The Bluestone Mining Company is considering three expansion plans. The first, Pl

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?

Explanation / Answer

Plan A

IRR = IRR({-325,25,25,25,25,25,25,25,25,25,25-10}) = -5.34%

Plan B

IRR = IRR({-50,20,20,20,20,20,20,20,20,20,20,20}) = 38.92%

Plan C

NPV = -200 + NPV(10%,15,16.5,18.15,19.97,21.96,24.16,26.57,29.23,32.15,35.37)

= -200 + 136.36

= -63.64

Prefer Plan B (As IRR is more than 10%, hence NPV also will be positive)

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