Maxine Peru, the CEO of Peru Resources, hardly noticed the plateof savory quenelles de brochet and the glass of Corton Char-lemagne '94 on the table before her. She was absorbed by the engi-necring report handed to her just as sho antered the cxccutivedining room.The report described a proposed now minc on the North Ridgeof Mt. Zircon. A vain of transcandental zirconium oro had beandiscovered thcre on land owned by Ms. Paru's company. Test bor-ings indicated sufficient reserves to produce 340 tons per ycar oftranscendental zirconium over a 7-ycar pariod.The vein probably also contnincd hydrated zircon gemstones.The amount and quality of theso zircons ware hard to predict, sincethoy tended to occur in "pockets." The new mine might comoacross onc, two, or dozons of pockets. The mining cngincer gucssedthat 150 pounds per yoar might bo found. The current price forhigh-quality hydrated zircon gemstones was $3,300 par pound.Peru Resources was a family-owned business with totnl assetsof $45 million, including cash reserves of $4 million. The outlayrequired for the new mine would be a major commitment. Fortu-nately, Paru Resources wns conscrvatively financed, and Ms. Perubelieved that the company could borrow up to $9 million at anintorost rute of about 8%.addition, new cnvironmental rogulations, if anacted, could incroasethe cost of the mine by $1.5 million.There was a choaper design for the minc, which would reduceits cost by $1.7 million and climinate much of the uncertnintyabout cost ovaruns. Unfortunately, this design would requiro muchhigher fixed opernting costs. Fixed costs would increase to$850,000 per ycar at planned production lovels.The curront price of trunscandental zirconium was S10.000 pcrton, but thero was no consonsus about future prices." Some cxpertswero projecting mpid price increases to as much as $14,000 perton. On the other hand, there were pessimistsB saying that pricescould bo as low as $7,500 per ton. Ms. Paru did not have strongvicws cither wny: Her best gucss was that price would just increasewith inflation at about 3.5% per yoar. (Mino opcruting costs wouldalso increaso with inflation.)Ms. Peru had wide cxperience in the mining business, and shoknow that investors in similar projects usually wanted a forecastednominal rate of return of at least 14%.You have been asked to assist Ms. Paru in cvalunting this proj-cct. Lay out the base-case NPV annlysis, and undertake sensitivity,sccnario, or break-even analyses as appropriate. Assume that PeruResources pays tnx at a 35% ratc. For simplicity, also assume thatthe investment in the mine could be depreciated for tax purposesstraight-line over 7 years.What forecasts or scenarios should worry Ms. Peru the most?Whare would additional informntion be most helpful? Is there acase for delaying construction of the new minc?The mine's opornting costs were projected at $900,000 per ycar,including $400,000 of fixed costs and $500,000 of variable costs.Ms. Peru thought these forccasts wore accuratc. The big questionmarks seemed to bc the initinl cost of the mino and the selling priceof transcendental zirconium.Opening the mine, and providing the necessary machinery andore-crunching facilities, was supposed to cost $10 million, but costoverruns of I0% or 15% wcre common in the mining business. In8 Thero wane no traded forward or futures contrncts on transcandantal zir-conium. Sco Chapter 24.

Net present value is the net present worth of a project computed by deducting the initial cash…

addition, new environmental regulations, if enncted, could incrouse Maxine Peru, the CEO of Peru Resources, hardly noticed the plate of savory qucnelles de brochet and the glass of Corton Char- lemagne '94 on the table before her. She was absorbed by the engi- neering report handed to her just as she antered the cxccutive dining room. The report described a proposed new minc on the North Ridge of Mt. Zircon. A vein of transcendental zirconium ore had been the cost of the mine by $1.5 million. discovered thcro on land owned by Ms. Paru's company. Test bor- ings indicated sufficiant rescrves to produce 340 tons per ycar of transcendantal zirconium over a 7-ycar period. The vein probably also contnincd hydrated zircon gemstones. The amount and quality of these zircons were hard to predict, since they tended to occur in "pockets." The new minc might come across onc, two, or dozens of pockets. The mining engincer guessed that 150 pounds per yoar might be found. The currant price for high-quality hydrated zircon gemstones was $3,300 per pound. Peru Resources was a family-owned business with totnl assets of $45 million, including cash reserves of $4 million. The outlay required for the new mine would be a major commitment. Fortu- nately, Peru Resources was conscrvatively financed, and Ms. Peru believed that the company could borrow up to $9 million at an There was a cheaper design for the mine, which would roduce its cost by $1.7 million and climinate much of the uncertainty about cost overruns. Unfortunately, this dosign would requiro much higher fixed opernting costs. Fixed costs would increase to $850,000 per ycar at planned production levels. The curront price of trunscendental zirconium was $10,000 per ton, but there was no consensus about future prices." Some cxperts were projecting rapid price increases to as much as S14,000 per ton. On the other hand, there were pessimists saying that prices could bo as low as $7,500 per ton. Ms. Peru did not have strong vicws cither wny: Her best gucss was that price would just increase with inflation at about 3.5% per year. (Minc opcrating costs would also increase with inflation.) Ms. Peru had wide experience in the mining business, and sho knew that investors in similar projects usually wanted a forecasted nominal rate of return of at least 14%. You have been asked to nssist Ms. Peru in evalunting this proj- cct. Lay out the base-case NPV annlysis, and undertnke sensitivity, scenario, or break-cven analysos as appropriate. Assume that Peru Resources pays tnx at a 35% rate. For simplicity, also assume that the investment in the mine could be deprecinted for tax purposes straight-line over 7 years. What forecasts or scenarios should worry Ms. Peru the most? Where would additional informntion be most helpful? Is thero a case for delaying construction of the new mine? interost rate of about 8%. The mine's oporating costs wcre projected at $900,000 per ycar, including $400,000 of fixed costs and $500,000 of variable costs. Ms. Peru thought these forccasts ware accuratc. The big question marks seemed to be the initinl cost of the mino and the selling price of transcendental zirconium. Opening the mine, and providing the necessary machinery and ore-crunching facilitics, was supposed to cost Sl0 million, but cost overruns of 10% or 15% were common in the mining business. In There were no traded forward or futures contracts on transcondental zir- conium. Sec Chapter 24.

