Pollution Busters Inc. is considering a purchase of 10 additional carbon sequesters for $103,000 apiece. The sequesters last for only 1 year before becoming saturated. Then the carbon is sold to the government.
Required:
a. Suppose the government guarantees the price of carbon. At this price, the payoff after 1 year is $120,510 for sure. How would you determine the opportunity cost of capital for this investment?
b. Suppose instead that the sequestered carbon has to be sold on the London Carbon Exchange. Carbon prices have been extremely volatile, but Pollution Bustersâ CFO learns that average rates of return from investments on that exchange have been about 22%. She thinks this is a reasonable forecast for the future. What is the opportunity cost of capital in this case?
c. If the expected return on the investment is still 17%, but instead depends on the price of carbon (so that it is no longer risk-free), then is the purchase of additional sequesters an attractive investment for the firm?
d. Suppose the government guarantees the price of carbon. At this price, the payoff after 1 year is $120,510 for sure. How would you determine the opportunity cost of capital for this investment?