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 $76.26 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%. a.Calculate the NPV and IRR with mitigation. Round your answers to two decimal places. Enter your answer for NPV in millions. Do not round your intermediate calculations. For example, an answer of $10,550,000 should be entered as 10.55 Negative value should be indicated by a minus sign. NPV $ million Calculate the NPV and IRR without mitigation. Round your answers to two decimal places. Enter your answer for NPV in millions. Do not round your intermediate calculations. For example, an answer of $10,550,000 should be entered as 10.55. million

Explanation / Answer

ELECTRIC UTILITY IN NORTHERN ARIZONA: a) NPV with mitigation = PV of cash inflows-Initial investment = 76.26*PVIFA(19,5)-250.17 = 76.26*3.05763-250.17 = $        (17.00) million IRR with mitigation: IRR is that discount rate for which PV of cash inflows=Initial investment Hence, 250.17 = 76.26*PVIFA(IRR,5) 3.2805=PVIFA(IRR,5) The PVIFA for 15% and 16% are 3.3522 and 3.2743 Hence, IRR lies between 15% and 16%. The value of IRR can be found out by simple interpolation as below: IRR = 15+(3.3522-3.2805)/(3.3522-3.2743) = 15.92% b) NPV without mitigation = PV of cash inflows-Initial investment = 70.00*PVIFA(19,5)-210.17 = 70.00*3.05763-210.17 = $             3.86 million IRR with mitigation: IRR is that discount rate for which PV of cash inflows=Initial investment Hence, 210.17 = 70.00*PVIFA(IRR,5) 3.0024=PVIFA(IRR,5) The PVIFA for 19% and 20% are 3.0576 and 2.9906 Hence, IRR lies between 19% and 20%. The value of IRR can be found out by simple interpolation as below: IRR = 19+(3.0576-3.0024)/(3.0576-2.9906) = 19.82%

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