The Bluestone Mining Company is considering three expansion plans. The first, Pl

Question

The Bluestone Mining Company is considering three expansion plans. The first, Plan A, is to spend $325 million on a massive expansion of their strip mine in Western Australia. This expansion is expected to yield an additional $25 million per year in cash flow over the next 10 years of production. At the end of the production period, Bluestone will need to spend $10 million to return the expansion site to its original condition. The second proposal, Plan B, is to replace the technology at the Western Australia site lowering annual operating costs by $20 million per year. The new technology costs $50 million to implement and has an expected useful life of 10 years. The third option, Plan C, is to acquire the assets of a small independent mining operation in South Africa for $200 million in cash. The South Africa operation is expected to generate an initial cash flow of $15 million per year which is expected to grow 10% annually thereafter. Bluestone’s cost of capital is 10%. Which expansion plan is the best financial decision for Bluestone since they can choose only one, and why?

Explanation / Answer

Bluestone should accept plan B as it has postive NPV and IRR 38% must higher than cost of capital of 10%. Other two plans are having negetive NPV and IRR much lower than cost of capital.

Plan A Plan B Plan C Initial CF -325,000,000 -50,000,000 -200,000,000 Year 1 25,000,000 20,000,000 15,000,000 Year 2 25,000,000 20,000,000            16,500,000 10% Increase CF Year 3 25,000,000 20,000,000            18,150,000 10% Increase CF Year 4 25,000,000 20,000,000            19,965,000 10% Increase CF Year 5 25,000,000 20,000,000            21,961,500 10% Increase CF Year 6 25,000,000 20,000,000            24,157,650 10% Increase CF Year 7 25,000,000 20,000,000            26,573,415 10% Increase CF Year 8 25,000,000 20,000,000            29,230,757 10% Increase CF Year 9 25,000,000 20,000,000            32,153,832 10% Increase CF Year 10 15,000,000 10 Million to clean 20,000,000            35,369,215 10% Increase CF Rate 10% 10% 10% NPV ($159,310,232.05) $66,264,856.47 ($57,851,239.67) IRR -5% 38% 3%

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