Case #1 Bullock, the owner of Bullock Gold Mining, is evaluating a new gold mine

Question

Case #1 Bullock, the owner of Bullock Gold Mining, is evaluating a new gold mine in South Dakota. Dan Dorty, 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 estimated of the gold deposits to Alma Garret, the company's CFO. Alma has been asked to perform an analysis of the new mine and present her recommendation on whether the company should open the new mine. Seth Alam has used the estimated the cost provided by Dan to determine the revenues that could be expected from the mine. She also projected the expense of opening mine and the annual operatine expenses. If the company opens the mine, it will cost $500 million today, and will have a cash outflow of 580 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. Bullock Mining has a 12% required return on all of its Gold mines. year cash flow 160000000 2 90000000 3 170000000 4 230000000 205000000 6 140000000 7 110000000 8 70000000 9 -80000000 1. Construct a spreadsheet to calculate a. b, c. the payback period, (10%) internal rate of return, (10%) and net present value (10%) of the proposed mine. 2. Based on your analysis, should thedompany open the mine? why?(10%)

Explanation / Answer

Answer 1-a Calculation of pay back period of proposed mine Year Cash flow Cumulative Cash flow 0 -$500,000,000 -$500,000,000 1 $60,000,000 -$440,000,000 2 $90,000,000 -$350,000,000 3 $170,000,000 -$180,000,000 4 $230,000,000 $50,000,000 5 $205,000,000 $255,000,000 6 $140,000,000 $395,000,000 7 $110,000,000 $505,000,000 8 $70,000,000 $575,000,000 9 -$80,000,000 $495,000,000 Payback period = 3 years + ($180,000,000/$230,000,000) = 3.78 years Answer 1-b Calculation of internal rate of return of proposed mine Year Cash flow 0 -$500,000,000 1 $60,000,000 2 $90,000,000 3 $170,000,000 4 $230,000,000 5 $205,000,000 6 $140,000,000 7 $110,000,000 8 $70,000,000 9 -$80,000,000 IRR = 18.87% Answer 1-c Calculation of NPV of proposed mine Year Cash flow Discount Rate @ 12% Present Value 0 -$500,000,000                  1.00000 -$500,000,000 1 $60,000,000                  0.89286 $53,571,429 2 $90,000,000                  0.79719 $71,747,449 3 $170,000,000                  0.71178 $121,002,642 4 $230,000,000                  0.63552 $146,169,158 5 $205,000,000                  0.56743 $116,322,505 6 $140,000,000                  0.50663 $70,928,357 7 $110,000,000                  0.45235 $49,758,414 8 $70,000,000                  0.40388 $28,271,826 9 -$80,000,000                  0.36061 -$28,848,802 NPV $128,922,978 Answer 2 The company should open the mine as the proposed mine has positive NPV and its IRR is greater than required rate of return.

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