Question
m A mining company has discovered a small silver deposit neighbouring its existing mine site. It has been estimated that there is a ten-year supply
m A mining company has discovered a small silver deposit neighbouring its existing mine site. It has been estimated that there is a ten-year supply of silver in the deposit that would return $13.5 million annually to the firm. The estimated cost of developing the site is $63.6 million and could be financed by the issuance of shares. The firm has experienced significant growth, and this is reflected in a cost of equity of 21.6%. After analyzing the returns to the project, the firms chief financial officer (CFO) recommends to the board not to continue with it as it is not profitable to the firm. However, in speaking with an investment dealer the following week, the CFO is told that it would be possible to float bonds for up to $42 million carrying a coupon of 12%. The flotation costs for debt and equity are both 1.2% and the marginal tax rate for the firm is 40%. Is it profitable for the firm to continue with the project now?
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