Case 4-27.

Sharpton fabricators corporation manufactures a variety of parts for the automative industry. th company uses a jo order costing system with a plantwide predetermined overhead rate based on direct hours. On December 10, 2015, the company's controller made a preliminary estimates of the predetermined overhead rate for 2016. The new rate was based on the estimated total manufacturing overhead cost of $2,475,000 and the estimated 52,000 total direct labor - hours for 2016. Pretermined overhead rate = $2,475,000/ $2,000 hours = $47.60 per direct labor hour. The new predetermined overhead rate was communicated to top managers in a meeting on December 11. The rate did not cause any comment because it was within a few pennies of the overhead rate that had been used during 2015. One of the subject discussed at the meeting was a proposal by the manager to purchase an automated milling machine built by central robotics the president of sharpton fabricators, kevin reynolds, agreed to meet with the regional sales representative from central robotics to discuss proposal. one of the following meeting, Mr raynolds met with jay warner central robotics sales represntatives. the following took place

Reynolds: Larry winter, our production manager asked me to meet with you because he is interested in installing an automated milling machine, frankly, I am skeptical, you going to have to show me this isnt just another expenisve toy for larry's people to play with.

Warner: That should not be difficult Mr Reynolds. The automated mailiing machine has three major advantage. First, it is much faster than the manual method you are using.It can produce as fast as twice as many parts as per hour as your present milling machine. Second, it is much more flexible. there are some up front programming cost but once those have been incurred, almost no setup on the machine for standard operation. You just punch the code of the standard operation, load the machines hopper with raw material and the machine does the rest.

Reynolds : Yeah, but what about cost? having twice the capacity in the mailing machine area wont do us much good. That center is idle much of the time anyway.

Warner: I was getting there, the third advantage of the autoimated milling machine is lower cost. larry winters and i look over your present operations and we estimated that the automated equipment will eliminate the need for about 6,000 direct labor hours a year. What is your direct labor cost per hour.

Reynolds : The wage rate in the milling area avarage about $21 per hour. Fringe benefits raise that figure to about $30 per hour.

Warner : Dont forget the overhead

Reynolds : next year the overhead rate will be about $48 per hour

Warner : so including fringe benefit and overhead, the cost per direct labor hour is about $78

Reynolds: thats righ.

warner : Since you save 6,000 direct labor hours per year, the cost savings would amount to about $468,000 a year.

Reynlds: that's pretty impressive, but you arent giving away the equipment are you?

Warner : Several options are available, including leasing and outright purchase just for comprison purposes, our 60 - month lease plan would requoire payment of only $30,000 per year

Reynolds: sold! When can install the equipment?

Shortly after this meeting, Mr Raynolds informed the comapny controller of the decision to lease the new equipment, which would be installed over the christmas vacation period.The conroller realise that this decision would require a recomputation of the predetermined overhead rate for the year 2016 since the decision would affect both the manufacturing overhead and the direct labor hours for the year. after taking with both the production manager and the sales represntative from the centra robotic, .the controller discovered that in addition to the annual lease cost of $300,000, the new machine would also require a skilled technician/ programmer who would have to be hired at a cost of $45,000 per year to maintain and program the equipment. Both of these costs would be included in factory overhead. There would be no other changes in total manufacturing overhead cost, which is almost entirely fixed. The controller assumed that the new machine would result in a reduction of 6,000 direct labor-hours for the year from the levels that had initially been planned. When the revised predetermined overhead rate for the year 2016 was circulated among the company's top managers, there was considerable dismay.

Required:

1. Recompute the predetermined overhead rate assuming that the new machine will be installed. Explain why the new predetermined overhead rate is higher or lower than the rate that was originally estimated for the year 2016.

