Question

Evaluate the economic potential of purchasing mineral rights to a known deposit adjacent to your existing mine. The acquisition of this private property would be incurred now (time zero) for a $2 million mineral rights acquisition cost. Mining equipment costs of $7 million will also be incurred at time zero along with a mine development cost of $4 million. An additional $1 million will be spent on mine development at the end-of-year one. Production is expected to start in year one with 150,000 tons of gold ore. Production in years two, three, and four is estimated at 250,000 tons of ore per year. It is estimated that the gold ore reserves will be depleted at the end-of-year four. Reclamation costs will be expensed in year five and will total $0.5 million. Equipment will also be sold in that year for $1 million. All ore is estimated to contain an aver grade of 0.1 ounces of gold per ton, with metallurgical recover estimated at 90%. The price of gold is forecasted to be uniform at $900 per ounce each year. Operating costs are also estimated to be uniform at $600 per ounce in each of years 1-4. Compute the project before tax cash flow (BTCF), and then determine the project NPV, ROR, GROR, and PVR for an investor seeking a 15% minimum rate of return.

Answer 1

In the United States and a few other countries, ownership of mineral resources was originally granted to the individuals or organizations that owned the surface. These property owners had both "surface rights" and "mineral rights." This complete private ownership is known as a "fee simple estate."

In year 4, the entire working capital investment is recovered, and hence the investment in working capital is negative

loss on sale of equipment at end of year 4 = book value - sale price

book value = original cost - accumulated depreciation

after-tax salvage value = salvage value + tax benefit on loss on sale of equipment (the loss is tax deductible, and hence reduces the tax outgo. This is treated as a cash inflow)

NPV, IRR and MRR are calculated using NPV, IRR and MIRR functions in Excel

Payback period is the time taken for the cumulative cash flows to equal zero

Discounted payback period is the time taken for the cumulative discounted cash flows to equal zero.

FuncoLand has developed an efficient, new cloud server that that it can sell to other corporations to boost online operations and stability. For FuncoLand, it would cost $7 million at Year 0 to buy the equipment necessary to manufacture the server. The project would require net working capital at the beginning of each year in an amount equal to 10% of the year’s projected sales; for example, NWC0 = 10% (Sales1). The servers would sell for $24 per unit, and specialists estimate that variable costs would amount to $17  per unit. After Year 1, the sales price and variable costs will increase at the inflation rate of 3%. The company’s nonvariable costs would be $100at Year 1 and would increase at the inflation rate each year thereafter. The server project would have a life of 4 years. If the project is undertaken, it must be continued for the entire 4 years. Also, the project’s returns are expected to be highly correlated with returns on the firm’s other assets. The firm believes it could sell 100 units per year. The equipment would be depreciated over a 5-year period, using MACRS rates (see page 500). The estimated market value of the equipment at the end of the project’s 4-year life is $500. FuncoLand’s federal-plus-state tax rate is 30%. Its cost of capital is 10%.