You are considering constructing a new plant in a remote wilderness area to process the ore from a planned mining operation. You anticipate that the plant will take a year to build and cost $95 million upfront. Once built, it will generate cash flows of $12 million per year starting two years from today. In 21 years, after its 20th year of operation, the mine will run out of ore and you expect to pay $145 million to shut the plant down and restore the area to its pristine state. Using a cost of capital of 12%: a. What is the NPV of the project? b. Is using the IRR rule reliable for this project? Explain. c. What are the IRRS of this project?
You are considering constructing a new plant in a remote wilderness area to process the ore from a planned mining operation. You anticipate that the plant will take a year to build and cost $95 million upfront. Once built, it will generate cash flows of $12 million per year starting two years from today. In 21 years, after its 20th year of operation, the mine will run out of ore and you expect to pay $145 million to shut the plant down and restore the area to its pristine state. Using a cost of capital of 12%: a. What is the NPV of the project? b. Is using the IRR rule reliable for this project? Explain. c. What are the IRRS of this project?
Chapter10: Capital Budgeting: Decision Criteria And Real Option
Section: Chapter Questions
Problem 12P
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Transcribed Image Text:You are considering constructing a new plant in a remote wilderness area to process the ore from a planned mining operation. You anticipate that the plant will take a
year to build and cost $95 million upfront. Once built, it will generate cash flows of $12 million per year starting two years from today. In 21 years, after its 20th year of
operation, the mine will run out of ore and you expect to pay $145 million to shut the plant down and restore the area to its pristine state. Using a cost of capital of 12%:
a. What is the NPV of the project?
b. Is using the IRR rule reliable for this project? Explain.
c. What are the IRRS of this project?
Expert Solution
Cash Flows:
| Year | Cash Flow |
| 0 | -95,000,000 |
| 1 | 0 |
| 2 | 12,000,000 |
| 3 | 12,000,000 |
| 4 | 12,000,000 |
| 5 | 12,000,000 |
| 6 | 12,000,000 |
| 7 | 12,000,000 |
| 8 | 12,000,000 |
| 9 | 12,000,000 |
| 10 | 12,000,000 |
| 11 | 12,000,000 |
| 12 | 12,000,000 |
| 13 | 12,000,000 |
| 14 | 12,000,000 |
| 15 | 12,000,000 |
| 16 | 12,000,000 |
| 17 | 12,000,000 |
| 18 | 12,000,000 |
| 19 | 12,000,000 |
| 20 | 12,000,000 |
| 21 | -145,000,000 |
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