Question

After discovering a new gold vein in the Colorado mountains, CTC Mining Corporation 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 $900,000 for new mining equipment and pay $165,000 for its installation. The gold mined will net the firm an estimated $350,000 each year over the 5-year life of the vein. CTC's cost of capital is 20%. For the purposes of this problem, assume that the cash inflows occur at the end of the year.

What is the project's NPV? Round your answer to the nearest dollar.

What is the project's IRR? Round your answer to two decimal places.

Should this project be undertaken if environmental impacts were not a consideration?

How should environmental effects be considered when evaluating this, or any other, project?

I. Environmental effects should be ignored since they would have no effect on the project's profitability. II. Environmental effects should be treated as sunk costs. III. Environmental effects could be added by estimating penalties or any other cash outflows that might be imposed on the firm to help return the land to its previous state (if possible).

Answer 1

Given

Cash out flow at Time 0=$900000+$165000= $ 1065000

Cash inflow for next 5 years= $350000 per year

Cost of capital = 20%

Present value of all the inflows

= P*((1-(1+r)^-n)/r)

= 350000*((1-(1.20)^-5)/.20)

= $ 1046714.25

NPV= -$1065000+$1046714.25 = -$18285.75

IRR will be calculated through Trail and Error method.

At 20% it gives -ve NPV .

If we try at 19%

= -$1065000+ 350000*((1-(1.19)^-5)/.19)

= $5172.21

Hence the IRR will be between 19% and 20%

Lets try with 19.22%

It gives -$1065000+ 350000*((1-(1.1922)^-5)/.1922)

= $-62.53 which is very close to zero

Hence IRR will be 19.22

We should not accept the Project as it gives Negative NPV and its IRRis lower than cost of capital.

Environmental effects should be considereed asby adding any penalities to the cash flow . It will further makes the NPV Negative .