Capital budgeting criteria: ethical considerations An electric utility is consid

Question

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 $210.17 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 $75.13 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 18%.

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 $   million
IRR  %

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 $   million
IRR  %

Explanation / Answer

A) 1)NPV with Mitigation : Company will spend more 40million for mitigation so that is 210.17+40 =$250.17million

NPV = (- 250.17) + 75.13 / (1+WACC)^1+ 75.13 / (1+WACC)^2+ 75.13 / (1+WACC)^3+ 75.13 / (1+WACC)^4+ 75.13 / (1+WACC)^5

NPV = (- 250.17) +75.13 / (1.18)^1+ 75.13 / (1.18)^2+ 75.13 / (1.18)^3+ 75.13 / (1.18)^4+ 75.13 / (1.18)^5

NPV = (- 250.17) +75.13 / (1.18)+ 75.13 / 1.39 + 75.13 / 1.64 + 75.13 / 1.93 + 75.13 / 2.28

NPV = (- 250.17) +63.66 +53.95 + 45.72 +38.75 + 32.85

NPV = (- 250.17) +234.93

NPV =(- $15.22 million)

NET PRESENT VALUE IS COMING IN NEGATIVE WHICH MEANS THERE IS A HUGE LOSS TO THE COMPANY IF THE PLANT IS MITIGATED

2) IRR WITH MITIGATION: Inorder to find IRR ,NPV always becomes zero ,R = IRR

0 = (- 250.17) + 75.13 / (1+R)^1+ 75.13 / (1+R)^2+ 75.13 / (1+R)^3+ 75.13 / (1+R)^4+ 75.13 / (1+R)^5

IRR = 15.28%

B) 3) NPV WITHOUT MITIGATION

NPV = (- 210.17) + 75.13 / (1+WACC)^1+ 75.13 / (1+WACC)^2+ 75.13 / (1+WACC)^3+ 75.13 / (1+WACC)^4+ 75.13 / (1+WACC)^5

NPV = (- 210.17) +75.13 / (1.18)^1+ 75.13 / (1.18)^2+ 75.13 / (1.18)^3+ 75.13 / (1.18)^4+ 75.13 / (1.18)^5

NPV = (- 210.17) +70 / (1.18)+ 70 / 1.39 + 70 / 1.64 + 70 / 1.93 + 70 / 2.28

NPV = (- 210.17) +59.32 +50.27 + 42.68 +36.11 + 30.60

NPV = (- 210.17) +218.9

NPV without mitigation = 8.73 $Million

B)4) IRR without mitigation :

0 = (- 210.17) + 70 / (1+R)^1+ 70 / (1+R)^2+ 70 / (1+R)^3+ 70 / (1+R)^4+ 70 / (1+R)^5

IRR = 19.82%

The Firm should start Without mitigation as With Mitigation it is making loss when compared to its net present worth and also the interanl rate of return is less compared to without mitigation.

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