Case 4 Air Pollution Final Answer 2.6.19

CASE 4: USING NET PRESENT VALUE IN DECISION MAKING
POWER PLANT POLLUTION PROBLEM

INTRODUCTION:
A company was cited by the local government for causing the pollution problem to the
small tourism island where the plant is located. The newly hired executive is concerned that
the pollution problem, which was presented to the senior executives a few months back, has
not been addressed by them.
BACKGROUND OF THE PROBLEM

A power plant, which was built in 1970 in a small vacation island, provides the electricity to
most of the islands. Presently, the company’s attention was called by the local government of
the island because it causes too much air pollution and caused a downshift in the island’s
tourism.
ALTERNATIVE SOLUTIONS
COST OF CAPITAL:
MARKET TOTAL WEIGHTED
SECURITIES QUANTITY PRICE VALUE AVERAGE DATA COSTS WACC
DEBT 7000 108 756,000 7% 7.5% (1-.35) 4.9% 0.35%
5% RFR,
RPM 12%,
COMMON 180000 50 9,000,000 86% BETA .90 11.3% 9.67%
PREFERRED 8000 95 760,000 7% 5.50% 5.5 0.40%
10,516,000 100% 10.42%
Alt. 1:
Pay the local government a one-time carbon offset tax payment of $13,000,000 as
compensation for the pollution caused by the power plant.
Pros: This will help boost the economy of the island and help the local government fund the
items that were cut because of the reduced tax revenues due to the decline of tourists arrivals
in the island caused by the island’s pollution problem.
Cons: The company will shell out $13Million immediately which might affect their financial
condition.
NPV ANALYSIS:
Factor Cost Present Value
Carbon Offset Tax Payment 1 ($13,000,000) ($13,000,000)
Net Present Value ($13,000,000)
Alt. 2:
Complete shutdown of the power plant but install a power cable from another power plant that
is located in a nearby island so that electricity can be provided to the vacation island. The other
power plant will still produce pollution but in a different island with a different local
government.
Pros: The company will be cleared from the local government’s report as causing the air
pollution in the island.
Cons:
a. The other plant in the nearby island will cause air pollution in their island.
b. The company will need to shell out several millions of dollars, as presented below:
End of current Yr. $1 Million
Yr. 2 $3 Million
Yearly, thereafter $1 Million
NPV ANALYSIS:
PV OR PVA
FACTOR CASH FLOWS OF CASHFLOWS
Cost at end of year 1 0.905633 -1,000,000.00 (905,633)
Cost at end of year 2 0.820171 -3,000,000.00 (2,460,514)
Cost at end of year 3 to 50 7.803556 -1,000,000.00 (7,803,556)
Net Present Value (11,169,703)
Alt. 3:
Retrofit the power plant with scrubbers the will reduce the pollution emission and make the
power plant to environmentally friendly.
Pros: It will solve the air pollution problem of the vacation island and clear the company of the
local government’s negative report.
Cons: The company will be spending a large amount from its funds to finance the project and
incur a yearly maintenance cost for 50 years, to wit:
a. $7.5 Million will be shelled out at the end of the current year.
b. $100,000 per year, for 50 years, will be spent for the maintenance of the
pollution scrubber machine
NPV ANALYSIS:
PV OR PVA
FACTOR CASH FLOWS OF CASHFLOWS
Cost at end of year 1 0.905633 -7,500,000.00 (6,792,248)
Cost yearly for 50 years 9.52936 -100000 -952936
Net Present Value (7,745,184)
SUMMARY OF NPVs per Alternative:

ALT. NET PRESENT VALUE
1 ($13,000,000)
2 ($11,169,703)
3 ($ 7,745,184)
CONCLUSION ON NPV ANALYSIS:

