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The state government is considering spending $60 million to protect a local waterway. If they spend this money, experts tell them that the benefits (mostly coming from protecting local fish and wildlife) will be valued at $8 million per year in years 1 through 10.

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a. The government budgeting office uses a discount rate of 7% to evaluate whether this is a good use of government funds. Will they suggest that the government should spend the money? Explain why 7% might be a reasonable discount rate for the government to use in this context.

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b. The government’s environmental protection agency uses a discount rate of 2% to evaluate whether this is a good use of government funds. Will they suggest that the government should spend the money? Explain why 2% might be a reasonable discount rate for the government to use in this context.

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c. Now instead, the government is considering spending $60 million on an environmental protection project that will have benefits of $8 million per year 101 years to 110 years in the future. Will the government think it’s a good idea to spend the money if it uses a discount rate of 2%? Some would argue that the government should instead use a discount rate of 0% in this case. Explain why and show whether the government should spend the money if it uses a 0% discount rate.

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Irving Heathcote
Irving HeathcoteLv2
28 Sep 2019

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Capital budgeting criteria: ethical considerations

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 $210.27 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 $75.69 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 18%.

A.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 %

B. How should the environmental effects be dealt with when evaluating this project?

I.The environmental effects should be treated as a remote possibility and should only be considered at the time in which they actually occur.

II.The environmental effects if not mitigated would result in additional cash flows. Therefore, since the plant is legal without mitigation, there are no benefits to performing a "no mitigation" analysis.

III.The environmental effects should be ignored since the plant is legal without mitigation.

IV.The environmental effects should be treated as a sunk cost and therefore ignored.

V.If the utility mitigates for the environmental effects, the project is not acceptable. However, before the company chooses to do the project without mitigation, it needs to make sure that any costs of "ill will" for not mitigating for the environmental effects have been considered in that analysis.


C. Should this project be undertaken?

I. The project should be undertaken only if they do not mitigate for the environmental effects. However, they want to make sure that they've done the analysis properly due to any "ill will" that might result from undertaking the project without concern for the environmental impacts.

II.The project should be undertaken only under the "mitigation" assumption.

III.The project should be undertaken since the IRR is positive under both the "mitigation" and "no mitigation" assumptions.

IV.The project should be undertaken since the NPV is positive under both the "mitigation" and "no mitigation" assumptions.

V.Even when no mitigation is considered the project has a negative NPV, so it should not be undertaken.

Problem 11-9
Capital budgeting criteria: ethical considerations

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 $239.99 million, and the expected cash inflows would be $80 million per year for 5 years. If the firm does invest in mitigation, the annual inflows would be $83.96 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 16%.

Calculate the NPV and IRR with mitigation. Round your answers to two decimal places. Enter your answer for NPV in millions. Do not round your intermediate calculations. For example, an answer of $10,550,000 should be entered as 10.55. Negative value should be indicated by a minus sign.
NPV $ _______ million
IRR % _______%

Calculate the NPV and IRR without mitigation. Round your answers to two decimal places. Enter your answer for NPV in millions. Do not round your intermediate calculations. For example, an answer of $10,550,000 should be entered as 10.55.
NPV $ _______ million
IRR _________ %

How should the environmental effects be dealt with when evaluating this project?

1. The environmental effects should be ignored since the plant is legal without mitigation.

2. The environmental effects should be treated as a sunk cost and therefore ignored.

3. If the utility mitigates for the environmental effects, the project is not acceptable. However, before the company chooses to do the project without mitigation, it needs to make sure that any costs of "ill will" for not mitigating for the environmental effects have been considered in that analysis.

4. The environmental effects should be treated as a remote possibility and should only be considered at the time in which they actually occur.

5. The environmental effects if not mitigated would result in additional cash flows. Therefore, since the plant is legal without mitigation, there are no benefits to performing a "no mitigation" analysis.

Answer __________

Should this project be undertaken?

1. The project should be undertaken only under the "mitigation" assumption.

2. The project should be undertaken since the IRR is positive under both the "mitigation" and "no mitigation" assumptions.

3. The project should be undertaken since the NPV is positive under both the "mitigation" and "no mitigation" assumptions.

4. Even when no mitigation is considered the project has a negative NPV, so it should not be undertaken.

5. The project should be undertaken only if they do not mitigate for the environmental effects. However, they want to make sure that they've done the analysis properly due to any "ill will" and additional "costs" that might result from undertaking the project without concern for the environmental impacts.


Answer __________

Capital budgeting criteria: ethical considerations

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 $239.99 million, and the expected cash inflows would be $80 million per year for 5 years. If the firm does invest in mitigation, the annual inflows would be $84.40 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 19%.

a. 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 _____ %

b. How should the environmental effects be dealt with when evaluating this project?

1. The environmental effects should be treated as a sunk cost and therefore ignored.

2. If the utility mitigates for the environmental effects, the project is not acceptable. However, before the company chooses to do the project without mitigation, it needs to make sure that any costs of "ill will" for not mitigating for the environmental effects have been considered in that analysis.

3. The environmental effects should be treated as a remote possibility and should only be considered at the time in which they actually occur.

4. The environmental effects if not mitigated would result in additional cash flows. Therefore, since the plant is legal without mitigation, there are no benefits to performing a "no mitigation" analysis.

5. The environmental effects should be ignored since the plant is legal without mitigation.

c. Should this project be undertaken?

1. The project should be undertaken since the NPV is positive under both the "mitigation" and "no mitigation" assumptions.

2. Even when no mitigation is considered the project has a negative NPV, so it should not be undertaken.

3. The project should be undertaken only if they do not mitigate for the environmental effects. However, they want to make sure that they've done the analysis properly due to any "ill will" that might result from undertaking the project without concern for the environmental impacts.

4. The project should be undertaken only under the "mitigation" assumption.

5. The project should be undertaken since the IRR is positive under both the "mitigation" and "no mitigation" assumptions.

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