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. However, if the firm does not deal with the problem at year 0 they would face a lawsuit at the end of the project (year 5) at a cost of $20 million. Developing the mine (without mitigation) would cost $60 million and the expected cash inflows would be $20 million for 5 years. The weighted average cost of capital (WACC) is 12%. Below is a summary of possible outcomes: NPV with mitigation costs at time 0 included = $2.1 million NPV without mitigation costs at time 0 and a lawsuit included in year 5 = $0.75 million Should the project be undertaken? If so, should the firm do the mitigation at time 0?
No, the project is too risky and should not be undertaken.
Yes, the project should be undertaken and the mitigation expense should be conducted at time 0.
Yes, the project should be undertaken and no mitigation should be conducted at time 0. No, the NPV’s are positive for every possible scenario.