Opening the mine, and providing the necessary machinery and ore-crunching faciliti was supposed to cost $10 million, but cost overruns of 10% or 15% were common in the mining business. Page 331 In addition, new environmental regulations, if enacted, could increase the cost of the mine by $1.5 million. There was a cheaper design for the mine, which would reduce its cost by $1.7 million and eliminate much of the uncertainty about cost overruns. Unfortunately, this design would require much higher fixed operating costs. Fixed costs would increase to $850,000 per year at planned production levels. The current price of transcendental zirconium was $10,000 per ton, but there was no consensus about future prices." Some experts were projecting rapid price increases to as much as $14,000 per ton. On the other hand, there were pessimists saying that prices could be as low as $7,500 per ton. Ms. Peru did not have strong views either way: Her best guess was that price would just increase with inflation at about 3.5% per year. (Mine operating costs would also increase with inflation.) Ms. Peru had wide experience in the mining business, and she knew that investors in similar projects usually wanted a forecast nominal rate of return of at least 14%. You have been asked to assist Ms. Peru in evaluating this project. Lay out the base-case NPV analysis, and undertake sensitivity, scenario, or break-even analyses as appropriate. Assume that Peru Resources pays tax at a 30% rate. For simplicity, also assume that the investment in the mine could be depreciated for tax purposes straight-line over 7 years. What forecasts or scenarios should worry Ms. Peru the most? Where would additional information be most helpful? Is there a case for delaying construction of the new mine?
Opening the mine, and providing the necessary machinery and ore-crunching faciliti was supposed to cost $10 million, but cost overruns of 10% or 15% were common in the mining business. Page 331 In addition, new environmental regulations, if enacted, could increase the cost of the mine by $1.5 million. There was a cheaper design for the mine, which would reduce its cost by $1.7 million and eliminate much of the uncertainty about cost overruns. Unfortunately, this design would require much higher fixed operating costs. Fixed costs would increase to $850,000 per year at planned production levels. The current price of transcendental zirconium was $10,000 per ton, but there was no consensus about future prices." Some experts were projecting rapid price increases to as much as $14,000 per ton. On the other hand, there were pessimists saying that prices could be as low as $7,500 per ton. Ms. Peru did not have strong views either way: Her best guess was that price would just increase with inflation at about 3.5% per year. (Mine operating costs would also increase with inflation.) Ms. Peru had wide experience in the mining business, and she knew that investors in similar projects usually wanted a forecast nominal rate of return of at least 14%. You have been asked to assist Ms. Peru in evaluating this project. Lay out the base-case NPV analysis, and undertake sensitivity, scenario, or break-even analyses as appropriate. Assume that Peru Resources pays tax at a 30% rate. For simplicity, also assume that the investment in the mine could be depreciated for tax purposes straight-line over 7 years. What forecasts or scenarios should worry Ms. Peru the most? Where would additional information be most helpful? Is there a case for delaying construction of the new mine?
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Hello, I need help calculating the NPV and break-even calculations. I need step-by-step to understand what I am doing.
Thank you
Transcribed Image Text:Opening the mine, and providing the necessary machinery and ore-crunching faciliti
was supposed
to cost $10 million, but cost overruns of 10% or 15% were common in the mining business. Page 331
In addition, new environmental regulations, if enacted, could increase the cost of the mine
by $1.5 million.
There was a cheaper design for the mine, which would reduce its cost by $1.7 million and eliminate
much of the uncertainty about cost overruns. Unfortunately, this design would require much higher
fixed operating costs. Fixed costs would increase to $850,000 per year at planned production levels.
The current price of transcendental zirconium was $10,000 per ton, but there was no consensus
about future prices." Some experts were projecting rapid price increases to as much as $14,000 per
ton. On the other hand, there were pessimists saying that prices could be as low as $7,500 per ton.
Ms. Peru did not have strong views either way: Her best guess was that price would just increase with
inflation at about 3.5% per year. (Mine operating costs would also increase with inflation.)
Ms. Peru had wide experience in the mining business, and she knew that investors in similar projects
usually wanted a forecast nominal rate of return of at least 14%.
You have been asked to assist Ms. Peru in evaluating this project. Lay out the base-case NPV analysis,
and undertake sensitivity, scenario, or break-even analyses as appropriate. Assume that Peru
Resources pays tax at a 30% rate. For simplicity, also assume that the investment in the mine could
be depreciated for tax purposes straight-line over 7 years.
What forecasts or scenarios should worry Ms. Peru the most? Where would additional information
be most helpful? Is there a case for delaying construction of the new mine?
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