Question 1 - 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 million, and the expected net cash inflows would be $80 million per year for 5 years. If the firm does invest in mitigation, the annual inflows would be $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?
Question 2 - Project S costs $15,000 and its expected cash flows would be $4,500 per year for 5 years. Mutually excusive project L costs $37,300, and its expected cash flows would be $11,000 per year for 5 years. If both projects have a WACC of 14%, which project would you recommend? Explain.