Silver Mining Corp (SMC) is analyzing a proposal to test drill a 10,000 acre pot
ID: 2624116 • Letter: S
Question
Silver Mining Corp (SMC) is analyzing a proposal to test drill a 10,000 acre potential field in Peru to test the depth, width, and quality of a suspected underground ore deposit. The drilling process and the testing of the metals will cost $1,000,000. The results will depend on the size of the deposit and the quality of the ore. Analysts estimate that there is a 40.0% probability that the quantity or the quality of the ore will not be good enough to justify mining in the site. On the other hand, there is a 40.0% probability that the ore will be of mineable quality, and a 20% chance that it will be exceptionally good. These are the estimated Net Incremental Cash Flows expected from the project in each possible state of the world:
Condition prob. CF1 CF2 CF3 CF4 CF5
Do not mine .40 0 0 0 0 0
Acceptable Deposit .40 500K 700K 500K 0 0
Excellent Deposit .20 700K 900K 900K 700K 500K
The required return for this type of investment is 15.0%. What is the probabilistically-adjusted NPV for this project? [$23,000]
Explanation / Answer
DO NOT MINE 1 2 3 2*3 YEAR AFTER TAX CASH FLOW PRESENT VALUE FACTOR @12% PRESENT VALUE 1 0 0.87 0 2 0 0.756 0 3 0 0.658 0 4 0 0.572 0 5 0 0.497 0 total 0 ACCEPTABLE DEPOSIT 1 2 3 2*3 YEAR AFTER TAX CASH FLOW PRESENT VALUE FACTOR @12% PRESENT VALUE 1 500000 0.87 435000 2 700000 0.756 529200 3 500000 0.658 329000 4 0 0.572 0 5 0 0.497 0 total 1293200 EXCELLENT DEPOSIT 1 2 3 2*3 YEAR AFTER TAX CASH FLOW PRESENT VALUE FACTOR @12% PRESENT VALUE 1 700000 0.87 609000 2 900000 0.756 680400 3 900000 0.658 592200 4 700000 0.572 400400 5 500000 0.497 248500 total 2530500 1 2 3 2*3 CONDITION PROBABILITY PRESENT VALUE OF CASH FLOW VALUE DO NOT MINE 0.4 0 0 ACCEPTABLE DEPOSIT 0.4 1293200 517280 EXCELLENT DEPOSIT 0.2 2530500 506100 1023380 CASH OUTFLOW $1,000,000 CASH INFLOW $1,023,380 NET PRESENT VALUE $23,380
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