(\newcommand{\cfourvec}[4]{\left[\begin{array}{c}#1 \\ #2 \\ #3 \\ #4 \end{array}\right]}\) \(\newcommand{\fivevec}[5]{\left[\begin{array}{r}#1 \\ #2 \\ #3 \\ #4 \\ #5 \\ \end{array}\right]}\) \(\newcommand{\cfivevec}[5]{\left[\begin{array}{c}#1 \\ #2 \\ #3 \\ #4 \\ #5 \\ \end{array}\right]}\) \(\newcommand{\mattwo}[4]{\left[\begin{array}{rr}#1 \amp #2 \\ #3 \amp #4 \\ \end{array}\right]}\) \(\newcommand{\laspan}[1]{\text{Span}\{#1\}}\) \(\newcommand{\bcal}{\cal B}\) \(\newcommand{\ccal}{\cal C}\) \(\newcommand{\scal}{\cal S}\) \(\newcommand{\wcal}{\cal W}\) \(\newcommand{\ecal}{\cal E}\) \(\newcommand{\coords}[2]{\left\{#1\right\}_{#2}}\) \(\newcommand{\gray}[1]{\color{gray}{#1}}\) \(\newcommand{\lgray}[1]{\color{lightgray}{#1}}\) \(\newcommand{\rank}{\operatorname{rank}}\) \(\newcommand{\row}{\text{Row}}\) \(\newcommand{\col}{\text{Col}}\) \(\renewcommand{\row}{\text{Row}}\) \(\newcommand{\nul}{\text{Nul}}\) \(\newcommand{\var}{\text{Var}}\) \(\newcommand{\corr}{\text{corr}}\) \(\newcommand{\len}[1]{\left|#1\right|}\) \(\newcommand{\bbar}{\overline{\bvec}}\) \(\newcommand{\bhat}{\widehat{\bvec}}\) \(\newcommand{\bperp}{\bvec^\perp}\) \(\newcommand{\xhat}{\widehat{\xvec}}\) \(\newcommand{\vhat}{\widehat{\vvec}}\) \(\newcommand{\uhat}{\widehat{\uvec}}\) \(\newcommand{\what}{\widehat{\wvec}}\) \(\newcommand{\Sighat}{\widehat{\Sigma}}\) \(\newcommand{\lt}{<}\) \(\newcommand{\gt}{>}\) \(\newcommand{\amp}{&}\) \(\definecolor{fillinmathshade}{gray}{0.9}\)

    Subsidies and Incentives in the Pro Forma

    In this section, we'll take our hypothetical wind project and look more closely at how subsidies and incentives can be incorporated into the pro forma financial statements. We'll focus on the PTC for this example. The project parameters for the wind turbine will remain the same, except that we'll extend the operational time horizon to 15 years from 10 years and assume fixed operations and maintenance costs of $10,000 per year. We'll also assume a sales price of $60 per MWh over the entire life of the wind project. The project parameters are shown in \(Table \text { } 12.1\).

    \(Table \text { } 12.1\): Wind Project Parameters

    Capital Cost 1,200,000  
    Annual discount rate 15 percent
    Decision Horizon (N) 10 Years
    Annual Output 3,000 MWh
    Marginal Cost $0 per MWh
    Variable O&M $5 per MWh
    Fixed O&M $10,000 per year
    Tax Rate 35 percent
    Sales Price $60 per MWh

    The analysis that we are describing here is included in an Excel file posted in the Lesson 12 module in Canvas, called "Wind Pro Forma.xlsx (no PTC)." The tables below will show some excerpts from the full P&L and Cash Flow tables.

    First, we'll take a look at the pro forma without the production tax credit. \(Tables \text { } 12.2\) and \(12.3\) show excerpts from the P&L and Cash Flow statements (Years 0 through 3 for each statement). You could also try to reproduce these yourself as an exercise - you can check your work using the Excel file that is in Canvas.

    \(Table \text { } 12.2\): P&L Statement for Years 0 through 3

      Year 0 Year 1 Year 2 Year 3
    Construction Cost $1,200,000 0 0 0
    Annual Operating Revenue $0 $180,000 $180,000 $180,000
    Annual Variable Operating Cost $0 $15,000 $15,000 $15,000
    Annual Fixed Operating Cost   $10,000 $10,000 $10,000
    Annual Net Operating Revenue   $155,000 $155,000 $155,000
    Depreciation Expense   $120,000 $216,000 $172,800
    Taxable Net Income   $35,000 $(61,000) $(17,800)
    Taxes   $12,250 $ - $ -
    Income Net of taxes   $22,750 $(61,000) $(17,800)

    \(Table \text { } 12.3\): Cash Flow Statement for Years 0 through 3.

