After discovering a new gold vein in the Colorado mountains, CTC Mining Corporat

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 results 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 16%. 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?
Yes or No and why?

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

I. 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).
II. Environmental effects should be ignored since they would have no effect on the project's profitability.
III. Environmental effects should be treated as sunk costs.

Explanation / Answer

Calculation of NPV:

Formula used = Cash flow/(Discount factor)^time.

Discount factor = 1+cost of capital

IRR is the rate which makes the NPV as zero. It will be calculated using trial and error method on excel sheet.

0

The discount factor as per the table above = 1.1922

IRR = 1.1922-1 = 0.1922 OR 19.22%

As IRR is greater than the cost of capital, the project should be undertaken.

For considering the environmental effects, the answer is option I i.e. penalties should be estimated or any other cash outflows should be factored while calculating the NPV and IRR.

Year Cash flow Discount factor PV 0 -1,065,000 1.16 -1,065,000 1 350,000 301,724 2 350,000 260,107 3 350,000 224,230 4 350,000 193,302 5 350,000 166,640 NPV 81,003

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