Highland Mining and Minerals Co. is considering the purchase of two gold mines.
ID: 464215 • Letter: H
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 $1,671,000 and will produce $326,000 per year in years 5 through 15 and $504,000 per year in years 16 through 25. The U.S. gold mine will cost $2,072,000 and will produce $285,000 per year for the next 25 years. The cost of capital is 10 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.)
Calculate the net present value for each project. (Do not round intermediate calculations and round your answers to 2 decimal places.)
Which investment should be made?
Assume the Australian mine justifies an extra 4 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.)
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 $1,671,000 and will produce $326,000 per year in years 5 through 15 and $504,000 per year in years 16 through 25. The U.S. gold mine will cost $2,072,000 and will produce $285,000 per year for the next 25 years. The cost of capital is 10 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.)
Explanation / Answer
The Net present value of Australian Gold Mine = - $ 1,671,000 + $ 0 / 1.101 + $ 0 / 1.102 + $ 0 / 1.103 + $ 0 / 1.104 + $ 326,000/1.105 + -----------------$ 326,0000/1.1015 + $ 504,000/1.1016 + ----------------$ 504,000/1.1025
NPV of Australian gold mine = $ 516,569.88
NPV of US Gold Mine = $ 514,956.41
The investment is to be made is Australian Gold Mine .
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b- 1 ) If the Australian mine justifies an extra 4 percent premium over the normal cost of capital, the cost of capital for Australian will be 14%
The NPV of Australian mine will be = -$ 250,220.68
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b-2) The new assumption changes the investment decision and US gold mine has a higher NPV when compared to Australian gold mine . Hence the investment is to be made in US gold mine .
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Year Cash Flows Australian Gold Mine US Gold Mine 0 ($1,671,000) ($2,072,000) 1 0 $285,000 2 0 $285,000 3 0 $285,000 4 0 $285,000 5 $326,000 $285,000 6 $326,000 $285,000 7 $326,000 $285,000 8 $326,000 $285,000 9 $326,000 $285,000 10 $326,000 $285,000 11 $326,000 $285,000 12 $326,000 $285,000 13 $326,000 $285,000 14 $326,000 $285,000 15 $326,000 $285,000 16 $504,000 $285,000 17 $504,000 $285,000 18 $504,000 $285,000 19 $504,000 $285,000 20 $504,000 $285,000 21 $504,000 $285,000 22 $504,000 $285,000 23 $504,000 $285,000 24 $504,000 $285,000 25 $504,000 $285,000Related Questions
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