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 eft that can be mined, and mining operations will produce 7,500 ounces per year. The required return on the gold mines 12 percent, and it will cost $14 million to open the mine. When the mine is opened, the company will sign a contract that will guarantee the pace for gold for the remaining life of the mine. If the mine is opened today, each ounce of gold will generate an after tax cash flow of $450 per ounce. If the company waits one year, there is a 60 percent probability that the contract price will generate an aftertax cash flow or $500 per ounce and a 40 percent probability that the afteftax cash flow will be $410 per ounce. What is the value of the option to wait? No not use a comma in your numerical answer.

Explanation / Answer

First calculate the expected price of gold per ounce after 1 year.

Price = 60% * 500 + 40% * 410 = $464

Since the mine has 60,000 ounces of gold, if 7,500 ounces are mined per year, mine will last for 60000 / 7500 = 8 years

Today at $450 per ounce, cash flows from year 1 are 450 * 7500 = 3,375,000

After 1 year, at $464 per ounce, cash flows from year 1 would be 464 * 7500 = 3,480,000

All the cash flows are entered into a table in excel as below

NPV of both projects can be found by using the below excel formula

If invested Today =NPV(12%,B2:B10) = $2,469,450.19

If invested after 1 year =NPV(12%,C2:C10) = $2,935,166.42

So value of wait = 2,935,166.42 - 2,469,450.19 = $465,716.23

Today After 1 Year Year 0         (14,000,000)         (14,000,000) Year 1              3,375,000              3,480,000 Year 2              3,375,000              3,480,000 Year 3              3,375,000              3,480,000 Year 4              3,375,000              3,480,000 Year 5              3,375,000              3,480,000 Year 6              3,375,000              3,480,000 Year 7              3,375,000              3,480,000 Year 8              3,375,000              3,480,000

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