2. What effect (if any) would this new rate have on the cost of jobs that do not use the new automated milling machine

3 Why would managers be concerned about the new overhead rate?

4 After seeing the new predertermined overhead rate, the production manager admitted that he probably wouldn't be able to eliminate all of the 6,000 direct labor hours. He had been hoping to accomplish the reduction by not replacing workers who retire or quit, but that would not be possible. As a result, the real labor savings would be only about 2,000 hours - one worker. Given this additional information, evaluate the original decision to acquire the automated milling machine from central robotics.

Case 4-27.

Sharpton Fabricators Corporation manufactures a variety of parts for the automotive industry. th company uses a job order costing system with a plant wide predetermined overhead rate based on direct hours. On December 10, 2015, the company's controller made preliminary estimates of the predetermined overhead rate for 2016. The new rate was based on the estimated total manufacturing overhead cost of $2,475,000 and the estimated 52,000 total direct labor - hours for 2016. Predetermined overhead rate = $2,475,000/ $2,000 hours = $47.60 per direct labor hour. The new predetermined overhead rate was communicated to top managers in a meeting on December 11. The rate did not cause any comment because it was within a few pennies of the overhead rate that had been used during 2015. One of the subjects discussed at the meeting was a proposal by the manager to purchase an automated milling machine built by central robotics the president of Sharpton fabricators, Kevin Reynolds, agreed to meet with the regional sales representative from central robotics to discuss proposal. One of the following meetings, Mr. Reynolds met with jay Warner central robotics sales representatives. The following took place

Reynolds: Larry winter, our production manager asked me to meet with you because he is interested in installing an automated milling machine, frankly, I am skeptical, you going to have to show me this isn’t just another expensive toy for Larry’s people to play with.

Warner: That should not be difficult Mr. Reynolds. The automated mailing machine has three major advantages. First, it is much faster than the manual method you are using. It can produce as fast as twice as many parts as per hour as your present milling machine. Second, it is much more flexible. There are some up front programming cost but once those have been incurred, almost no setup on the machine for standard operation. You just punch the code of the standard operation; load the machines hopper with raw material and the machine does the rest.

Reynolds: Yeah, but what about cost? Having twice the capacity in the mailing machine area won’t do us much good. That center is idle much of the time anyway.

Warner: I was getting there; the third advantage of the automated milling machine is lower cost. Larry winters and i look over your present operations and we estimated that the automated equipment will eliminate the need for about 6,000 direct labor hours a year. What is your direct labor cost per hour?

Reynolds: The wage rate in the milling area average about $21 per hour. Fringe benefits raise that figure to about $30 per hour.

Warner: Don’t forget the overhead

Reynolds: next year the overhead rate will be about $48 per hour

Warner: so including fringe benefit and overhead, the cost per direct labor hour is about $78

Reynolds: that’s right.

Warner: Since you save 6,000 direct labor hours per year, the cost savings would amount to about $468,000 a year.

Reynolds: that's pretty impressive, but you aren’t giving away the equipment are you?

Warner: Several options are available, including leasing and outright purchase just for comparison purposes, our 60 - month lease plan would require payment of only $30,000 per year

Reynolds: sold! When can install the equipment?

Shortly after this meeting, Mr. Reynolds informed the company controller of the decision to lease the new equipment, which would be installed over the Christmas vacation period. The controller realizes that this decision would require a recomputation of the predetermined overhead rate for the year 2016 since the decision would affect both the manufacturing overhead and the direct labor hours for the year. After taking with both the production manager and the sales representative from the central robotic, .the controller discovered that in addition to the annual lease cost of $300,000, the new machine would also require a skilled technician/ programmer who would have to be hired at a cost of $45,000 per year to maintain and program the equipment. Both of these costs would be included in factory overhead. There would be no other changes in total manufacturing overhead cost, which is almost entirely fixed. The controller assumed that the new machine would result in a reduction of 6,000 direct labor-hours for the year from the levels that had initially been planned. When the revised predetermined overhead rate for the year 2016 was circulated among the company's top managers, there was considerable dismay.

Required:

(1) Recompute the predetermined overhead rate assuming that the new machine will be installed. Explain why the new predetermined overhead rate is higher or lower than the rate that was originally estimated for the year 2016.

