A silver mine can yield 10,000 ounces of silver at a variable cost of $32 per ou

Question

A silver mine can yield 10,000 ounces of silver at a variable cost of $32 per ounce. The fixed costs of operating the mine are $40,000 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.

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?

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

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?

Explanation / Answer

a. The Average Selling Price per ounce = (48+24)/2 = $36

    Variable Cost per ounce = $32

    Average Cash Flows from the mine if it is always kept in operation = (36-32)*10000 = $40000

Note : Fixed Cost is not considered being irrelevant for decision making.

b. In years of low silver prices, the mine can be shut down.

Selling Price of silver per ounce will be $48.

Average Cash Flows from mine = (48-32)*10000 = $160000

Note : Fixed Cost is not considered being irrelevant for decision making.

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