Problem 19.24 (Algorithmic) 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 $630,000 and will cost $44,960 in increased annual operation plus an annual purchase of $7,460 of filtration medium. However, management projects the following savings:

Water usage	$	67,880
Chemical usage		42,330
Sludge disposal		89,790
Recovered metal sales		44,790
Sampling of discharge		119,750
Total	$	364,540

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 companys 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:

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		$ ____
Year 1:		______
Operating costs		$ _____
Savings		______
Depreciation shield		_____
Total		$ _____
Years 27:
Operating costs		$ _____
Savings		_____
Depreciation shield		_____
Total		$ _____
Year 8:
Operating costs		$ _____
Savings		_____
Depreciation shield		_____
Total		$ _____
Years 910:
Operating costs		$ _____
Savings		_____
Total		$ _____

2. What is the payback period? Round your answer to two decimal places. _____ years

3. Calculate the NPV of the closed-loop system. Round intermediate calculations and the final answer to the nearest dollar. $ _____

Suppose, for example, that the annual fines being incurred are $75,480, the sales effect is $60,440 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 $302,500. 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	- Decreases by ______ years
NPV	- Decreases by ______ years