A mining company is considering a new project. Because the mine has received a permit, the project would be legal; but it would cause significant harm to a nearby river. The firm could spend an additional $10 million at Year 0 to mitigate the environmental problem, but it would not be required to do so. Developing the mine (without mitigation) would require an initial outlay of $60 million, and the expected cash inflows would be $20 million per year for 5 years. If the firm does invest in mitigation, the annual inflows would be $21 million. The risk-adjusted WACC is 15%. How should the environmental effects be dealt with when this project is evaluated? The environmental effects if not mitigated could result in additional loss of cash flows and/or fines and penalties due to ill will among customers, community, etc. Therefore, even though the mine is legal without mitigation, the company needs to make sure that they have anticipated all costs in the "no mitigation" analysis from not doing the environmental mitigation. The environmental effects should be ignored since the mine is legal without mitigation. The environmental effects should be treated as a sunk cost and therefore ignored. The environmental effects if not mitigated would result in additional cash flows. Therefore, since the mine is legal without mitigation, there are no benefits to performing a "no mitigation" analysis. The environmental effects should be treated as a remote possibility and should only be considered at the time in which they actually occur.
Net Present Value
Net present value is the most important concept of finance. It is used to evaluate the investment and financing decisions that involve cash flows occurring over multiple periods. The difference between the present value of cash inflow and cash outflow is termed as net present value (NPV). It is used for capital budgeting and investment planning. It is also used to compare similar investment alternatives.
Investment Decision
The term investment refers to allocating money with the intention of getting positive returns in the future period. For example, an asset would be acquired with the motive of generating income by selling the asset when there is a price increase.
Factors That Complicate Capital Investment Analysis
Capital investment analysis is a way of the budgeting process that companies and the government use to evaluate the profitability of the investment that has been done for the long term. This can include the evaluation of fixed assets such as machinery, equipment, etc.
Capital Budgeting
Capital budgeting is a decision-making process whereby long-term investments is evaluated and selected based on whether such investment is worth pursuing in future or not. It plays an important role in financial decision-making as it impacts the profitability of the business in the long term. The benefits of capital budgeting may be in the form of increased revenue or reduction in cost. The capital budgeting decisions include replacing or rebuilding of the fixed assets, addition of an asset. These long-term investment decisions involve a large number of funds and are irreversible because the market for the second-hand asset may be difficult to find and will have an effect over long-time spam. A right decision can yield favorable returns on the other hand a wrong decision may have an effect on the sustainability of the firm. Capital budgeting helps businesses to understand risks that are involved in undertaking capital investment. It also enables them to choose the option which generates the best return by applying the various capital budgeting techniques.
A mining company is considering a new project. Because the mine has received a permit, the project would be legal; but it would cause significant harm to a nearby river. The firm could spend an additional $10 million at Year 0 to mitigate the environmental problem, but it would not be required to do so. Developing the mine (without mitigation) would require an initial outlay of $60 million, and the expected
How should the environmental effects be dealt with when this project is evaluated?
- The environmental effects if not mitigated could result in additional loss of cash flows and/or fines and penalties due to ill will among customers, community, etc. Therefore, even though the mine is legal without mitigation, the company needs to make sure that they have anticipated all costs in the "no mitigation" analysis from not doing the environmental mitigation.
- The environmental effects should be ignored since the mine is legal without mitigation.
- The environmental effects should be treated as a sunk cost and therefore ignored.
- The environmental effects if not mitigated would result in additional cash flows. Therefore, since the mine is legal without mitigation, there are no benefits to performing a "no mitigation" analysis.
- The environmental effects should be treated as a remote possibility and should only be considered at the time in which they actually occur.
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