CAPITAL BUDGETING CRITERIA: ETHICAL CONSIDERATIONS

A mining company is considering a new project. Because the minehas received a permit, the project would be legal; but it wouldcause significant harm to a nearby river. The firm could spend anadditional $9.66 million at Year 0 to mitigate the environmentalProblem, but it would not be required to do so. Developing the mine(without mitigation) would cost $57 million, and the expected cashinflows would be $19 million per year for 5 years. If the firm doesinvest in mitigation, the annual inflows would be $20 million. Therisk-adjusted WACC is 11%. a. Calculate the NPV and IRR withmitigation. Round your answers to two decimal places. Do not roundyour intermediate calculations. Enter your answer for NPV inmillions. For example, an answer of $10,550,000 should be enteredas 10.55.

NPV $ ________ million

IRR ________ %

Calculate the NPV and IRR without mitigation. Round your answersto two decimal places. Do not round your intermediate calculations.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 thisproject is evaluated?

I. The environmental effects if not mitigated would result inadditional cash flows. Therefore, since the mine is legal withoutmitigation, there are no benefits to performing a "no mitigation"analysis.

II. The environmental effects should be treated as a remotepossibility and should only be considered at the time in which theyactually occur. III. The environmental effects if not mitigatedcould result in additional loss of cash flows and/or fines andpenalties due to ill will among customers, community, etc.Therefore, even though the mine is legal without mitigation, thecompany needs to make sure that they have anticipated all costs inthe "no mitigation" analysis from not doing the environmentalmitigation.

IV. The environmental effects should be ignored since the mineis legal without mitigation.

V. The environmental effects should be treated as a sunk costand therefore ignored.

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c. Should this project be undertaken? _________________

If so, should the firm do the mitigation?

I. Under the assumption that all costs have been considered, thecompany would not mitigate for the environmental impact of theproject since its NPV without mitigation is greater than its NPVwhen mitigation costs are included in the analysis.

II. Under the assumption that all costs have been considered,the company would mitigate for the environmental impact of theproject since its IRR with mitigation is greater than its IRR whenmitigation costs are not included in the analysis.

III. Under the assumption that all costs have been considered,the company would not mitigate for the environmental impact of theproject since its NPV with mitigation is greater than its NPV whenmitigation costs are not included in the analysis.

IV. Under the assumption that all costs have been considered,the company would not mitigate for the environmental impact of theproject since its IRR without mitigation is greater than its IRRwhen mitigation costs are included in the analysis.

V. Under the assumption that all costs have been considered, thecompany would mitigate for the environmental impact of the projectsince its NPV with mitigation is greater than its NPV whenmitigation costs are not included in the analysis.

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