Question

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 $9.66 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 $57 million, and the expected cash inflows would be $19 million per year for 5 years. If the firm does invest in mitigation, the annual inflows would be $20 million. The risk-adjusted WACC is 10%.

1. 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  %

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

   1. 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.
   2. The environmental effects should be ignored since the mine is legal without mitigation.
   3. The environmental effects should be treated as a sunk cost and therefore ignored.
   4. 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.
   5. The environmental effects should be treated as a remote possibility and should only be considered at the time in which they actually occur.
   
   -Select-IIIIIIIVVItem 5

3. Should this project be undertaken?
   -Select-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.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.Item 6

   If so, should the firm do the mitigation?

   1. 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.
   2. 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.
   3. 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.
   4. 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.
   5. 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.

Answer 1

A:

	Without Mitigation
NPV	15.02
IRR	19.9%

	With Mitigation
NPV	9.16
IRR	15.2%

B: Option I

If the mitigation is carried out, there is negative NPV. This renders the project unviable. However the company needs to consider the negative impacts of not undertaking mitigation. This may be in the form of loss of goodwill of the business and reputation of the company which will in turn impact the future growth prospects and share value.

The environmental effects cannot be ignored and hence option II is incorrect. This is not sunk cost but incremental cash outflow and hence option III is incorrect. The cost of mitigation is a certainty and not a remote possibility and hence option V is incorrect. They are various benefits to undertaking the cost in the form of additional goodwill and fulfilment of social responsibility and hence option IV is incorrect.

C: Option II

The project should be undertaken only if there is no mitigation. However the cost of negative goodwill and penalties should be taken into account.

If mitigation is undertaken there is negative NPV and so this option is unviable. The internal rate of return is lesser than the cost of capital and hence this option is unviable. However if mitigation is not undertaken the project is beneficial and hence needs to be considered.

WORKINGS