Question

Flag Seth Bullock, the owner of Bullock Gold Mining, is evaluating a new gold mine in South Dakota. Dan Dority, the company's geologist, has just finished his analysis of the mine site. He has estimated that the mine would be productive for eight years, after which the gold would be completely mined. Dan has taken an estimate of the gold deposits to Alma Garrett, the company's financial officer. Alma has been asked by Seth to perform an analysis of the new mine and present her recommendation on whether the company should open the new mine. Alma has used the estimates provided by Dan to determine the revenues that could be expected from the mine. She has also projected the expense of opening the mine and the annual operating expenses. If the company opens the mine, it will cost $850 million today, and it will have a cash outflow of $120 million nine years from today in costs associated with closing the mine and reclaiming the area surrounding it. The expected cash flows each year from the mine are shown in the table. Bullock Mining has a 12 percent required return on all of its gold mines.

0	-850,000,000
1	165,000,000
2	190,000,000
3	225,000,000
4	245,000,000
5	235,000,000
6	195,000,000
7	175,000,000
8	155,000,000
9	-120,000,000

A. Based on the above, construct a spreadsheet to calculate the Net Present Value, modified internal rate of return (MIRR), the payback period and the discounted payback period (Assume a cut off of 5 years for the payback and discounted payback period).

B. Based on your analysis, should the company open the mine?

Answer 1

A:

NPV:

Thus NPV = $95,268,940.02

Modified internal rate of return (MIRR): the formula is: present value of costs = terminal value/(1+mirr)^n

= 850,000,000 + (120,000,000/1.12^9) = [165,000,000*1.12^8 + 190,000,000*1.12^7 + 225,000,000 * 1.12^6 + 245,000,000*1.12^5 + 235,000,000*1.12^4 + 195,000,000*1.12^3 + 175,000,000*1.12^2 + 155,000,000*1.12]/(1+mirr)^9

Or 893,273,203 = 2,741,305,218/(1+mirr)^9

Or (1+mirr)^9 = 3.06883

Or MIRR = 13.27%

Payback and discounted payabck:

Year	CF	PV	Cumulative CFs	Cumulative discounted CFs
0	-       850,000,000	-     850,000,000	-         850,000,000	- 850,000,000
1	165,000,000	147,321,429	-         685,000,000	- 702,678,571
2	190,000,000	151,466,837	-         495,000,000	- 551,211,735
3	225,000,000	160,150,556	-         270,000,000	- 391,061,179
4	245,000,000	155,701,929	-            25,000,000	- 235,359,250
5	235,000,000	133,345,311	210,000,000	- 102,013,939
6	195,000,000	98,793,069	405,000,000	-      3,220,870
7	175,000,000	79,161,113	580,000,000	75,940,243
8	155,000,000	62,601,900	735,000,000	138,542,143
9	-       120,000,000	-       43,273,203	615,000,000	95,268,940

Payback = 4 + (25000/235000) = 4.00011 years

Discounted payback = 6 + (3220870/79161113) = 6.04 years

B: Yes, the company should open the mine. Its NPV is positive and as per NPV criteria a positive NPV means that the project is financially feasible. The project’s MIRR of 13.27% > required return of 12% and hence the project is feasible as per the MIRR criteria as well. As shown above the project’s payback of 4.00011 years is < the cut off of 5 years and this also makes the project feasible. The project’s discounted payback of 6.04 years exceeds the cutoff point of 5 years but considering that NPV and MIRR criteria are satisfied the mine should be opened.