Copco Mining, a copper mining company is considering a mining project that will

Question

Copco Mining, a copper mining company is considering a mining project that will have an initial cost of $4,550,000 and generate revenues of $3,500,000 per year for three years. During the fourth year, the mine will be shut down and there will be clean-up costs of $ 6,000,000 to restore the land to its original state, (a process that will be completed during the fourth year.) The plot of the NPV of this project (i.e., its NPV profile) for interest rates varying from 0 to 20% is given below. a) Can you use the IRR rule to decide whether to undertake this project or not? Why or why not? Explain. b) According to this profile for what values of the cost of capital is it worth undertaking the project? Explain why

NPV Profile $80,000.00 $60,000.00 $20,000.00 0.00 0% 2% 4% 6% 8% 10% 12% 14% 18% 20% 20,000.00 540,000.0 $60,000.00 $80,000.00 Discount Rate

Explanation / Answer

We cannot use the IRR rule to decide whether to undertake the project or not. This is because, IRR will only give you the % returns while to decide whether to accep a project, we need to see the absolute value generated by the project. The absolute wealth created is done by NPV method. So while IRR method and NOV method both indicate the same decision, NPV method is preferred over IRR.

If we see the graph carefully, NPV is posotive only when interest rate is greater than 2% but less than 16%

We will accept a project only if it has positive NPV. Hence, the cost of capital that should be maintained for accepting the project must be between 2% and 16%

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