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 $270.11 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 $93.87 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%.

Explanation / Answer

Without environmental risk mitigation Year Cash Flow Discounted Cash Flow @ 18% 0 -270.11 -270.11 1 90 76.27118644 2 90 64.63659868 3 90 54.77677854 4 90 46.42099876 5 90 39.33982946 Net Present Value (in $ Million) 11.34 With environmental risk mitigation Year Cash Flow Discounted Cash Flow @ 18% 0 -310.11 -310.11 1 93.87 79.55084746 2 93.87 67.41597242 3 93.87 57.13218002 4 93.87 48.41710171 5 93.87 41.03144213 Net Present Value (in $ Million) -16.56 Based on the NPV, the company should not mitigate the environmental risk

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