Question

Please answer only with BA2 PLUS Financial calculator

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 $239.99 million, and the expected net cash inflows would be $80 million per year for 5 years. If the firm does invest in mitigation, the annual inflows would be $85.19 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 17%.
a) Calculate the NPV and IRR with and without mitigation.
b) How should the environment effects be dealt with when evaluating this project?
c) Should this project be undertaken? If so, should the firm do the mitigation?

Answer 1

a:

	Without Mitigation
NPV	15.96
IRR	19.9%

	With Mitigation
NPV	-7.44
IRR	15.8%

b: The environmental impact cannot be ignored since that can have additional costs in the form of negative goodwill/fines/penalties/corrective action.

c: Yes, the project can be undertaken without mitigation since NPV is positive. However it should be ensured that all negative costs have been taken into account.

Workings