Question

1. After discovering a new gold vein in the Colorado Mountains, CTC Mining Corp must decide whether to go ahead and develop the deposit. The most cost-effective method of mining gold is sulfuric acid extraction, a process that could result in environmental damage. Before proceeding with the extraction, CTC must spend $1,200,000 for new mining equipment and pay $200,000 for its installation. The gold mined will net the firm an estimated $375,000 each year for the 5-year life of the vein. CTC’s cost of capital is 12%. For the purposes of this problem, assume that the cash inflows occur at the end of the year.

1. What are the project’s NPV and IRR?
2. Should this project be undertaken if environmental impacts were not a consideration?
3. How should environmental effects be considered, or any other, project?

Answer 1

Initial investment = New Mining Equipment + Installation cost = 1,200,000 + 200,000 = 1,400,000
Cash Flows = 365,000
number of Periods = 5
Rate = 12%
NPV of Investment = -initial Investment + PV of all cash flows using annuity formula = -1,400,000 + 365,000*(1-(1+12%)^-5)/12% = -1,400,000 + 1,315,743.31 = -84256.89

IRR using excel formula

	A	B	C	D	E	F
1	-1400000	365000	365000	365000	365000	365000
IRR	9.54%	Using excel formula=IRR(A1:F1)

b. No the project should not be overtaken  as NPV is negative and IRR is less than cost of capital.

c. Environmental impacts should be calculated and shown as costs in each years or at the end of the project cleaning cost or one time environmental damage cleanup cost is added or calculation.

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