Your power plant on Gilligan\'s Island is producing too much air pollution. You

Question

Your power plant on Gilligan's Island is producing too much air pollution. You have 1) three choices for dealing with this problem: You can pay a pollution tax (one time) of $10m immediately. You can close the plant and install a power cable from the mainland. That will cost you $1m at the end of $0.5m forever after that for maintenance this year, $3m at the end of next year (construction costs) and then emissions. That will cost S9m at You can retrofit the plant with scrubbers to reduce the the end of this year and $0.1m forever after that for maintenance Assume that the cost of generating power on the mainland is approximately the same as the cost ng power at your Gilligan's Island plant and assume your cost of capital (WACC) is 10%, which alternative would your choose?

Explanation / Answer

Option A = 10 M

For Option B & C we need use Present value analysis

Perpetuity value = cost / discount rate

Option B = 1/(1+10%) + 3/(1+10%)2 + (0.5/0.1)(1+10%)2 = 7.52 M

Option C = 9/(1+10%) + (0.1/0.1)(1+10%) = 9.09 M

Option B has the lowest value, hence Option B

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