Question

Newmont Goldcorp is evaluating when to open a gold mine. The remaining life of the mine is 8 years and the mining operations will produce 5800 ounces per year. The required return on the gold mine is 12 percent, and it will cost $33.8 million to open the mine. When the mine is opened, the company will sign a contract that will guarantee the price of gold for the remaining life of the mine. IF the mine is opened today, each ounce of gold will generate an after-tax cash flow of $1,380 per ounce. If the company waits one year, there is a 60% probability that the contract price will generate an after-tax cash flow of $1580 per ounce and a 40 percent probability that the aftertax cash flow will be $1280 per ounce, What is the value of the option to wait?

Answer 1

NPV if the mine is opened today:

PMT (annual cash flow) = annual production*after-tax cash flow per oz = 5,800*1,380 = 8,004,000

N = 8; rate = 12%, solve for PV.

PV of after-tax cash flows = 39,760,988.69

NPV = -initial investment + PV of after-tax cash flows = -33,800,000 + 39,760,988.69 = 5,960,988.69

NPV if the mine is opened after one year:

NPV (after one year) = -initial investment + sum of (probability*PV of after-tax cash flows)

PV of after-tax cash flows if prob. = 60%: PMT = 5,800*1,580 = 9,164,000; N = 8; rate = 12%, solve for PV.

PV(60%) = 45,523,450.82

PV of after-tax cash flows if prob. = 40%: PMT = 5,800*1,280 = 7,424,000; N = 8; rate = 12%, solve for PV.

PV(40%) = 36,879,757.63

NPV (after one year) = -33,800,000 + (60%*45,523,450.82 + 40%*36,879,757.63) = 8,265,973.55

NPV (today) = NPV (after one year)/(1+12%) = 8,265,973.55/1.12 = 7,380,333.52

Value of the option to wait = 7,380,333.52 - 5,960,988.69 = 1,419,344.83