Question

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 expected net 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 11%. a) Calculate the NPV and IRR with and without mitigation. b) How should the environmental effects be dealt with when this project is evaluated? c) Should this project be undertaken? If so, should the firm do the mitigation?

Answer 1

1.
=-60-10+21/11%*(1-1/1.11^5)=7.61383737063881

2.
=RATE(5,21,-60-10)=15.2382371163585%

3.
=-60+20/11%*(1-1/1.11^5)=13.9179403529893

4.
=RATE(5,20,-60)=19.8577097872796%

5.
The environmental effects if not mitigated could result in additional loss of cash flows and/or fines and penalties due to ill will among customers, community, etc. Therefore, even though the mine is legal without mitigation, the company needs to make sure that they have anticipated all costs in the "no mitigation" analysis from not doing the environmental mitigatio

6.
Under the assumption that all costs have been considered, the company would not mitigate for the environmental impact of the project since its NPV without mitigation is greater than its NPV when mitigation costs are included in the analysis.