addition, new environmental regulations, if enncted, could incrouse Maxine Peru, the CEO of Peru Resources, hardly noticed the plate of savory qucnelles de brochet and the glass of Corton Char- lemagne '94 on the table before her. She was absorbed by the engi- neering report handed to her just as she antered the cxccutive dining room. The report described a proposed new minc on the North Ridge of Mt. Zircon. A vein of transcendental zirconium ore had been the cost of the mine by $1.5 million. discovered thcro on land owned by Ms. Paru's company. Test bor- ings indicated sufficiant rescrves to produce 340 tons per ycar of transcendantal zirconium over a 7-ycar period. The vein probably also contnincd hydrated zircon gemstones. The amount and quality of these zircons were hard to predict, since they tended to occur in "pockets." The new minc might come across onc, two, or dozens of pockets. The mining engincer guessed that 150 pounds per yoar might be found. The currant price for high-quality hydrated zircon gemstones was $3,300 per pound. Peru Resources was a family-owned business with totnl assets of $45 million, including cash reserves of $4 million. The outlay required for the new mine would be a major commitment. Fortu- nately, Peru Resources was conscrvatively financed, and Ms. Peru believed that the company could borrow up to $9 million at an There was a cheaper design for the mine, which would roduce its cost by $1.7 million and climinate much of the uncertainty about cost overruns. Unfortunately, this dosign would requiro much higher fixed opernting costs. Fixed costs would increase to $850,000 per ycar at planned production levels. The curront price of trunscendental zirconium was $10,000 per ton, but there was no consensus about future prices." Some cxperts were projecting rapid price increases to as much as S14,000 per ton. On the other hand, there were pessimists saying that prices could bo as low as $7,500 per ton. Ms. Peru did not have strong vicws cither wny: Her best gucss was that price would just increase with inflation at about 3.5% per year. (Minc opcrating costs would also increase with inflation.) Ms. Peru had wide experience in the mining business, and sho knew that investors in similar projects usually wanted a forecasted nominal rate of return of at least 14%. You have been asked to nssist Ms. Peru in evalunting this proj- cct. Lay out the base-case NPV annlysis, and undertnke sensitivity, scenario, or break-cven analysos as appropriate. Assume that Peru Resources pays tnx at a 35% rate. For simplicity, also assume that the investment in the mine could be deprecinted for tax purposes straight-line over 7 years. What forecasts or scenarios should worry Ms. Peru the most? Where would additional informntion be most helpful? Is thero a case for delaying construction of the new mine? interost rate of about 8%. The mine's oporating costs wcre projected at $900,000 per ycar, including $400,000 of fixed costs and $500,000 of variable costs. Ms. Peru thought these forccasts ware accuratc. The big question marks seemed to be the initinl cost of the mino and the selling price of transcendental zirconium. Opening the mine, and providing the necessary machinery and ore-crunching facilitics, was supposed to cost Sl0 million, but cost overruns of 10% or 15% were common in the mining business. In There were no traded forward or futures contracts on transcondental zir- conium. Sec Chapter 24.

Managerial Accounting

15th Edition

ISBN:9781337912020

Author:Carl Warren, Ph.d. Cma William B. Tayler

Publisher:Carl Warren, Ph.d. Cma William B. Tayler

Chapter7: Variable Costing For Management analysis

Section: Chapter Questions

Problem 2PA: The demand for solvent, one of numerous products manufactured by Logan Industries Inc., has dropped...

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