When it comes to cost decisions, projects with the lowest NPV is the most viable or acceptable
project because it provides the lowest risk to the company. Based on the NPV Analysis
summary, Alternative 3 with the lowest NPV is the most acceptable alternative.
PROPOSED SOLUTION:
Based on the NPV analyses, the company is better off when it comes to Alternative 3 which is to
retrofit the power plant with scrubbers at the end of the year in the amount of $7.5 Million
and incur $100,000 yearly maintenance cost for 50 years.
To install scrubbers to the machines of the power plant in order to reduce air pollution
emissions will rehabilitate the power plant’s machineries with devices (scrubbers) that will not
cause air pollution to the vacation island, an environmentally friendly solution and more fitting
solution.
Alternative 1 is not an acceptable solution because it is costly to the company with an NPV of
($13 Million) and is just a compensation to the damage caused by the power plant to the
environment. It is not a permanent solution to the air pollution problem because the power
plant will still be causing air pollution to the vacation island.
Alternative 2 is not an acceptable solution because no.1, the NPV of ($11 Million plus) which is
still very costly to the company, and no. 2, the air pollution issue was not solved because using
the nearby island’s power plant will be detrimental to the other island’s air quality which is not
an ethical solution to the problem.
In conclusion, Alternative 3 is the best solution because of the following reasons:

a. It is more ethical.
b. It provides a permanent solution to the air pollution problem.
c. It is least costly to the company because it has the lowest negative NPV.
The Queensland Government (https://www.qld.gov.au/environment/pollution/

monitoring/air/air-pollution/controlling) shared an article entitled, “Controlling Air Pollution”,
which discusses the many ways to reduce air pollution. The article also discussed industrial
devices that help control air pollution. One of these devices is the “Particle and gas removal—
packed bed wet scrubber.” The A packed bed wet scrubber removes gaseous and particle
contaminants from a gas stream. It works by bringing the gas stream into contact with a
scrubbing liquid (usually water). The scrubbing liquid absorbs the gaseous pollutants, and the
spray droplets physically capture the particles. The packed bed of non-reactive material gives a
greater gas-to-liquid contact which improves the removal of particle pollutants. Although the
packed bed wet scrubber can remove gaseous and particle pollutants, the particular design
makes it more efficient at one or the other. Using certain scrubbing liquids can increase
gaseous pollutant removal, e.g. using an alkaline liquid to remove acidic pollutants. Trapping
and treating droplets of the scrubbing liquid can allow it to be recycled.
A picture of the device is presented below:

RECOMMENDATION:
The top management and senior managers of the power plant needs to immediately look into
the financial position of the company because in the determination of the cost of capital in
order to compute for the NPV of the project, the component of the company’s equity show
that it has a high margin of safety because its Common Stock represent 86% of the total capital
of the company.
A $7.5 Million investment on the project needs to be raised and because the debt ratio is just
7%, the company may want to take advantage of financial leverage when financing the project,
as long as the borrowing rate does not exceed the current cost of debt.
The company may also engage in environmental protection projects in collaboration with the
local government and the tourism department of the vacation island so that the island’s
environmental protection campaign becomes more sustainable. This will require involving the
top management, its executives, workers and employees.
In addition, in order to improve the reputation of the power plant from being an air pollution
causing company to a clean-air advocate, it may want to advertise the installation of scrubbers
in its machineries.

Case 4 Air Pollution Final Answer 2.6.19

Uploaded by

Copyright:

Available Formats

Case 4 Air Pollution Final Answer 2.6.19

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Case 4 Air Pollution Final Answer 2.6.19

Uploaded by

Copyright:

Available Formats

CASE 4: USING NET PRESENT VALUE IN DECISION MAKING

POWER PLANT POLLUTION PROBLEM

BACKGROUND OF THE PROBLEM

SUMMARY OF NPVs per Alternative:

CONCLUSION ON NPV ANALYSIS:

In conclusion, Alternative 3 is the best solution because of the following reasons:

The Queensland Government (https://www.qld.gov.au/environment/pollution/

A picture of the device is presented below:

You might also like