(2) What effect (if any) would this new rate have on the cost of jobs that do not use the new automated milling machine?

(3) Why would managers be concerned about the new overhead rate?

(4) After seeing the new predetermined overhead rate, the production manager admitted that he probably wouldn't be able to eliminate all of the 6,000 direct labor hours. He had been hoping to accomplish the reduction by not replacing workers who retire or quit, but that would not be possible. As a result, the real labor savings would be only about 2,000 hours - one worker. Given this additional information, evaluate the original decision to acquire the automated milling machine from central robotics.

Leisure Manufacturing, Inc. is a producer of grills. Its current line of grills are selling excellently. However, in order to cope with the foreseeable competition from other similar products, LM spent $6,200,000 to develop a new line of expert grills (new model development cost). The grill measurses 55"W x 25"D x 48"H and weighs 60 pounds on two wheels and two stable legs. It has 4 stainless steel tube burners providing a total of 48,000 BTU on a push and turn integrated ignition system using liquid propane gas. It is versifuel compatible. That means it can be converted to use nautral gas with the implementation of the optional versifuel kit. The primary cooking area is 480 sq. inches enabling a cooking capacity of 28 burgers at the same time whereas the warming rack area is 180 sq. inches. In addition to the black stainless steel control panel and two black powder-coated side shelves on the left, the grill has a black stainless steel 12,000-BTU side burner for the preparation of sauces and side dishes on the right.  The grill includes a porcelain-coated cast iron cooking grid panel and a black porcelain-coated flame tamer for each individual burner. The warming rack is built with porcelain-coated steel. The lid is made of stainless steel with aluminized steel liner and black steel endcaps. The oval temperature gauge is located in the center of the lid. The same porcelain-coated steel is used to build the bottom bowl. Its porcelain heat plates are designed to reduce flare ups. The company had also spent a further $1,000,000 to study the marketability of this new line of expert grill model (marketability studying cost).

LM is able to produce the expert grills at a variable cost of $60 each. The total fixed costs for the operation are expected to be $10,000,000 per year. LM expects to sell 3,500,000 units, 4,300,000 units, 3,200,000 units, 1,800,000 units and 1,200,000 units of the new grill model per year over the next five years respectively. The new expert grills will be selling at a price of $150 each. To launch this new line of production, LM needs to invest $35,000,000 in equipment which will be depreciated on a seven-year MACRS schedule. The value of the used equipment is expected to be worth $3,800,000 as at the end of the 5 year project life.

LM is planning to stop producing the existing grill model entirely in two years. Should LM not introduce the expert grill, sales per year of the existing grill model will be 1,800,000 units and 1,400,000 units for the next two years respectively. The existing model can be produced at variable costs of $50 each and total fixed costs of $7,500,000 per year. The existing grill model are selling for $115 each. If LM produces the expert grill model, sales of existing model will be eroded by 1,080,000 units for next year and 1,190,000 units for the year after next. In addition, to promote sales of the existing model alongside with the expert grill model, LM has to reduce the price of the existing model to $85 each. Net working capital for the expert grill project will be 20 percent of sales and will vary with the occurrence of the cash flows. As such, there will be no initial NWC required. The first change in NWC is expected to occur in year 1 according to the sales of the year. LM is currently in the tax bracket of 35 percent and it requires a 20 percent returns on all of its projects. The firm also requires a payback of 3 years for all projects.

You have just been hired by LM as a financial consultant to advise them on this expert grill project. You are expected to provide answers to the following questions to their management by their next meeting which is scheduled sometime next month.   

What is/are the sunk cost(s) for this expert grill project? Briefly explain. You have to tell what sunk cost is and the amount of the total sunk cost(s). In addition, you have to advise LM on how to handle such cost(s).

What are the cash flows of the project for each year?

What is the payback period of the project?

What is the PI (profitability index) of the project?  

