A geologist and a mining engineer have decided to form a company to develop industrial mineral projects in British Columbia and Yukon. Between themselves and some friends and relatives they have managed to raise quite a bit of money. During the first year, they spent $150,000. Based on their findings during that first year, they expect to spend $600,000 each year for the next three years on more detailed trenching, drilling, sampling and assaying at selected sites. If things go as expected, they think it would be possible to sell the mineral rights to at least one property for $3,500,000 probably at the end of the fourth year. 

 

A. Draw a realistic cash flow diagram of the company's operations over the four-year period. Briefly explain your drawing. 

 

B. The geologist and engineer are excited and tell the Cobre Mines story to anyone who will listen. After listening to their story, one person said: "Wow, if your numbers are right, you will have spent $1.95M and received $3.5M on the sale - that's somewhere between a 50% and a 100% return!" In one sentence say what this person does not understand.

 

C. The estimates of spending and the sale price are very rough, but are based on experience and recent sales of the mineral rights to similar properties. What is the anticipated rate of return? 

 

D. Suppose the sale of the mineral rights does not happen in year 4. How many more years could they continue to spend $600,000/year and then sell the mineral rights before the rate of return drops to 10%? [3 marks] Hint: Using Goal Seek, set NPV to 0 by changing the operational cost end-date cell. 

 

E. Suppose all the money they spent on the project before the sale was loaned to them. The principal of each loan will be paid from the proceeds of the sale. Whatever is left after the loan principals are paid will be used to pay interest on the loans and then whatever is left after that is profit. How much would be left for interest payments and profit after the loan principals are paid if the sale occurs at the end of year 4? How much would be left if the sale occurs at the end of the time determined in d)