Question

Complete this problem and respond to the following questions:

Here it is:

Capital budgeting criteria: ethical considerations

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 $209.71 million, and the expected cash inflows would be $70 million per year for 5 years. If the firm does invest in mitigation, the annual inflows would be $75.84 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%.

1. Calculate the NPV and IRR with mitigation. Round your answers to two decimal places. Enter your answer for NPV in millions. For example, an answer of $10,550,000 should be entered as 10.55.
   NPV $ (43.77)? million
   IRR  %

   Calculate the NPV and IRR without mitigation. Round your answers to two decimal places. Enter your answer for NPV in millions. For example, an answer of $10,550,000 should be entered as 10.55.
   NPV $    million
   IRR  %

a.       Should this project be undertaken? Why or why not?

b.        If so, should the firm do the mitigation? Why or why not?

Answer 1

Let's calculate the NPV & IRR for the new power plant with & without mitigation.

New Power Plant NPV & IRR - Without Mitigation
Particulars	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Total
Initial Investment	-209.71	70	70	70	70	70
WACC	17%	17%	17%	17%	17%	17%
DCF	1	$0.855	$0.731	$0.624	$0.534	$0.456
NPV @ 17%	(209.71)	59.83	51.14	43.71	37.36	31.93	14.24
IRR							20%

New Power Plant NPV & IRR - With Mitigation
Particulars	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Total
Initial Investment	-249.71	70	70	70	70	70
WACC	17%	17%	17%	17%	17%	17%
DCF	1	$0.855	$0.731	$0.624	$0.534	$0.456
NPV @ 17%	(250)	60	51	44	37	32	(26)
IRR							12%

a. Based on the above table, we can conclude that the project should be undertaken since it results in a positive NPV. Also it generates employment in the area of the plant by providing 350 jobs.

b. The firm should not go for mitigation since it results in negative NPV over the period.