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. Can you use the IRR rule to decide whether to undertake this project or not? Why or why not? Explain. According to this profile for what values of the cost of capital is it worth undertaking the project? Explain why.

Explanation / Answer

(a) IRR rule cannot be applied here.

IRR is that discount rate at which, when all cash flows are discounted, NPV is zero. Here, NPV is zero at 2 discount rates (2% and 16%) and therefore, there are multiple IRRs making the IRR decision rule inapplicable.

(b)

In general. the higher the IRR, the more attractive a project is. Therefore, the IRR of 16% is more desirable than an IRR of 2%.

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