Question

A mining company is considering whether to develop a mining property. It is estimated that an immediate expenditure of $8 million will be needed to bring the property into production. Thereafter, the net cash inflow will be $1.9 million at the end of each year for the next 10 years. After that, an additional expenditure of $3 million at the end of the 11th year will be required to close down the mine and restore the surrounding area. For projects like this, the company would expect to earn at least j = 22%. (a) Should the company proceed with the investment? (b) What would the immediate expenditure have to be before your answer to (a) would change?

Answer 1

A) We need to calculate the NPV of the project to decide whether to go ahead with the project or not.

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Year 11 Cash flow -8 1.9 1.9 1.9 1.9 1.9 1.9 1.9 1.9 1.9 1.9 -3 we need to calculate the NPV of the project The minimum required rate of return is 22% cash flow can be taken from above, use financial calculator to calculate the NPV The NPV comes out to be -0.883 million Since the NPV is negative the company should not proceed with the investment

B) Since the NPV comes out to be $- 0.883 million, so if the immediate expenditure is less than $7.117 million then the NPV of the project would be positive. In that circumstances the project can be taken up.