Question

Highland Mining and Minerals Co. is considering the purchase of two gold mines. Only one investment will be made. The Australian gold mine will cost $1,630,000 and will produce $306,000 per year in years 5 through 15 and $572,000 per year in years 16 through 25. The U.S. gold mine will cost $2,012,000 and will produce $270,000 per year for the next 25 years. The cost of capital is 10 percent. Use Appendix D for an approximate answer but calculate your final answers using the formula and financial calculator methods. (Note: In looking up present value factors for this problem, you need to work with the concept of a deferred annuity for the Australian mine. The returns in years 5 through 15 actually represent 11 years; the returns in years 16 through 25 represent 10 years.)
  
a-1. Calculate the net present value for each project. (Do not round intermediate calculations and round your answers to 2 decimal places.)
  

   
a-2. Which investment should be made?
  

	Australian mine
	U.S. mine

  
b-1. Assume the Australian mine justifies an extra 1 percent premium over the normal cost of capital because of its riskiness and relative uncertainty of cash flows. Calculate the new net present value given this assumption. (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places.)
  

  
  
b-2. Does the new assumption change the investment decision?
  

	yes
	No

Answer 1

a-1)Australian gold mine:

Present value of annual cash flow =[PVA10%5-15*A1]+[PVA 10%16-25*A2]

                                     = [4.43621*306000]+[1.47096*572000]

                                      = 1357480.26+ 841389.12

                                       = $ 2,198,869.38

NPV =present value -initial investment

   = 2,198,869.38- 1,630,000

      = $ 568,869.38

US gold mine:

Present value =PVA 10%,25*A

          = 9.07704*270000

           = $ 2450800.80

NPV = 2450800.80-2012000= $ 438,800.80

A-2)Australian mine should be undertaken as its NPV is higher.

b1)cost of capital for Australian mine will be 10+1% =11%

Present value = [PVA11%5-15*A1]+[PVA 11%16-25*A2]

       = [4.08842*306000]+[1.230875*572000]

       = 1251056.52+ 704060.5

      = 1955117.02

NPV = 1955117.02- 1630000

       = 325117.02

B-2)yes ,then investmen should be made in U.S. mine