NPV and IRR Analysis After discovering a new gold vein in the Colorado mountains
ID: 2647586 • Letter: N
Question
NPV and IRR Analysis
After discovering a new gold vein in the Colorado mountains, CTC Mining Corporation must decide whether to go ahead and develop the deposit. The most cost-effective method of mining gold is sulfuric acid extraction, a process that results in environmental damage. Before proceeding with the extraction, CTC must spend $900,000 for new mining equipment and pay $165,000 for its installation. The gold mined will net the firm an estimated $350,000 each year over the 5-year life of the vein. CTC's cost of capital is 20%. For the purposes of this problem, assume that the cash inflows occur at the end of the year.
What is the project's NPV? Round your answer to the nearest dollar.
$
What is the project's IRR? Round your answer to two decimal places.
%
Should this project be undertaken if environmental impacts were not a consideration?
-Select- Yes or No
How should environmental effects be considered when evaluating this, or any other, project?
-Select-
I. Environmental effects should be treated as sunk costs.
II. Environmental effects could be added by estimating penalties or any other cash outflows that might be imposed on the firm to help return the land to its previous state (if possible).
III. Environmental effects should be ignored since they would have no effect on the project's profitability.
Explanation / Answer
Net Present value can be calculated by finding the multiplying the cash flow with the PV factor
In our case we have cost of capital as 20%, so we will consider 20% as discounting factor.
PV factor can be found by the following formula
PV factor = 1 / (1+R)n
Where R is discounted rate and n is number of years
See the table for the PV factor calculation
NPV = PV factor * cash flow
NPV (PV Factor * Cash Flow)
1,046,714.25
IRR is rate at which our NPV of the future cash flow is equal to the initial investment.
It can be found by the following formula
Initial capital = 1 / (1+IRR) + 1 / (1 + IRR)2 + -------------- 1/ (1+IRR)n
Initial capital = $900,000 + $165,000 = 1,065,000
Substituting in the formula we get our IRR as 19.2%
If IRR is less than Cost of capital we will reject the project
If IRR is more than cost of capital we will accept the project
In this case IRR is less than cost of capital thus we are rejecting this project.
The answer for the last question is
II. Environmental effects could be added by estimating penalties or any other cash outflows that might be imposed on the firm to help return the land to its previous state (if possible).
Year Cash Flows Discounting at rate of 20% (PV Factor)NPV (PV Factor * Cash Flow)
1 350,000 0.833333 291,666.67 2 350,000 0.694444 243,055.56 3 350,000 0.578704 202,546.30 4 350,000 0.482253 168,788.58 5 350,000 0.401878 140,657.15 Total Net Present Value1,046,714.25
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