An electric utility is considering a new power plant in northern Arizona. Power

Question

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 $239.67 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 $85.21 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%.

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.

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.

Explanation / Answer

(1) Computation of NPV and IRR of the project with mitigation.We have,

   Annual Cash flow = $ 84.95 million

    Number of years = 5

   Initital investment = 240.52 + 40.00 = 280.52 Million

   Cost of Capital    = 16%

(a) Computation of Net Present Value(NPV) of the project.We have,

Step1: Computation of present value of cash inflow. We have

    Present value of Future Cash inflow = Cash Inflow x PVIFA( 16% , 5 Years)

Present value of Future Cash inflow = 84.95 x 3.274 = $ 278.13 million

Step2: Computation of Net Present Value.We have,

NPV = Present Value of Cash Inflow - Cash Outflow

NPV = 278.13 - 280.52 = - $ 2.39 Million

Hence, NPV of project with mitigation is - $ 2.39 million.

(b) Computation of IRR of project.We have,

Step1: Computation of NPV at cost of capital 15%.we have,

    NPV = ( 84.95 X 3.352) - 280.52 = 284.77 - 280.52 = $ 4.46 Million

Step2: Computation of IRR project.We have,

   IRR = 15 +[ 4.46/(4.46 + 2.39) x (16 - 15 ) ] = 15.65 %

Hence, IRR of project with mitigation cost is 15.65%.

(2) Computation of NPV and IRR of project without mitigation Cost.We have,

(a) Computation of NPV of project without mitigation Cost.We have,

NPV of project = ( 80 x 3.274) - 240.52 = $ 21.40 Million

Hence, NPV of the project without mitigation cost = $ 21.40 Million.

(b) Computation of IRR of project without mitigation Cost.We have,

Step1: Computation of NPV of project at cost of capital 20%.We have,

   NPV of project = ( 80 x 2.990) - 240.52 = 239.25 - 240.52 = - $ 1.27 million

Step2: Computation of IRR of project without mitigation Cost.We have,

IRR = 16 + [ 21.40/(21.40 + 1.27) x (20-16)] = 19.78 %

Hence, IRR of project without mitigation Cost is 19.78 %.

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