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Stephens, Inc. refines (smelts) heavy metals and is a big polluter. The EPA recently fined Stephens $1,000,000 for their past violations and warned that Stephens would need to install scrubbers on their smoke stacks. The cost of the scrubbers is $600,000 and they have a 3-year life; at the end of 3 years Stephens will have to pay an additional $200,000 to remove and dispose of the scrubbers. The scrubbers also cost $200,000 per year in maintenance to keep them running properly. Stephens uses straight-line depreciation, has a tax rate of 30% and estimates the appropriate discount rate to be 10%. Alternatively, Stephens could choose not to comply and face a fine of $1,000 a day (paid annually in installments of $365,000, beginning in one year).
Problem 1: What is the NPV of installing the scrubbers?
Problem 2: What is the equivalent annual cost (EAC) of installing the scrubbers?
Problem 3: Is Stephens better off (in financial terms only) installing the scrubbers or paying the fine? At what discount rate would Stephens be indifferent to installing the scrubbers or paying the fine?
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