THE TENNESSEE VALLEY AUTHORITY:
THE COST OF POWER
A Group Case Analysis
Presented to the
Accountancy Department
Ramon V. del Rosario College of Business
De La Salle University
In partial fulfillment
Of the course requirements
In ACYFMG2 K36
SUBMITTED TO:
Ms. Melanie C. Li
SUBMITTED BY:
Asuncion, Stephanie Ann M.
Rabaya, Ynna Louise O.
Salazar, Gillian Nina E.
September 17, 2021
I. INTRODUCTION
The Tennessee Valley Authority (TVA), headquartered in downtown Knoxville, is the
United States’ biggest public electric utility organization. Despite being completely owned by the
nation’s federal government, TVA is not funded by taxes. Instead, it is funded by the sale of
electricity to its consumers and borrowings from the financial market through debt issuance.
As the country’s leading energy supplier, it must be prepared to satisfy consumers’
growing energy demands. In doing so, chosen strategies must always be consistent with TVA’s
mission that shed light on energy, environment, and economic growth. However, it has never
been easy. More so now, the organization’s future is highly unclear due to an economic slump
and the possible levy of new legislative restrictions. Such has made it more difficult to fulfill
TVA’s promise of a reliable yet inexpensive supply of power to its consumers.
With the occurrence of such, Morgan — TVA’s newly-appointed Vice President of energy
supply management — was entrusted with presenting a plan addressing TVA’s strategic choice,
tackling the following: its energy source structure, related financial expenses, and impact on the
organization.
Such is made further complicated by the fact that TVA must replace a large portion of its
existing power production capacity. Construction of coal, natural gas, nuclear, wind, and solar
facilities, as well as the purchase of power requirements from other electricity suppliers, are all
its prospected sources for additional power generation. However, the costs, capacity, projected
cash flows, environmental effects, and useful lifetimes of these alternatives are all very
different. Be that as it may, the chosen alternative must take into consideration its financial,
political, social, technological, and environmental implications — particularly now that a new
trend of doing business in a more sustainable manner exists.
Given the following circumstances: [1] increasing demand for affordable energy [2]
current economic condition of Tennessee and [3] pressures brought on by the environmental
revolution on energy sources, Morgan must now come up with a decision on what should TVA’s
long-term strategy be to satisfy its stakeholders and to consistently achieve its three-fold
mission. All while maintaining the flexibility to deal with short-term financial and operational
challenges.
II. DISCUSSION
1. What is the appropriate cost of capital to be used for the capital budgeting decision?
Explain.
The cost of capital is a financial instrument used by businesses to evaluate various
projects and expenditures, with the goal of lowering costs (O’Connell, 2018). It measures the
opportunity cost of each investment and aid managers in deciding whether a project should be
accepted or not, for the benefit of the business.
In the case of TVA, VP Morgan presumes that the company will be needing to issue debt
with 30 years in maturity. As such, government bonds will be used as a basis considering that
TVA’s current outstanding bond issues have a shorter maturity. Wall Street Journal published
that U.S. government bonds in the year 2042, 30 years after the current year in the case, have
a coupon rate of 3% with a yield to maturity of 2.54%. However, due to the fact that the
current economic and political situation in the U.S. is unstable, VP Morgan concluded that there
would be a premium of 100 basis points (BPS) over the current government bond rates.
According to Fernando (2021), a 100 BPS is equivalent to a 1% change. This premium is then
added to the yield of maturity of 2.54%, resulting in a cost of capital of 3.54%.
Therefore, TVA must use 3.54% as the cost of capital in its capital budgeting decision.
Each potential investment must be assessed using this computed rate to calculate each project’s
net present value. VP Morgan should also take into account that investments must have at least
a 3.54% return or higher to be executed by the company. Using the cost of capital, VP
Morgan’s decision would be able to supply the amount of capital required to expand the firm’s
operations while still maintaining the lowest debt possible to please shareholders.
2. Evaluate the projects (alternatives) using the net present value (NPV) approach. Include any
assumptions and justification in coming up with your evaluation.
Again and again, it is believed that money on hand today is more valuable than the
same amount of money in one’s control tomorrow. It is owing to the fact that inflation eats
away its purchasing power. Due to the ever-changing value of money, as time passes, it is
necessary to convert the investments’ values into today’s dollars to arrive at a proper
comparison. One approach to do such is through the use of net present value.
Net present value (NPV) is said to be the present value of the cash flows at the required
rate of return of a project relative to one’s original investment (Gallo, 2014). Through doing so,
an organization like TVA could use the obtained information to determine if a project is
beneficial.
Although alternative approaches like the payback method and the internal rate of return
(IRR) exists, NPV is frequently the chosen method for most financial analysts due to the
following reasons: [1] NPV makes provision for the time value of money (TVM), and [2] it is
