Capital budgeting criteria: ethical considerations An electric utility is consid
ID: 2648977 • Letter: C
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 $240.20 million, and the expected cash inflows would be $80 million per year for 5 years. If the firm does invest in mitigation, the annual inflows would be $84.98 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 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 %
How should the environmental effects be dealt with when evaluating this project?
If the utility mitigates for the environmental effects, the project is not acceptable. However, before the company chooses to do the project without mitigation, it needs to make sure that any costs of "ill will" for not mitigating for the environmental effects have been considered in that analysis.
The environmental effects should be treated as a remote possibility and should only be considered at the time in which they actually occur.
The environmental effects if not mitigated would result in additional cash flows. Therefore, since the plant is legal without mitigation, there are no benefits to performing a "no mitigation" analysis.
The environmental effects should be ignored since the plant is legal without mitigation.
The environmental effects should be treated as a sunk cost and therefore ignored.
-Select-IIIIIIIVVItem 5Should this project be undertaken?
The project should be undertaken since the IRR is positive under both the "mitigation" and "no mitigation" assumptions.
The project should be undertaken since the NPV is positive under both the "mitigation" and "no mitigation" assumptions.
Even when no mitigation is considered the project has a negative NPV, so it should not be undertaken.
The project should be undertaken only if they do not mitigate for the environmental effects. However, they want to make sure that they've done the analysis properly due to any "ill will" that might result from undertaking the project without concern for the environmental impacts.
The project should be undertaken only under the "mitigation" assumption.
-Select-IIIIIIIVVItem 6
Explanation / Answer
Answer: Calculation of NPV with mitigation:
Calculation of NPV without mitigation:
Calculation of IRR without mitigation:
Excel formula =IRR(range of cash flows including initial cost)
In this formula, you have to input the cash flow numbers in Excel then select the data range.
If you don't want to input the data, you can use Texas Baii plus Financial calculator:
a. Press CF key then input -240.2, hit ENTER key. (the screen will show CF0= -240.2)
b. press down arrow, then input 80, hit ENTER key (CO1=80 , it means cash flow in period1=80 million)
c. Press down arrow, input 5, hit Enter key. (FO1=5, it means the 80 cash flow repeats 5 times)
d. press IRR key, then hit CPT. ( IRR= 19.75%)
Calculation of IRR with mitigation:
use the method above, initial cost = -240.2 + (-40) = -280.2.
IRR= 15.73%
According to NPV: Without mitigation is considered because it has positive NPV.
According to IRR: With mitigation is considered because it has higher irr as compared to without mitigation.
Particulars Time PVF (19%) Amount ($)in million PV ($) Cash outflow: Additional cost 0 1 40 40 Plant cost 0 1 240.2 240.2 P.V.C.O (A) 280.2 Cash inflow:(B) 1-5- 3.05763 84.98 259.8374 NPV (B-A) -20.3626