*** Will you guys please show me how you got your answer mathematically rather t
ID: 2620533 • Letter: #
Question
*** Will you guys please show me how you got your answer mathematically rather than through excel - this will help me better understand how to solve for each. Thank you!
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 $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 $93.81 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%. a. 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 S IRR million 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 $ IRR million b. How should the environmental effects be dealt with when evaluating this project? I. 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. II. The environmental effects should be ignored since the plant is legal without mitigation. III. The environmental effects should be treated as a sunk cost and therefore ignored IV. 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 that analysis. ·The environmental effects should be treated as a remote possibility and should only be considered at the time in which they actually occur. c. Should this project be undertaken? I. Even when no mitigation is considered the project has a negative NPV, so it should not be undertakern II. 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" that might result from undertaking the project without concern for the environmental impacts III. The project should be undertaken only under the "mitigation" assumption IV. The project should be undertaken since the IRR is positive under both the "mitigation" and "no mitigation assumptions. V. The project should be undertaken since the NPV is positive under both the "mitigation" and "no mitigation assumptions.Explanation / Answer
a. Formula for Net Present Value (NPV) calculation
Net present value (NPV) of Project = Sum of [cash flows/ (1+wacc) ^t] - initial cash outflow
Where, (Mitigation)
Initial Outflow of Cash for project = - ($269.63 + $40) = -$309.63 million
Annual cash inflow = $93.81 million per year
Weightage average cost of capital WACC=15%
And time period t = 1, 2, 3, 4 and 5
Therefore,
NPV = $93.81/ (1+15%) ^1 +$93.81/ (1+15%) ^2 + $93.81/ (1+15%) ^3 + $93.81/ (1+15%) ^4 + $93.81/ (1+15%) ^5 - $309.63
= $81.57 + $70.93 + $61.68 + $53.64 + $46.64- $309.63
= $4.84 million
Therefore NPV is $4.84
Now we can use following formula to calculate internal rate of return (IRR) where Internal Rate of Return (IRR) is the discount rate at which the Net Present Value (NPV) of a project is zero.
Sum of [cash flows/ (1+IRR) ^t] - initial cash outflow = 0
$93.81/ (1+IRR) ^1 + $93.81/ (1+IRR) ^2 + $93.81/ (1+IRR) ^3 + $93.81/ (1+IRR) ^4 + $93.81/ (1+IRR) ^5 - $309.63 = 0
By trial and error method, we get
The internal rate of return (IRR) = 15.66%
No mitigation:
Initial Outflow of Cash for project = -$269.63 million
Annual cash inflow = $90 million per year
Weightage average cost of capital WACC=15%
And time period t = 1, 2, 3, 4 and 5
Therefore,
NPV = $90/ (1+15%) ^1 +$90/ (1+15%) ^2 + $90/ (1+15%) ^3 + $90/ (1+15%) ^4 + $90/ (1+15%) ^5 - $269.63
= $78.26 + $68.05 + $59.18 + $51.46 + $44.75 - $269.63
= $32.06 million
Therefore NPV is $32.06
Now we can use following formula to calculate internal rate of return (IRR) where Internal Rate of Return (IRR) is the discount rate at which the Net Present Value (NPV) of a project is zero.
Sum of [cash flows/ (1+IRR) ^t] - initial cash outflow = 0
$90/ (1+IRR) ^1 +$90/ (1+IRR) ^2 + $90/ (1+IRR) ^3 + $90/ (1+IRR) ^4 + $90/ (1+IRR) ^5 - $269.63 = 0
By trial and error method, we get
The internal rate of return (IRR) = 19.92%
b. Even when mitigation is considered the project has a positive NPV and IRR is more than required rate of return of 15% therefore it should be undertaken. Whether company should mitigate or don’t mitigate for environmental problems; all costs should be considered, if the company would not mitigate for the environmental impact of the project since its NPV is $32.06 million and if mitigates NPV is $4.84 million. The factor that this project will provide good employment opportunity in the area should also be considered.
Therefore none of the options seems correct.
c. The project should be undertaken since the NPV is positive under both “mitigation” and “no mitigation assumptions”
Therefore correct answer is option V.
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