Hickock Mining is evaluating when to open a gold mine. The mine has 60,000 ounce

Question

Hickock Mining is evaluating when to open a gold mine. The mine has 60,000 ounces of gold left that can be mined, and mining operations will produce 7,500ounces per year. The required return on the gold mine is 12%, and it will cost $14million to open the mine. When the mine is opened, the company will sign a contract that will guarantee the price of gold for the remaining life of the mine. If the mine is opened today, each ounce of gold will generate an aftertax cash flow of $450 per ounce. I the company waits one year, there is a 60% probability that the contract price will generate an aftertax cash flow of $500 per ounce and a 40% probability that the aftertax cash flow will be $410 per ounce. What is the NPV in one year to wait, NPV today for waiting, What is the value of the option to wait.

Explanation / Answer

This can be easily done on excel just follow some steps as follows. Step1: Go to excel and click "insert" to insert the function. Step2: Select the "PV" function as we are finding the present value in this case. Step3: Enter the values as Rate = 12%; Nper = 1; PMT = 0; FV = -3,750,000 Step4: Click "OK" to get the desired value. The value comes to "$3,348,214" At 60% probability, future value is determined as $7500*$500 = $3,750,000 Similarly calculating the present value at 40% probability. Step1: Go to excel and click "insert" to insert the function. Step2: Select the "PV" function as we are finding the present value in this case. Step3: Enter the values as Rate = 12%; Nper = 1; PMT = 0; FV = -3,075,000 Step4: Click "OK" to get the desired value. The value comes to "$2,745,535" At 40% probability, future value is determined as $7500*$500 = $3,075,000 Therefore, the present value is low at 40% probability. Hence, the present value of the option to wait is $2,745,535

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