The Bluestone Mining Company is considering three expansion plans. The first, Pl
ID: 2755144 • Letter: T
Question
The Bluestone Mining Company is considering three expansion plans. The first, Plan A, is to spend $325 million on a massive expansion of their strip mine in Western Australia. This expansion is expected to yield an additional $25 million per year in cash flow over the next 10 years of production. At the end of the production period, Bluestone will need to spend $10 million to return the expansion site to its original condition. The second proposal, Plan B, is to replace the technology at the Western Australia site lowering annual operating costs by $20 million per year. The new technology costs $50 million to implement and has an expected useful life of 10 years. The third option, Plan C, is to acquire the assets of a small independent mining operation in South Africa for $200 million in cash. The South Africa operation is expected to generate an initial cash flow of $15 million per year which is expected to grow 10% annually thereafter. Bluestone’s cost of capital is 10%. Which expansion plan is the best financial decision for Bluestone since they can choose only one, and why? (Please show your work so I can better understand the process)
Explanation / Answer
Answer:
To choose the best expansion plan among the given plans we need to calculate the Net Present Values for each expansion plan;
Plan A:
Present Value of Cash Outflows = $ 325 million + $ 10 million x PVF@10% for 10th year = $ 325 million + $ 10 million x 0.3855 = $ 328.855 million
Present Value of Cash Inflows = $ 25 million x PVAF@10% for 10 years = $ 25 million x 6.1445 = $ 153.6142 million
therefore, Net Present Value of Plan A = $ 153.6142 - $ 328.855 = ($ 175.2413) negative NPV.
Plan B:
Present Value of Cash Outflows = $ 50 million
Present Values of Annual Saving in Cost or Cash Inflows = $ 20 million x PVAF@10% for 10 years = $ 20 million x 6.1455 = $ 122.8913 million
Net Present Value of Plan B = $ 122.8913 million - $ 50 million = $ 72.8913 million possitive NPV
Plan C:
Present Value of Cash Outflow = $ 200 million
Present Value of Cash Inflows (assuming the project life of 10 years) = sum of ($ 15 million x PVF@10% for year 1 + $ 15 million x 1.1 x PVF@10% for year 2 + .........................+ $ 15 million x 1.19 x PVF@ 10% for year 10) = $ 13.64 million x 10 = $ 136.40 million
therefore, Net Present Value for Plan C = $ 136.40 million - $ 200 million = ($ 63.6 million) negative NPV.
Conclusion: The best expansion plan among the three given plans is Plan B because it gives possitive Net Present Value.
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