1. A4-4

A mineral property is producing at a rate that will generate $5 million in annual operating profit (revenue minus operating costs) during the next year (assume end of year one). Escalation of operating costs is expected to be offset by sales escalation in future years so that the annual end-of-year operating profit will remain constant at $5 million each year until the mineral reserves are depleted. At the current production rate, mineral reserves will be depleted at the end of ten years from now. An increase in the annual production rate is being considered by incurring a $2 million equipment and development cost now (time zero) and a $4 million equipment and development cost a year from now (end of year one). These expansion costs would permit increasing mineral production to give a projected total operating profit of $6 million at year one (cash flow of $2 million) and $8 million per year at years two through eight when reserves will be depleted at the increased production rate. The alternatives are summarized below. Use NPV analysis to evaluate the economic desirability of the expansion investments for a minimum ROR of 20%. Verify your NPV findings by making a valid ROR analysis and PVR analysis of these mutually exclusive alternatives.