Highland Mining and Minerals Co. is considering the purchase of two gold mines.
ID: 2739013 • Letter: H
Question
Highland Mining and Minerals Co. is considering the purchase of two gold mines. Only one investment will be made. The Australian gold mine will cost $1,609,000 and will produce $370,000 per year in years 5 through 15 and $538,000 per year in years 16 through 25. The U.S. gold mine will cost $2,032,000 and will produce $312,000 per year for the next 25 years. The cost of capital is 5 percent. Use Appendix D for an approximate answer but calculate your final answers using the formula and financial calculator methods. (Note: In looking up present value factors for this problem, you need to work with the concept of a deferred annuity for the Australian mine. The returns in years 5 through 15 actually represent 11 years; the returns in years 16 through 25 represent 10 years.)
Calculate the net present value for each project. (Do not round intermediate calculations and round your answers to 2 decimal places.)
Which investment should be made?
Assume the Australian mine justifies an extra 3 percent premium over the normal cost of capital because of its riskiness and relative uncertainty of cash flows. Calculate the new net present value given this assumption. (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places.)
Calculate the net present value for each project. (Do not round intermediate calculations and round your answers to 2 decimal places.)
Explanation / Answer
The formula for NPV calculation
NPV = {Net Period Cash Flow/(1+r)^t} - Initial Investment
where r is cost of capital
and t is the number of time periods.
-1.
Calculate the net present value for each project. (Do not round intermediate calculations and round your answers to 2 decimal places.)
Net Present Value
The Australian mine
$2,917,757.94
The U.S. mine
$2,365,310.70
a-2.
Which investment should be made?
Australian mine, as NPV is higher for Australian mine.
b-1.
Assume the Australian mine justifies an extra 3 percent premium over the normal cost of capital because of its riskiness and relative uncertainty of cash flows. Calculate the new net present value given this assumption. (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places.)
Net Present Value
The Australian mine
$1,470,550.24
b-
Does the new assumption change the investment decision? Yes now U.S. Mine is has higher NPV so prefer that
year Cash flow from Australian Mine CF1 Formula PV of each cash flow at 5% Formula PV of each cash flow at (5+3)= 8% cash flow from U.S. Mine CF2 Formula PV of each cash flow at 5% 0 -1609000 CF1/(1+5%)^0 -1609000 CF1/(1+8%)^0 -1609000 -2032000 CF2/(1+5%)^0 -2032000 1 0 CF1/(1+5%)^1 0 CF1/(1+8%)^1 0 312000 CF2/(1+5%)^1 297142.86 2 0 CF1/(1+5%)^2 0 CF1/(1+8%)^2 0 312000 CF2/(1+5%)^2 282993.20 3 0 CF1/(1+5%)^3 0 CF1/(1+8%)^3 0 312000 CF2/(1+5%)^3 269517.33 4 0 CF1/(1+5%)^4 0 CF1/(1+8%)^4 0 312000 CF2/(1+5%)^4 256683.17 5 370000 CF1/(1+5%)^5 289904.68 CF1/(1+8%)^5 251815.78 312000 CF2/(1+5%)^5 244460.16 6 370000 CF1/(1+5%)^6 276099.70 CF1/(1+8%)^6 233162.76 312000 CF2/(1+5%)^6 232819.20 7 370000 CF1/(1+5%)^7 262952.09 CF1/(1+8%)^7 215891.45 312000 CF2/(1+5%)^7 221732.58 8 370000 CF1/(1+5%)^8 250430.56 CF1/(1+8%)^8 199899.49 312000 CF2/(1+5%)^8 211173.88 9 370000 CF1/(1+5%)^9 238505.30 CF1/(1+8%)^9 185092.12 312000 CF2/(1+5%)^9 201117.98 10 370000 CF1/(1+5%)^10 227147.90 CF1/(1+8%)^10 171381.59 312000 CF2/(1+5%)^10 191540.94 11 370000 CF1/(1+5%)^11 216331.34 CF1/(1+8%)^11 158686.66 312000 CF2/(1+5%)^11 182419.94 12 370000 CF1/(1+5%)^12 206029.84 CF1/(1+8%)^12 146932.09 312000 CF2/(1+5%)^12 173733.27 13 370000 CF1/(1+5%)^13 196218.90 CF1/(1+8%)^13 136048.23 312000 CF2/(1+5%)^13 165460.26 14 370000 CF1/(1+5%)^14 186875.14 CF1/(1+8%)^14 125970.59 312000 CF2/(1+5%)^14 157581.20 15 370000 CF1/(1+5%)^15 177976.33 CF1/(1+8%)^15 116639.43 312000 CF2/(1+5%)^15 150077.33 16 538000 CF1/(1+5%)^16 246464.00 CF1/(1+8%)^16 157037.07 312000 CF2/(1+5%)^16 142930.79 17 538000 CF1/(1+5%)^17 234727.62 CF1/(1+8%)^17 145404.70 312000 CF2/(1+5%)^17 136124.57 18 538000 CF1/(1+5%)^18 223550.11 CF1/(1+8%)^18 134633.98 312000 CF2/(1+5%)^18 129642.44 19 538000 CF1/(1+5%)^19 212904.87 CF1/(1+8%)^19 124661.09 312000 CF2/(1+5%)^19 123468.99 20 538000 CF1/(1+5%)^20 202766.54 CF1/(1+8%)^20 115426.94 312000 CF2/(1+5%)^20 117589.52 21 538000 CF1/(1+5%)^21 193110.99 CF1/(1+8%)^21 106876.79 312000 CF2/(1+5%)^21 111990.02 22 538000 CF1/(1+5%)^22 183915.23 CF1/(1+8%)^22 98959.99 312000 CF2/(1+5%)^22 106657.16 23 538000 CF1/(1+5%)^23 175157.36 CF1/(1+8%)^23 91629.62 312000 CF2/(1+5%)^23 101578.25 24 538000 CF1/(1+5%)^24 166816.54 CF1/(1+8%)^24 84842.24 312000 CF2/(1+5%)^24 96741.19 25 538000 CF1/(1+5%)^25 158872.89 CF1/(1+8%)^25 78557.63 312000 CF2/(1+5%)^25 92134.46 NPV $2,917,757.94 $1,470,550.24 $2,365,310.70Related Questions
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