Question

CAPITAL BUDGETING CRITERIA: ETHICAL CONSIDERATIONS

A mining company is considering a new project. Because the mine has received a permit, the project would be legal; but it would cause significant harm to a nearby river. The firm could spend an additional $9 million at Year 0 to mitigate the environmental Problem, but it would not be required to do so. Developing the mine (without mitigation) would cost $51 million, and the expected cash inflows would be $17 million per year for 5 years. If the firm does invest in mitigation, the annual inflows would be $18 million. The risk-adjusted WACC is 10%.

Calculate the NPV and IRR with mitigation. Round your answers to two decimal places. Do not round your intermediate calculations. Enter your answer for NPV in millions. For example, an answer of $10,550,000 should be entered as 10.55.
NPV $ __million
IRR ___ %

Calculate the NPV and IRR without mitigation. Round your answers to two decimal places. Do not round your intermediate calculations. Enter your answer for NPV in millions. For example, an answer of $10,550,000 should be entered as 10.55.
NPV $ ___million
IRR ___ %

How should the environmental effects be dealt with when this project is evaluated?

A. The environmental effects if not mitigated would result in additional cash flows. Therefore, since the mine is legal without mitigation, there are no benefits to performing a "no mitigation" analysis.

B. The environmental effects should be treated as a remote possibility and should only be considered at the time in which they actually occur.

C.The environmental effects if not mitigated could result in additional loss of cash flows and/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 make sure that they have anticipated all costs in the "no mitigation" analysis from not doing the environmental mitigation.

D.The environmental effects should be ignored since the mine is legal without mitigation.

E. The environmental effects should be treated as a sunk cost and therefore ignored.

Should this project be undertaken?
-Select-The project should not be undertaken under the "mitigation" assumption.Even when mitigation is considered the project has a positive NPV, so it should be undertaken.Even when mitigation is considered the project has a positive IRR, so it should be undertaken.The project should not be undertaken under the "no mitigation" assumption.The project should be undertaken only under the "no mitigation" assumption.Item 6

If so, should the firm do the mitigation?

A. Under the assumption that all costs have been considered, the company would not mitigate for the environmental impact of the project since its NPV without mitigation is greater than its NPV when mitigation costs are included in the analysis.

B. Under the assumption that all costs have been considered, the company would mitigate for the environmental impact of the project since its IRR with mitigation is greater than its IRR when mitigation costs are not included in the analysis.

C. Under the assumption that all costs have been considered, the company would not mitigate for the environmental impact of the project since its NPV with mitigation is greater than its NPV when mitigation costs are not included in the analysis.

D. Under the assumption that all costs have been considered, the company would not mitigate for the environmental impact of the project since its IRR without mitigation is greater than its IRR when mitigation costs are included in the analysis.

E. Under the assumption that all costs have been considered, the company would mitigate for the environmental impact of the project since its NPV with mitigation is greater than its NPV when mitigation costs are not included in the analysis.

Answer 1

PROJECT WITHOUT MITIGATION:
NPV = 17*(1.10^5-1)/(0.1*1.1^5) -51 =	$       13.44	millions
IRR:
IRR is that discount rate for which the NPV = 0. This means that the PV of the cash inflows, when discounted with the IRR of the project, should be equal to the initial investment. Putting in the form of an equation, we have Initial investment = Annual cash inflow*PVIFA(IRR,n). This means that Initial investment/Annual cash inflow = PVIFA(IRR,n). The value of IRR can be interpolated from the Interest factor tables.
				So
				51/17 = 3 = PVIFA(IRR,5)
				From the annuity interest factor tables, the factor for
				20% is 2.9906 and for 19% it is 3.0576
The value of IRR = 19+(3.0576-3)/(2.0576-2.9906) =	18.94%
PROJECT WITH MITIGATION:
NPV = 18*(1.10^5-1)/(0.1*1.1^5) -60 =	$         8.23	millions
IRR:
60/18 = 3.3333 = PVIFA(IRR,5)
From the annuity interest factor tables, the factor for
16% is 3.3522 and for 15% it is 3.2743
The value of IRR = 15+(3.3522-3.3333)/(3.3522-3.2743) =	15.24%
How should the environmental effects be dealt with when this project is evaluated?
E. The environmental effects should be treated as a sunk cost and therefore ignored.
Should this project be undertaken?
Even when mitigation is considered the project has a positive NPV, so it should be undertaken.
If so, should the firm do the mitigation?
E. Under the assumption that all costs have been considered, the company would mitigate for the environmental impact of the project since its NPV with mitigation is greater than its NPV when mitigation costs are not included in the analysis.
In this case NPV would be = 18*(1.10^5-1)/(0.1*1.1^5) -51 =	$       17.23