What is the IRR (internal rate of return) of the project?

What is the NPV (net present value) of the project?

Should the project be accepted based on Payback, PI, IRR and NPV? Briefly explain.

Estimation of sunk costs

Provide below the amounts of the sunk costs you identified from the case description above.

1st sunk cost: $     being        cost  (Use exactly the same wording as in the case background information.)

2nd sunk cost: $     being     cost  (Use exactly the same wording as in the case background information.)

Total sunk costs = $  

Net Sales Estimation: Use the formula stated below to calculate the net sales.

Year t Net Sales

=Unit sales of new model for Year t × Price of new model

– Reduction in unit sales of existing model for Year t × Current price of existing model

– [(Unit sales of existing model for Year t if new model project is not launched – Reduction in unit sales of existing model if new model project is launched) × (Current price of existing model – Reduced price of existing model)]

Year 1 Net Sales

=  × $   –  × $  

     – (   –  ) × ($   – $   )

= $           

Year 2 Net Sales

=  × $   –  × $  

     – (   –  ) × ($   – $   )

= $  

Year 3 Net Sales = $  

Year 4 Net Sales = $  

Year 5 Net Sales = $  

Variable Cost Estimation: Use the formula stated below to calculate the variable costs.

Year t Variable costs

=   Unit sales of new model for Year t × Variable cost per unit of new model

   – Reduction in unit sales of existing model for Year t × Variable cost per unit of existing model

Year 1 Variable costs

=   × $   –  × $  

=$  

Year 2 Variable costs

=   × $   –  × $  

=$     

Year 3 Variable costs =$     

Year 4 Variable costs =$     

Year 5 Variable costs =$     

Love it or hate it, IKEA is the most successful furniture retailer ever. With 276 stores in 36 countries, they have managed to develop their own special way of selling furniture. Their stores’ layout means customers often spend two hours in a store – far longer than in rival furniture retailers. IKEA’s philosophy goes back to the original business, started in the 1950s in Sweden by Ingwar Kamprad. He built a showroom on the outskirts of Stockholm where land was cheap and simply displayed suppliers’ furniture as it would be in a domestic setting. Increasing sales soon allowed IKEA to start ordering its own self-designed products from local manufacturers. But it was innovation in its operations that dramatically reduced its selling costs. These included the idea of selling furniture as self-assembly flat packs, which reduced production and transport costs, and its ‘showroom-warehouse’ concept, which required customers to pick the furniture up themselves from the warehouse (which reduced retailing costs). Both of these operating principles are still the basis of IKEA’s retail operations process today. Stores are designed to facilitate the smooth flow of customers, from parking, moving through the store itself, to ordering and picking up goods. At the entrance to each store large notice boards provide advice to shoppers. For young children , there is a supervised play area for a time. Parents are recalled via the loudspeaker system if the child has any problems. IKEA ‘allow customers to make up their minds in their own time’ but ‘information point’ have staff who can help. All furniture carries a ticket with code number which indicates its location in the warehouse. (For larger items customers go to the information desks for assistance.) There is also an area where smaller items are displayed, and can be picked directly. Customers then pay at the checkouts, where a ramped conveyor belt moves purchases to the checkout staff. The exit area has service points, and a loading area that allows customers to bring their cars from the car park and load their purchases. Behind the public face of IKEA’s huge stores is a complex worldwide network of suppliers. 1 300 direct suppliers, about 10 000 sub-suppliers, and wholesale and transport operations, including 26 distribution centres. This supply network is vitally important to IKEA. From purchasing raw materials, right through to finished products arriving in its customers’ homes, IKEA relies on close partnership with its suppliers to achieve both ongoing supply efficiency and new product development . However, IKEA closely controls all supply and development activities from IKEA’s hometown of Älmhult in Sweden. But success brings its own problems and some customers became increasingly frustrated with overcrowding and long waiting times. In response IKEA launched a programme ‘designing out’ the bottlenecks. The changes included:

 clearly marked in-store short cuts allowing those customers who just want to visit one area to avoid having to go through all the preceding areas;

 express checkout tills for customers with a bag only rather than a trolley;

 extra ‘help staff’ at key points to help customers;

 redesign of the car parks, making it easier to navigate;

 dropping the ban on taking trolleys out to the car parks for laoding (originallly implemented to stop vehicles being damaged);

 a new warehouse system to stop popular product lines running out during the day;

 more children’s play area.

