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 $209.71 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 $75.84 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 17%.a) Calculate the NPV and IRR with and without mitigation.

b) How should the environment effects be dealt with when evaluating this project?
c) Should this project be undertaken? If so, should the firm do the mitigation?

Answer 1

Without Mitigation:

Net Present Value $14,244,2‬00

IRR 19.92%

With mitigation

Net Present Value: $ -7,071,600

IRR = 15.76%

The project should be started without hte mitigation effort as would decrease the return below the cost of capital of the company.

Step-by-step explanation:

Present value without mitigation

`C * (1-(1+r)^(-time) )/(rate) = PV\\`

C 70.00

time 5

rate 0.17

`70 * (1-(1+0.17)^(-5) )/(0.17) = PV\\`

PV $223.9542

Less

cost $209.71

Net Present Value 14,2442‬

IRR (using excel)

we input the -209.71 in one cell

then, we enter the 70 millon five times below the cost

and use the IRR formula to get the answer:

0.1992 = 19.92%

With mitigation:

`C * (1-(1+r)^(-time) )/(rate) = PV\\`

C 75.84

time 5

rate 0.17

`75.84 * (1-(1+0.17)^(-5) )/(0.17) = PV\\`

PV $242.6384

Less

249.71 cost

Net present value -7,0716

IRR:

A

1 -249.71

2 +75.84

3 +75.84

4 +75.84

5 +75.84

6 +75.84

=IRR(A1:A6)

= 0.1576