Highland Mining and Minerals Co. is considering the purchase of two gold mines.

Question

Highland Mining and Minerals Co. is considering the purchase of two gold mines. Only one investment will be made. The Australian gold mine will cost $1,649,000 and will produce $353,000 per year in years 5 through 15 and $503,000 per year in years 16 through 25. The U.S. gold mine will cost $2,054,000 and will produce $282,000 per year for the next 25 years. The cost of capital is 13 percent. Use Appendix D for an approximate answer but calculate your final answers using the formula and financial calculator methods. (Note: In looking up present value factors for this problem, you need to work with the concept of a deferred annuity for the Australian mine. The returns in years 5 through 15 actually represent 11 years; the returns in years 16 through 25 represent 10 years.)
  
a-1. Calculate the net present value for each project. (Do not round intermediate calculations and round your answers to 2 decimal places.)
  

   
a-2. Which investment should be made?
  

  
b-1. Assume the Australian mine justifies an extra 2 percent premium over the normal cost of capital because of its riskiness and relative uncertainty of cash flows. Calculate the new net present value given this assumption. (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places.)
  

  
  
b-2. Does the new assumption change the investment decision?
  

Australian mine U.S. mine

Explanation / Answer

a 1)

Statement showing NPV

a 2) Investment should be made in Australian gold mine as NPV is high

B 1)

B 2) Yes since Australian gold mine's NPV becomes negative

Australian gold mine U.S. gold mine Year Revenue PVIF@13% PV Revenue PVIF@13% PV 1 0.885 0 282000 0.885 249558 2 0.783 0 282000 0.783 220847 3 0.693 0 282000 0.693 195440 4 0.613 0 282000 0.613 172956 5 353000 0.543 191594.3 282000 0.543 153058 6 353000 0.480 169552.4 282000 0.480 135450 7 353000 0.425 150046.4 282000 0.425 119867 8 353000 0.376 132784.4 282000 0.376 106077 9 353000 0.333 117508.3 282000 0.333 93874 10 353000 0.295 103989.7 282000 0.295 83074 11 353000 0.261 92026.27 282000 0.261 73517 12 353000 0.231 81439.18 282000 0.231 65059 13 353000 0.204 72070.07 282000 0.204 57574 14 353000 0.181 63778.82 282000 0.181 50951 15 353000 0.160 56441.44 282000 0.160 45089 16 503000 0.141 71172.61 282000 0.141 39902 17 503000 0.125 62984.61 282000 0.125 35311 18 503000 0.111 55738.59 282000 0.111 31249 19 503000 0.098 49326.19 282000 0.098 27654 20 503000 0.087 43651.49 282000 0.087 24473 21 503000 0.077 38629.64 282000 0.077 21657 22 503000 0.068 34185.52 282000 0.068 19166 23 503000 0.060 30252.68 282000 0.060 16961 24 503000 0.053 26772.28 282000 0.053 15010 25 503000 0.047 23692.28 282000 0.047 13283 Total 1667637 2067056 Less: Initial Investment 1649000 2054000 NPV 18637 13056

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