IKEA spokewoman Nicki Craddock said: ‘We know people love our products but hate our shopping experience. We are being told that by customers every day, so we can’t afford not to make changes. We realised a lot of people taook offence at being herded like sheep on a long route around stores. Now if you know what you are looking for and just want to get in, grab it and get out, you can.’

REQUIRED: Using appropriate academic sources and supporting evidence from the case study above:

1.1 Identify and define any FOUR (4) strategic operations management decision areas that IKEA has relied on to innovate its operations. State the objective of each of the four decision areas identified, and for each decision area identified providetwo examples of activities used by IKEA to achieve the objective. (20)

Love it or hate it, IKEA is the most successful furniture retailer ever. With 276 stores in 36 countries, they have managed to develop their own special way of selling furniture. Their stores’ layout means customers often spend two hours in a store – far longer than in rival furniture retailers. IKEA’s philosophy goes back to the original business, started in the 1950s in Sweden by Ingwar Kamprad. He built a showroom on the outskirts of Stockholm where land was cheap and simply displayed suppliers’ furniture as it would be in a domestic setting. Increasing sales soon allowed IKEA to start ordering its own self-designed products from local manufacturers. But it was innovation in its operations that dramatically reduced its selling costs. These included the idea of selling furniture as self-assembly flat packs, which reduced production and transport costs, and its ‘showroom-warehouse’ concept, which required customers to pick the furniture up themselves from the warehouse (which reduced retailing costs). Both of these operating principles are still the basis of IKEA’s retail operations process today.

Stores are designed to facilitate the smooth flow of customers, from parking, moving through the store itself, to ordering and picking up goods. At the entrance to each store large notice boards provide advice to shoppers. For young children , there is a supervised play area for a time. Parents are recalled via the loudspeaker system if the child has any problems. IKEA ‘allow customers to make up their minds in their own time’ but ‘information point’ have staff who can help. All furniture carries a ticket with code number which indicates its location in the warehouse. (For larger items customers go to the information desks for assistance.) There is also an area where smaller items are displayed, and can be picked directly. Customers then pay at the checkouts, where a ramped conveyor belt moves purchases to the checkout staff. The exit area has service points, and a loading area that allows customers to bring their cars from the car park and load their purchases.

Behind the public face of IKEA’s huge stores is a complex worldwide network of suppliers. 1 300 direct suppliers, about 10 000 sub-suppliers, and wholesale and transport operations, including 26 distribution centres. This supply network is vitally important to IKEA. From purchasing raw materials, right through to finished products arriving in its customers’ homes, IKEA relies on close partnership with its suppliers to achieve both ongoing supply efficiency and new product development . However, IKEA closely controls all supply and development activities from IKEA’s hometown of Älmhult in Sweden.

But success brings its own problems and some customers became increasingly frustrated with overcrowding and long waiting times. In response IKEA launched a programme ‘designing out’ the bottlenecks. The changes included:

clearly-marked in-store short cuts allowing those customers who just want to visit one area to avoid having to go through all the preceding areas;

• express checkout tills for customers with a bag only rather than a trolley;

• extra ‘help staff’ at key points to help customers;

• redesign of the car parks, making it easier to navigate;

• dropping the ban on taking trolleys out to the car parks for laoding (originallly implemented to stop vehicles being

  damaged);

• a new warehouse system to stop popular product lines running out during the day;

• more children’s play area.   

