Pollution Prevention, P2 Investment

Heaps Company produces jewelry that requires electroplating with gold, silver, and other valuable metals. Electroplating uses large amounts of water and chemicals, producing wastewater with a number of toxic residuals. Currently, Heaps uses settlement tanks to remove waste; unfortunately, the approach is inefficient, and much of the toxic residue is left in the water that is discharged into a local river. The amount of toxic discharge exceeds the legal, allowable amounts, and the company is faced with substantial, ongoing environmental fines. The environmental violations are also drawing unfavorable public reaction, and sales are being affected. A lawsuit is also impending, which could prove to be quite costly.

Management is now considering the installation of a zero-discharge, closed-loop system to treat the wastewater. The proposed closed-loop system would not only purify the wastewater, but also produce cleaner water than that currently being used, increasing plating quality. The closed-loop system would produce only four pounds of sludge, and the sludge would be virtually pure metal, with significant market value. The system requires an investment of $619,500 and will cost $45,170 in increased annual operation plus an annual purchase of $7,920 of filtration medium. However, management projects the following savings:

Water usage	$	67,460
Chemical usage		41,850
Sludge disposal		89,620
Recovered metal sales		45,020
Sampling of discharge		119,570
Total	$	363,520

The equipment qualifies as a seven-year MACRS asset. Management has decided to use straight-line depreciation for tax purposes, using the required half-year convention. The tax rate is 40 percent. The projected life of the system is 10 years. The hurdle rate is 16 percent for all capital budgeting projects, although the company's cost of capital is 12 percent.

The present value tables provided in Exhibit 19B.1 and Exhibit 19B.2 must be used to solve the following problems.

Required:

Question Content Area

1. Based on the financial data provided, prepare a schedule of expected cash flows. Enter cash outflows as negative amounts and cash inflows as positive amounts.

Heaps Company Schedule of Expected Cash Flow

Year 0	$fill in the blank 6c6fa4fbbfacf9c_1
Year 1:
Operating costs	$fill in the blank 6c6fa4fbbfacf9c_2
Savings	fill in the blank 6c6fa4fbbfacf9c_3
Depreciation shield	fill in the blank 6c6fa4fbbfacf9c_4
Total	$fill in the blank 6c6fa4fbbfacf9c_5
Years 27:
Operating costs	$fill in the blank 6c6fa4fbbfacf9c_6
Savings	fill in the blank 6c6fa4fbbfacf9c_7
Depreciation shield	fill in the blank 6c6fa4fbbfacf9c_8
Total	$fill in the blank 6c6fa4fbbfacf9c_9
Year 8:
Operating costs	$fill in the blank 6c6fa4fbbfacf9c_10
Savings	fill in the blank 6c6fa4fbbfacf9c_11
Depreciation shield	fill in the blank 6c6fa4fbbfacf9c_12
Total	$fill in the blank 6c6fa4fbbfacf9c_13
Years 910:
Operating costs	$fill in the blank 6c6fa4fbbfacf9c_14
Savings	fill in the blank 6c6fa4fbbfacf9c_15
Total	$fill in the blank 6c6fa4fbbfacf9c_16

2. What is the payback period? Round your answer to two decimal places. fill in the blank 5dd10fffb01e069_1 years

3. Calculate the NPV of the closed-loop system. Round intermediate calculations and the final answer to the nearest dollar. $fill in the blank 5dd10fffb01e069_2

Should the company invest in the system?

YesNoYes

4. The calculation in Requirement 3 ignored several factors that could affect the project's viability: savings from avoiding the annual fines, positive effect on sales due to favorable environmental publicity, increased plating quality from the new system, and the avoidance of the lawsuit. Can these factors be quantified?

YesNoYes

If so, should they have been included in the analysis?

YesNoYes

Suppose, for example, that the annual fines being incurred are $75,360, the sales effect is $59,790 per year, the quality effect is not estimable, and cancellation of the lawsuit because of the new system would avoid an expected settlement at the end of Year 3 (including legal fees) of $292,200. Assuming these are all after-tax amounts, what effect would their inclusion have on the payback period? On the NPV? Round payback to two decimal places and round NPV calculation and final answer to the nearest dollar.

Payback	IncreasesDecreasesDecreases	by	fill in the blank 5dd10fffb01e069_7	years
NPV	IncreasesDecreasesIncreases	by	$fill in the blank 5dd10fffb01e069_9