Hickock Mining is evaluating when to open a gold mine. The mine has 37,100 ounce
ID: 2704560 • Letter: H
Question
Hickock Mining is evaluating when to open a gold mine. The mine has 37,100 ounces of gold left that can be mined, and mining operations will produce 5,300 ounces per year. The required return on the gold mine is 10 percent, and it will cost $33.3 million 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 $1,330 per ounce. If the company waits one year, there is a 55 percent probability that the contract price will generate an aftertax cash flow of $1,530 per ounce and a 45 percent probability that the aftertax cash flow will be $1,230 per ounce.
What is the value of the option to wait? (2 decimal places)
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L.J.
Explanation / Answer
price of gold next year= 1530 * .55 + 1230*.45= $1,395
price this year= $1330
total gold= 37,100 ounces
used in 1 year= 5300
total years of use= 37100/5300= 7 years
At this year total return= 1330*5300= $7,049,000
the rate of return is more than 10% of invested sum $33.3 million , so it can be done
total return in 7 years= 49,343,000
Next year= 1395*5,300= $ 7,393,500
total return in 7 years=51,754,500
difference per year= 344,500
difference in 7 years= 2,411,500
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