IKEA spokeswoman Nicki Craddock said: ‘We know people love our products but hate our shopping experience. We are being told that by customers every day, so we can’t afford not to make changes. We realised a lot of people taook offence at being herded like sheep on a long route around stores. Now if you know what you are looking for and just want to get in, grab it and get out, you can.’

REQUIRED:

Using appropriate academic sources and supporting evidence from the case study above:

1. Identify and define any FOUR (4) strategic operations management decision areas that IKEA has relied on to innovate its operations. State the objective of each of the four decision areas identified, and for each decision area identified provide two examples of activities used by IKEA to achieve the objective.

1. Assume Joker Company uses a periodic inventory system. Calculate cost of goods sold and ending inventory using (1) FIFO, (2) LIFO and (3) average cost. Round per unit cost to two decimal places.

2. Assume Joker Company uses a perpetual inventory system. Calculate cost of goods sold and ending inventory using (1) FIFO, (2) LIFO and (3) average cost. Round per unit cost to two decimal places.

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 $269.63 million, and the expected cash inflows would be $90 million per year for 5 years. If the firm does invest in mitigation, the annual inflows would be $92.94 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 16%.

1. Calculate the NPV and IRR with mitigation. Round your answers to two decimal places. Enter your answer for NPV in millions. Do not round your intermediate calculations. For example, an answer of $10,550,000 should be entered as 10.55. Negative value should be indicated by a minus sign.
   NPV $   million
   IRR  %

   Calculate the NPV and IRR without mitigation. Round your answers to two decimal places. Enter your answer for NPV in millions. Do not round your intermediate calculations. 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 evaluating this project?
   1. If the utility mitigates for the environmental effects, the project is not acceptable. However, before the company chooses to do the project without mitigation, it needs to make sure that any costs of "ill will" for not mitigating for the environmental effects have been considered in the original analysis.
   2. The environmental effects should be treated as a remote possibility and should only be considered at the time in which they actually occur.
   3. The environmental effects if not mitigated would result in additional cash flows. Therefore, since the plant is legal without mitigation, there are no benefits to performing a "no mitigation" analysis.
   4. The environmental effects should be ignored since the plant is legal without mitigation.
   5. The environmental effects should be treated as a sunk cost and therefore ignored.
3. Should this project be undertaken?
   1. The project should be undertaken since the IRR is positive under both the "mitigation" and "no mitigation" assumptions.
   2. The project should be undertaken since the NPV is positive under both the "mitigation" and "no mitigation" assumptions.
   3. Even when no mitigation is considered the project has a negative NPV, so it should not be undertaken.
   4. The project should be undertaken only if they do not mitigate for the environmental effects. However, they want to make sure that they've done the analysis properly due to any "ill will" and additional "costs" that might result from undertaking the project without concern for the environmental impacts.
   5. The project should be undertaken only under the "mitigation" assumption.

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 $270.34 million, and the expected cash inflows would be $90 million per year for 5 years. If the firm does invest in mitigation, the annual inflows would be $93.63 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 19%.

A. Calculate the NPV and IRR with mitigation. Round your answers to two decimal places. Enter your answer for NPV in millions. Do not round your intermediate calculations. For example, an answer of $10,550,000 should be entered as 10.55. Negative value should be indicated by a minus sign.
NPV $   million
IRR  %

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

B. How should the environmental effects be dealt with when evaluating this project?

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

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

III. The environmental effects should be ignored since the plant is legal without mitigation.

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

V. If the utility mitigates for the environmental effects, the project is not acceptable. However, before the company chooses to do the project without mitigation, it needs to make sure that any costs of "ill will" for not mitigating for the environmental effects have been considered in the original analysis.

Should this project be undertaken?

I. The project should be undertaken only if they do not mitigate for the environmental effects. However, they want to make sure that they've done the analysis properly due to any "ill will" and additional "costs" that might result from undertaking the project without concern for the environmental impacts.

II. The project should be undertaken only under the "mitigation" assumption.

III. The project should be undertaken since the IRR is positive under both the "mitigation" and "no mitigation" assumptions.

