Question

After discovering a gold vein in the Colorado Mountains, CTC Mining Corporation must decide to go ahead and develop the deposit. The most cost effective method of mining gold is the sulfuric acid extraction, a process that could result in environmental damage. To begin mining CTC must spend $900,000 for new mining equipment and pay $165,000 for its installation. The mining operation will net the firm an estimated $350,000 per year and the vein is expected to last for five years. CTC’s has no debt, preferred stock of $250,000 with annual dividends of $23,750. And $2.5 million in common stock with a cost of 15%. Assume that the cash flows occur at the end of each year.

a. What is the Cost of Capital that should be used on this project.

b. What is the project’s NPV, PI, IRR, PB, 7 DPB?

c. Assuming environmental impacts are not considered, should the project be undertaken?

d. How should environmental effects be considered when evaluating this or any other project? How might these concepts affect the decision to invest?

Answer 1

1-cost of preferred stock = preferred dividend/value of preferred stock	(23750/250000)	9.50%
WACC	value	weight	component cost	weight*component cost
preferred stock	250000	0.090909091	9.5	0.863636364
common stock	2500000	0.909090909	15	13.63636364
total	2750000	WACC = sum of weigh*component cost		14.5
2-
Year	0	1	2	3	4	5
cash flow	-1065000	350000	350000	350000	350000	350000
present value factor =1/(1+r)^n r =14.5%	1	0.873362445	0.762761961	0.666167652	0.581805809	0.508127344
present value of cash flow = cash flow*present value factor	-1065000	305676.8559	266966.6864	233158.6781	203632.0332	177844.5705
NPV =sum of present value of cash flow	122278.82
PI =1+(NPV/initial investment)	1+(122278.82/1065000)	1.11
IRR = Using IRR function in MS excel	IRR(C4450:H4450)	19.22%
payback period = initial investment/annual cash flow	1065000/350000	3.04
Year	0	1	2	3	4	5
present value of cash flow = cash flow*present value factor	-1065000	305676.8559	266966.6864	233158.6781	203632.0332	177844.5705
cumulative value of present value of cash flow		305676.8559	572643.5423	805802.2203	1009434.254	55565.74645
						amount to be recovered in year 5
discounted payback period =year before final year of recovery+(amount to be recovered in year 5/present value of cash flow in year 5)	4+(55565.74/177844.57)	4.31
3-yes project should be undertaken as NPV is positive, IRR Is greater than required rate of return, PI is more than 1 and payback period is less than the life of the project.
4-Environmental effects can be included in investment decisions by incorporating the monetary value of environment losses and taxes and pentaly levied by government in investment decision. This loss in environment value would be added in the cost of the project. the increase in cost either would increase the amount of initial investment or would reduce the cash flow related with project.