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 $270.46 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 $93.41 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%. 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

Total Cost = Cost excluding mitigation = $270.46m
The revenue is $90m every year which we assume is at the end.

Thus, NPV = -270.46 + 90{(1+i)-1 + (1+i)-2 + .. + (1+i)-5} where, i = 0.19
= -270.46 + 811.07 = $4.73m

At IRR, PV of cost = PV of revenue
or, 270.46 = 90{(1+i)-1 + (1+i)-2 + .. + (1+i)-5}
On interepolating we find i = 19.79%

Thus, NPV = $500.61m and IRR = 19.79%

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