A silver mine can yield 13,000 ounces of silver at a variable cost of $32 per ou

Question

A silver mine can yield 13,000 ounces of silver at a variable cost of $32 per ounce. The fixed costs of operating the mine are $52,000 per year. In half the years, silver can be sold for $48 per ounce; in the other years, silver can be sold for only $24 per ounce. Ignore taxes.

a. What is the average cash flow you will receive from the mine if it is always kept in operation and the silver always is sold in the year it is mined?

b. Now suppose you can shut down the mine in years of low silver prices. Calculate the average cash flow from the mine.

a. What is the average cash flow you will receive from the mine if it is always kept in operation and the silver always is sold in the year it is mined?

b. Now suppose you can shut down the mine in years of low silver prices. Calculate the average cash flow from the mine.

Explanation / Answer

a. Let us consider the costs for per year.

Cost per year = 13000*32 + 52000 = $468,000

Let us consider the revnue when price = 48. The revenue = 13000*48 = 624,000

In the year when price =24, the revenue = 13000*24 = 312,000

hence average revenue per year =( 624,000+312,000)/2 = $468,000

Since cost and revneue is the same which is 468,000, the average cash flow = 0 (zero)

b. When the mine is shut in years of low prices, the cash flow is

Cost = 468,000 (from part a)

Revenue when silver price = 48, is 624,000 (from part a)

So average cash flow in that year = 624000-468000 = $156,000

Cash flow in the next year = 0

So average cash per year =( 156000+0)/2 = $78,000

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