Question

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 $624 million today, and it will have a cash outflow of $90 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 following table. Bullock Mining has a 12 percent required return on all of its gold mines. Construct a spreadsheet to calculate the payback period, internal rate of return, modified internal rate of return, and net present value of the proposed mine. Based on your analysis, should the company open the mine?

Year	Cash Flow
0	−$624,000,000
1	70,000,000
2	129,000,000
3	183,000,000
4	235,000,000
5	210,000,000
6	164,000,000
7	108,000,000
8	86,000,000
9	−90,000,000

1. Construct a spreadsheet to calculate the payback period, internal rate of return, modified internal rate of return, and net present value of the proposed mine.
2. Based on your analysis, should the company open the mine?

Answer 1

Let us first fill the values in a spreadsheet

To find payback period, let us first find the cumulative cash flow. Payback period is the period in which the cumulative cash flow becomes +ve

Hence, payback period = 4 + 70000000/210000000 = 4.33 years

For Internal rate of return, we can use the excel function =IRR(cash flows)

Hence, IRR = 15.37%

For MIRR, we can use the function = MIRR(values, financing rate, reinvest rate)

financing rate = reinvest rate = required rate of return = 12%

Hence, MIRR = 13,34%

To calculate NPV, we can use the formula = NPV(rate, cash flows)

Hence, NPV = $66,357,552

Since the NPV is +ve, the company should open the mine