In: Finance
An electric utility is considering 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 has received 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 $240.73 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 $84.66 million. Unemployment in the area where the plant would be built is high, and the plant would provide about 350 good jobs. The risk adjusted WACC is 19%. ****please use financial calculator to solve****
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a:
With Mitigation | |
NPV | -21.87 |
IRR | 15.46% |
Without Mitigation | |
NPV | 3.88 |
IRR | 19.72% |
B: option II
The environmental effects are not sunk costs. If mitigation is done the net present value is negative due to which this is not a viable option. However the company needs to ensure that or negative effects of penalties and loss of goodwill have been taken into account during the analysis.
The environmental effects are a certainty and not a possibility. Moreover there are benefits of performing unknown mitigation analysis provided all relevant costs are taken into account. The environmental effects cannot be ignored since noncompliance made result in heavy penalties and costs to the company.
C: Option III
The net present value is positive without a mitigation and negative with mitigation. However it needs to be ensured that all the relevant costs such as penalties in case of non mitigation and loss of goodwill due to ignoring environmental effects have been taken into account.
WORKINGS
Year | Without Mitigation | With Mitigation | |
0 | -240.73 | -280.73 | |
1 | 80 | 84.66 | |
2 | 80 | 84.66 | |
3 | 80 | 84.66 | |
4 | 80 | 84.66 | |
5 | 80 | 84.66 | |
Without Mitigation | With Mitigation | ||
NPV | 3.88 | NPV | -21.87 |
IRR | 19.72% | IRR | 15.46% |
Formulae