Question 7. (15 points) Marcel Corporation is considering a silver mining projec

Question

Question 7. (15 points) Marcel Corporation is considering a silver mining project would cost $50 million today and generate positive cash flows of $15 million a year at the end of each of the next 5 years.   The project's cost of capital is 10%.

a.      Calculate the project's NPV if the company proceeds now.

b.   The company is fairly confident about its cash flow forecast, but expects to have better price information in 2 years. The company believes the cost will be $55 million in 2 years. It estimates there is a 90% change CFs will be $16 million for 5 years and a 10% change CFs will be $12 million for 5 years. Should the company proceed with the project now or wait 2 years until it has better information?

Explanation / Answer

NPV=-50+15/1.1+15/1.1^2+15/1.1^3+15/1.1^4+15/1.1^5=6.8618 million

Expected cash flows for 5 years=0.9*16+0.1*12=15.6 million

Expected NPV in 2 years=-55+15.6/1.1+15.6/1.1^2+15.6/1.1^3+15.6/1.1^4+15.6/1.1^5=4.136274

As the expected NPV in 2 years is less than present NPV and then present value of expected NPV in 2 years will be even more less than present NPV..Hence, we should not wait but we should do the project now.

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