Problem 11-8 Capital budgeting criteria: ethical considerations A mining company
ID: 2650696 • Letter: P
Question
Problem 11-8
Capital budgeting criteria: ethical considerations
A mining company is considering a new project. Because the mine has received a permit, the project would be legal; but it would cause significant harm to a nearby river. The firm could spend an additional $11 million at Year 0 to mitigate the environmental Problem, but it would not be required to do so. Developing the mine (without mitigation) would cost $69 million, and the expected net cash inflows would be $23 million per year for 5 years. If the firm does invest in mitigation, the annual inflows would be $24 million. The risk adjusted WACC is 13%.
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
NPV and IRR with mitigation
NPV = Present value of cash inflows - present value of cash outflows = [24 x PVAF(13%, 5 years)] - (69 + 11)
= (24 x 3.517) - 80 = $4.41 million
To find IRR we need two discount rates, one on which npv is positive and one on which npv is negative. If we look at 15% discount rate NPV = $0.45 and if we look at 16% discount rate NPV = -$1.42. We have found the two discount rates.
IRR = lower rate + NPV at lower rate x (Higher rate - Lower rate)/(NPV at lower rate - NPV at higher rate)
= 15% + 0.45 x (16 - 15)/(0.45 - (-1.42)) = 15.24%
NPV and IRR without mitigation
NPV = Present value of cash inflows - present value of cash outflows = [23 x PVAF(13%, 5 years)] - 69
= (23 x 3.517) - 69 = $11.89
If we look at 19% NPV is 1.33. Now look at 20% NPV is -$0.22.
IRR = lower rate + NPV at lower rate x (Higher rate - Lower rate)/(NPV at lower rate - NPV at higher rate)
= 19% + 1.33 x (20 - 19)/(1.33 - (-0.22)) = 19.86%