      Year 0 Year 1 Year 2 Year 3
    (1) Investment Activities $(1,200,000)      
    (2)        
    (3) Net Income from Operating   $91,750 $8,000 $51,200
    (4)        
    (5) Depreciation Expenses   $120,000 $216,000 $172,800
    (6)        
    (7) Net increase or decrease        
    (8) in cash $(1,200,000) $211,750 $224,000 $224,000

    Based on the cash flow statement, we can calculate the net present value and IRR for this project. If you make the calculation yourself or look at the Excel sheet, you will find that the project has a 15-year NPV that is negative - over that time period the project loses $400,440 in present discounted value terms. The IRR is calculated to be 7%.

    Here the IRR is itself useful information - it tells you how low the WACC would need to be in order for the project to break even. You can thus use the IRR in evaluating the usefulness of loan guarantees or low-interest loans in making renewable energy projects profitable. In this case, if the wind project has a 50% debt and 50% equity financing structure, then even if the cost of debt were driven down to 0%, the project would still face a WACC of around 10%. Since this is higher than the IRR, we can conclude that unless the mix of debt and equity financing can be adjusted (more debt, less equity) then a zero-interest loan will not be sufficient to make our wind project profitable.

    Now, we'll incorporate the production tax credit for wind into our analysis. This section of the discussion will reference a different Excel file, "Wind Pro Forma.xlsx (with PTC)," which is also posted in the Lesson 12 module in Canvas. Here we'll simply assume that our project is eligible for the PTC, and that the PTC is set at $23 per MWh.

    To incorporate the PTC into the pro forma, we need to add an extra line to the P&L statement, which calculates the amount of the tax credit. Since the tax credit is calculated as a direct deduction from taxes paid, it is possible (and you'll see it happen in this example) that the Taxes line item in the P&L actually turns out to be negative. This indicates that the wind project receives a check from the IRS each year, because of the production tax credit. (The depreciation allowances also contribute here.) \(Table \text { } 12.4\) shows Years 0 through 4 of the P&L statement with the PTC included. Please have a look at the Excel file in Canvas as well - you will notice that there is a line item for the tax credit only for years 1 through 10 (after which the project is no longer eligible for the PTC).

    \(Table \text { } 12.4\). P&L Statement for Years 0 through 3 with the PTC.

      Year 0 Year 1 Year 2 Year 3
    Construction Cost $1,200,000 0 0 0
    Annual Operating Revenue   $180,000 $180,000 $180,000
    Annual Variable Operating Cost   $15,000 $15,000 $15,000
    Annual Fixed Operating Cost   $10,000 $10,000 $10,000
    Annual Net Operating Revenue   $155,000 $155,000 $155,000
    Depreciation Expense   $120,000 $216,000 $172,800
    Taxable Net Income   $35,000 $(61,000) $(17,800)
    Tax Credit   $69,000 $69,000 $69,000
    Taxes   $(56,750) $(69,000) $(69,000)
    Income Net of Taxes   $91,750 $8,000 $51,200

    \(Table \text { } 12.5\) shows the cash flow statement for Years 0 through 3. There is no real adjustment needed for the cash flow statement, since the cash flow statement starts with the "Income Net of Taxes" line item from the P&L.

    \(Table \text { } 12.5\): Cash flow statement for Years 0 through 3, with the PTC.

      Year 0 Year 1 Year 2 Year 3
    (1) Investment Activities $(1,200,000)      
    (2)        
    (3) Net Income from Operating   $91,750 $8,000 $51,200
    (4)        
    (5) Depreciation Expenses   $120,000 $216,000 $172,800
    (6)        
    (7) Net increase or decrease        
    (8) in cash $(1,200,000) $211,750 $224,000 $224,000

    We can again go and calculate the net present value and IRR of the plant. The PTC in this case does not make the NPV positive - the project loses $54,145 in present discounted value terms - but the PTC does increase the NPV by close to $350,000 over the life of the plant. It also raises the IRR to 14%. In this case, if the PTC could be coupled with RECs for the project (even if those RECs were not worth very much individually), then the NPV would likely increase to positive territory.


    This page titled 12.4: Subsidies and Incentives in the Pro Forma is shared under a CC BY-NC-SA license and was authored, remixed, and/or curated by Seth Blumsack (John A. Dutton: e-Education Institute) .

    • Was this article helpful?