IV. The project should be undertaken since the NPV is positive under both the "mitigation" and "no mitigation" assumptions.

V. Even when no mitigation is considered the project has a negative NPV, so it should not be undertaken.

(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 $209.90 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 $76.14 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 16%.

1. Calculate the NPV and IRR with mitigation. Enter your answer for NPV in millions. For example, an answer of $10,550,000 should be entered as 10.55. Negative values, if any, should be indicated by a minus sign. Do not round intermediate calculations. Round your answers to two decimal places.
   NPV: $ _________million
   IRR: _____________ %

   Calculate the NPV and IRR without mitigation. Enter your answer for NPV in millions. For example, an answer of $10,550,000 should be entered as 10.55. Negative values, if any, should be indicated by a minus sign. Do not round intermediate calculations. Round your answers to two decimal places.
   NPV: $ ________million
   IRR: __________%

2. How should the environmental effects be dealt with when evaluating this project?
   1. The environmental effects should be treated as a sunk cost and therefore ignored.
   2. If the utility mitigates for the environmental effects, the project is not acceptable. However, before the company chooses to do the project without mitigation, it needs to make sure that any costs of "ill will" for not mitigating for the environmental effects have been considered in the original analysis.
   3. The environmental effects should be treated as a remote possibility and should only be considered at the time in which they actually occur.
   4. The environmental effects if not mitigated would result in additional cash flows. Therefore, since the plant is legal without mitigation, there are no benefits to performing a "no mitigation" analysis.
   5. The environmental effects should be ignored since the plant is legal without mitigation.
   
   _______________

1. Should this project be undertaken?
   1. The project should be undertaken since the NPV is positive under both the "mitigation" and "no mitigation" assumptions.
   2. Even when no mitigation is considered the project has a negative NPV, so it should not be undertaken.
   3. The project should be undertaken only if they do not mitigate for the environmental effects. However, they want to make sure that they've done the analysis properly due to any "ill will" and additional "costs" that might result from undertaking the project without concern for the environmental impacts.
   4. The project should be undertaken only under the "mitigation" assumption.
   5. The project should be undertaken since the IRR is positive under both the "mitigation" and "no mitigation" assumptions.

______________

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 $239.88 million, and the expected cash inflows would be $80 million per year for 5 years. If the firm does invest in mitigation, the annual inflows would be $85.32 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 16%. Calculate the NPV and IRR with mitigation. Round your answers to two decimal places. Enter your answer for NPV in millions. Do not round your intermediate calculations. For example, an answer of $10,550,000 should be entered as 10.55. Negative value should be indicated by a minus sign. NPV $ million IRR % Calculate the NPV and IRR without mitigation. Round your answers to two decimal places. Enter your answer for NPV in millions. Do not round your intermediate calculations. 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 evaluating this project? The environmental effects should be treated as a sunk cost and therefore ignored. If the utility mitigates for the environmental effects, the project is not acceptable. However, before the company chooses to do the project without mitigation, it needs to make sure that any costs of "ill will" for not mitigating for the environmental effects have been considered in the original analysis. The environmental effects should be treated as a remote possibility and should only be considered at the time in which they actually occur. The environmental effects if not mitigated would result in additional cash flows. Therefore, since the plant is legal without mitigation, there are no benefits to performing a "no mitigation" analysis. The environmental effects should be ignored since the plant is legal without mitigation. Should this project be undertaken? The project should be undertaken since the NPV is positive under both the "mitigation" and "no mitigation" assumptions. Even when no mitigation is considered the project has a negative NPV, so it should not be undertaken. The project should be undertaken only if they do not mitigate for the environmental effects. However, they want to make sure that they've done the analysis properly due to any "ill will" and additional "costs" that might result from undertaking the project without concern for the environmental impacts. The project should be undertaken only under the "mitigation" assumption. The project should be undertaken since the IRR is positive under both the "mitigation" and "no mitigation" assumptions.