Seth Bullock, the owner of Bullock Gold Mining, is evaluating a new gold mine in

Question

Seth Bullock, the owner of Bullock Gold Mining, is evaluating a new gold mine in South Dakota. Dan Dority, the company’s geologist, has just finished his analysis of the mine site. He has estimated that the mine would be productive for eight years, after which the gold would be completely mined. Dan has taken an estimate of the gold deposits to Alma Garrett, the company’s financial officer. Alma has been asked by Seth to perform an analysis of the new mine and present her recommendation on whether the company should open the new mine. Alma has used the estimates provided by Dan to determine the revenues that could be expected from the mine. She has also projected the expense of opening the mine and the annual operating expenses. If the company opens the mine, it will cost $650 million today, and it will have a cash outflow of $72 million nine years from today in costs associated with closing the mine and reclaiming the area surrounding it. The expected cash flows each year from the mine are shown in the table on this page. Bullock Mining has a 12 percent required return on all of its gold mines. Year Cash Flow 0 $650,000,000 1 80,000,000 2 121,000,000 3 162,000,000 4 221,000,000 5 210,000,000 6 154,000,000 7 108,000,000 8 86,000,000 9 72,000,000 QUESTIONS 1. Construct a spreadsheet to calculate the payback period, internal rate of return, modified internal rate of return, and net present value of the proposed mine. 2. Based on your analysis, should the company open the mine? 3. Bonus question: Most spreadsheets do not have a built-in formula to calculate the payback period. Write a VBA script that calculates the payback period for a project.

Explanation / Answer

Part 1 and Part 2 have been answered. The VBA script can be created an expert in computer science.

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Part 1)

Payback Period

Payback period is the period within which the initial investment is recovered with the company. The payback period is calculated with the use of following table:

As, it can be seen that the accumulated cash flow turns to a positive value between Year 4 and Year 5, it indicates that the company is able to recover its investment between these 2 years. The payback period is calculated with the use of following formula:

Payback Period = Year upto which Partial Recovery is Made + Balance Amount/Cash Flow of the Year in which Full Recovery is Made = 4 + 66,000,000/210,000,000 = 4.31 Years

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IRR

IRR is the minimum rate of return acceptable from a project. It can be calculated with the use of IRR function of EXCEL/Financial Calculator. The basic formula for calculating IRR is given below:

NPV = 0 = Cash Flow Year 0 + Cash Flow Year 1/(1+IRR)^1 + Cash Flow Year 2/(1+IRR)^2 + Cash Flow Year 3/(1+IRR)^3 + Cash Flow Year 4/(1+IRR)^4 + Cash Flow Year 5(1+IRR)^5 + Cash Flow Year 6/(1+IRR)^6 + Cash Flow Year 7/(1+IRR)^7 + Cash Flow Year 8/(1+IRR)^8 + Cash Flow Year 9/(1+IRR)^9

The IRR is calculated with the use of EXCEL as follows:

IRR = 13.25%

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MIRR

MIRR can be calculated with the use of MIRR Function of EXCEL which is MIRR((Values)),finance_rate,reinvest_rate) where values = Cash Flows, Finance_Rate = 0 and Reinvest Rate = Required Return (12%). MIRR has been calculated with the use of EXCEL as follows:

MIRR = 11.69%

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NPV

NPV is the difference between the present value of cash inflows and cash outflows. The basic formula for calculating NPV is given below:

NPV = Cash Flow Year 0 + Cash Flow Year 1/(1+Required Return)^1 + Cash Flow Year 2/(1+Required Return)^2 + Cash Flow Year 3/(1+Required Return)^3 + Cash Flow Year 4/(1+Required Return)^4 + Cash Flow Year 5(1+Required Return)^5 + Cash Flow Year 6/(1+Required Return)^6 + Cash Flow Year 7/(1+Required Return)^7 + Cash Flow Year 8/(1+Required Return)^8 + Cash Flow Year 9/(1+Required Return)^9

NPV has been calculated with the use of EXCEL as follows:

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Part 2)

The company should open the mine as it will provide a positive NPV.

Year Cash Flow Accumulated Cash Flow 0 -650,000,000 -650,000,000 1 80,000,000 -570,000,000 2 121,000,000 -449,000,000 3 162,000,000 -287,000,000 4 221,000,000 -66,000,000 5 210,000,000 144,000,000 6 154,000,000 7 108,000,000 8 86,000,000 9 72,000,000

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