You own a coal mining company and are considering opening a new mine. The mine w

Question

You own a coal mining company and are considering opening a new mine. The mine will cost $117.3 million to open If this money is spent immediately, the mine will generate $20.7 million for the next 10 years. After that, the coal will run out and the site must be cleaned and maintained at environmental standards. The cleaning and maintenance are expected to cost $1.6 million per year in perpetuity, What does the IRR rule say about whether you should accept this opportunity? If the cost of capital is 7.9%, what does the NPV rule say? NPV of the Investment in the Coal Mine 18-1 10 20 Discount Rate (%) What does the IRR rule say about whether you should accept this opportunity? (Select the best choice below.) A. Reject the opportunity because the IRR is lower than the 7.9% cost of capital O B. There are two IRRs, so you cannot use the IRR as a criterion for accepting the opportunity O C. Accept the opportunity because the IRR is greater than the cost of capital. D. The IRR is r: 10 88%, so accept the opportunity The NFV using the cost of capital of 7.9% is million (Round to three decimal places) The plot of the NPV as a function of the discount rate is n shaped it intersects the x-axis atr. 1 90% and r= 10.88% What does the NPV nie say? choice below.) Select the best 0 A. If the opportunity cost of capital is greater than r= 10 88%, the investment should be undertaken. O B. Reject the project because the NPV is negative ° C. If the opportunity cost of capital is less than 1.90%, the investment should be undertaken O D If the opportunity cost of capital is between r= 1.90% and r-10 88%, the investment should be undertaken

Explanation / Answer

1. IRR rule:

0 = -117,300,000+20,700,000/IRR*(1-(1/(1+IRR)^10))+ ((-1,600,000/IRR)/(1+IRR)^10)

Solving the above equation we will get 2 different IRRs and so the answer is option "b" - there are two IRRs so you cannot use the IRR as a criterion for accepting the opportunity.

2. NPV =

-117,300,000+20,700,000/0.079*(1-(1/(1+0.079)^10))+ ((-1,600,000/0.079)/(1+0.079)^10)

= $12,758.929.983

3. The answer is option "d" - as between the rate of 1.90% and 10.88% the NPV will be positive.

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