Question

Recall from P11-28 that when the market price of gold is C$1,562.50 per ounce (C$ stands for Canadian dollars) the NPV for Maritime Resources Corp.—a Canadian mining firm that was reopening an old gold mine that had ceased operations in the past due to low gold prices—is C$44,188,992. Reopening the mine would require an up-front capital expenditure of C$67.8 million and annual operating expenses of C$19.42 million. Maritime expects that over a 5-year operating life it can recover 174,000 ounces of gold from the mine and that the project will have no terminal value. Maritime uses straight-line depreciation, has a 21.04% corporate tax rate, and has an 11.2% cost of capital. Before moving forward with the project, Maritime would like to determine the sensitivity of its capital budgeting decision to the market price of gold, which could fluctuate over the 5-year project life.

a. Calculate the internal rate of return (IRR) for the gold mine project if the price of gold drops 10%.

b. Calculate the net present value (NPV) for the gold mine project if the price of gold drops 10%.

c. Calculate the internal rate of return (IRR) for the gold mine project if the price of gold drops 20%.

d. Calculate the net present value (NPV) for the gold mine project if the price of gold drops 20%.

e. Below what price per ounce of gold is Maritime’s reopening of its old gold mine no longer acceptable?

Answer 1

Formula	Initial investment (I)	6,78,00,000
	Op.expenses/year (O)	1,94,20,000
	Life of mine (years) (L)	5
	Gold recovery (oz)	1,74,000
Gold recovery/L	Gold recovery/year ('R)	34,800
(I/L)	Depreciation	1,35,60,000
	Tax rate	21.04%
	Cost of capital	11.20%

a). Calculating annual cash flow when gold price drops by 10%:

New price (P) = 1,562.50*(1-10%) = 1,406.25

Formula	Annual CFs:
(R*P)	Revenue (S)	4,89,37,500
	Operating expenses (O)	1,94,20,000
	Depreciation (D)	1,35,60,000
(S-O-D)	Operating profit (OP)	1,59,57,500
(21.04%*OP)	Tax @ 21.04%	33,57,458
(OP -tax)	Net income (NI)	1,26,00,042
	Add: depreciation (D)	1,35,60,000
(NI + D)	Total cash flow (CF)	2,61,60,042

Calculating IRR:

Year (n)
0	-6,78,00,000
1	2,61,60,042
2	2,61,60,042
3	2,61,60,042
4	2,61,60,042
5	2,61,60,042
IRR	26.82%

(Calculated using IRR() function in excel)

IRR = 26.82% (if gold price drops by 10%)

b). NPV when gold price drops by 10%

Annual cash flow = 26,160,042 (as calculated above)

Present Value of cash inflows using PV() function in excel:

PMT	2,61,60,042
N	5
I/Y	11.20%
PV	9,62,00,354.96

NPV = initial investment + 96,200,354.96 = -67,800,000 + 96,200,354.96 = C$28,400,354.96 (Answer)

c). Annual cash flow if gold price drops by 20%:

P = 1,562.50*(1-20%) = C$1,250

Formula	Annual CFs:
(R*P)	Revenue (S)	4,35,00,000
	Operating expenses (O)	1,94,20,000
	Depreciation (D)	1,35,60,000
(S-O-D)	Operating profit (OP)	1,05,20,000
(21.04%*OP)	Tax @ 21.04%	22,13,408
(OP -tax)	Net income (NI)	83,06,592
	Add: depreciation (D)	1,35,60,000
(NI + D)	Total cash flow (CF)	2,18,66,592

IRR:

Year (n)
0	-6,78,00,000
1	2,18,66,592
2	2,18,66,592
3	2,18,66,592
4	2,18,66,592
5	2,18,66,592
IRR	18.38%

IRR (when gold price drops by 20%) = 18.38%

d). NPV when gold price drops by 20%:

Annual cash flow - 21,866,592 (as calculated above)

PMT	2,18,66,592
N	5
I/Y	11.20%
PV	8,04,11,717.69

NPV = = initial investment + 80,411,717.69 = -67,800,000 + 80,411,717.69 = C$12,611,717.69 (Answer)

e). Using Solver in excel, solve for NPV = 0, changing the price/ounce.

At a price of C$1,125.19, NPV becomes negative. So, at this price, reopening the mine won't be a viable option.