After discovering a new gold vein in the Colorado Mountains CTC Mining Corporati

Question

After discovering a new gold vein in the Colorado Mountains CTC Mining Corporation must decide whether to mine the deposit. The most cost-effective method of mining gold is sulfuric acid extraction, a process that results in environmental damage. To go ahead 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 14 percent. For the purposes of this problem, assume that the cash inflows occur at the end of the year.
a. What are the NPV and IRR of this project?
b. Should this project be undertaken, ignoring environmental concerns?
c. How should environmental effects be considered when evaluating this, or any other, project? How might these effects change your decision in part b?

Explanation / Answer

A) cash flow from the proposed minings:
Year
1 -$1,065,000
0 350,000
2    350,000
3   350,000
4   350,000
5   350,000

NPV = $136,578.34 and IRR= 19.22%

b) Yes , since NPV is 0 (ans IRR>WACC)

c) THe analysis in (a) ignores the environmental damage caused by the mining process.Envronmrntal damage is an example of externality. The firm should deduct the cost of it from the expected cash flows to get a better estimates of marginal benefits and costs. If environemental costs are large enough then it may lead the manager to quit the project in hand.

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