The project without mitigation should be undertaken

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c. The project without mitigation should be undertaken because NPVwithout mitigation is higher than NPV with mitigation, its NPV is positiveand its IRR is greater than the company’s cost of capital.
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CAPITAL BUDGETING CRITERIA: ETHICAL CONSIDERATIONS An electric utility is consid-ering a new power plant in northern Arizona. Power from the plant would be sold in the Phoenix area, where it is badly needed. Because the firm hasreceived a permit, the plant would be legal; but it would cause some air pollution. The company could spend an additional $40 million at Year 0 to mitigate the environmental problem, but it would not be required to do so. The plant without mitigation would cost $240 million, and the expected cash inflows would be $80 million per year for 5 years. If the firm does invest in mitigation, the annual inflows would be $84 million. Unemployment in the area where the plant would bebuilt is high, and the plant would provide about 350 good jobs. The risk-adjusted WACC is 17%.a. Calculate the NPV and IRR with and without mitigation.b. How should the environmental effects be dealt with when evaluating this project?c. Should this project be undertaken? If so, should the firm do the mitigation?a.Plant without mitigationPV of annual cash flows = 70x (1.175- 1) / (0.17x 1.175) = 70(1.192) / (0.372) = $223.95Less initital investment $210.08NPV = $223.95 - $210.08 = $13.87IRR = 70x PVIFA(r,5)r is the irr 3.0011 = PVIFA(r,5) 19% 20%Interset factors from the factor table 3.0576 and 2.9906IRR = 19+( 3.0576-3.0011 ) / ( 3.0576-2.9906 ) = 19.84%Plant with mitigationPV of annual cash flows = 75.17x (1.175-1) / (0.17x 1.175) = $240.49Less initital investment $250.08NPV = $240.49 - $250.08 = $(9.59)IRR = 250.08 = 15.17x PVIFA(r,5)r is the irr 3.3269 = PVIFA(r,5) 15% 16%
Interset factors from the factor table 3.3522 and 3.2743IRR = 15+(3.3522-3.2269) / (3.3522-3.2743) = 15.32%b/ The environmental effects if not mitigated could result in additional loss of cash flowsand/or fines and penalties due to ill will among customers, community, etc. Therefore,even though the mine is legal without mitigation, the company needs to makesure that they have anticipated all costs in the “no mitigation” analysis from not doing theenvironmental mitigation.c/ Even when mitigation is considered the project has a positive NPV, so it should be undertaken.The question becomes whether you mitigate or don’t mitigate for environmental problems.Under the assumption that all costs have been considered, the

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