Question: Pollution Buster, Inc., in considering a purchase…
Pollution Buster, Inc., in considering a purchase of 10 additional carbon sequesters for $100,000 piece. The sequesters lasts for only one year until saturated with carbon. Then the carbon is removed and sold.
a) Suppose the government guarantees the price of carbon. At this price, the payoff after 1 year is guaranteed to be $115,000. How would you determine the opportunity cost of capital for this investment?
b) Suppose instead that sequesters carbon has to sell on the London Carbon Exchange. Carbon prices have been extremely volatile, but Pollution Busters’ CFO learns that average rates of return from investment on that exchange have been about 20%. She thinks that is reasonable forecast for the future. What is the opportunity cost of capital in this case? Is the purchase of an additional sequester a worthwhile capital investment if she expects that the price of extracted carbon will be $115,000?
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