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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

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 $10 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 $60 million, and the expected cash inflows would be $20 million per year for 5 years. If the firm does invest in mitigation, the annual inflows would be $21 million. The risk-adjusted WACC is 12%.

  1. a. Calculate the NPV and IRR with and without mitigation.
  2. b. How should the environmental effects be dealt with when this project is evaluated?
  3. c. Should this project be undertaken? If so, should the firm do the mitigation?

a.

Summary Introduction

To calculate: The NPV and IRR of the given project with and without mitigation.

Introduction:

Capital Budgeting:

It refers to the long-term investment decisions that has been taken by the top management of a company and that are irreversible in nature. These decisions require investment of large amount of cash of the company.

Net Present Value (NPV):

It is a method under capital budgeting which includes the calculation of net present value of the project in which company is investing. The calculation is done by calculating the difference between the value of cash inflow and value of cash outflow after considering the discounted rate.

Internal Rate of Return (IRR):

It refers to the rate of return that is computed by the company to make a decision regarding the selection of a project for investment. This rate provides the basis for selection of projects with lower cost of capital and rejection of project with higher cost of capital.

Explanation

Given information:

Cost of the project with mitigation is $70 million and without mitigation is $60 million.

Life of the project is 5 years.

Cash inflow expected per year with mitigations is $21 million and without mitigation $20 million.

Cost of capital is 12%.

The calculation of NPV and IRR with mitigation on spreadsheet is:

b.

Summary Introduction

To identify: The way in which the environmental effects should be dealt with when this project is evaluated

c.

Summary Introduction

To explain: Whether the project should be undertaken or not with or without mitigation.

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