Problem #1

BHP Billiton, owner of several iron ore mines in Australia, has discovered two new mining sites for iron ore. They have hired a local geologist and an engineering firm to estimate costs and ore yields for these two sites if they are opened.

	Site A	Site B
Variable extraction costs per ton	$3.50	$4.10
Fixed costs over the life of the mine:
Blasting	$160,000	$195,000
Construction	$200,000	$235,000
Maintenance	$30,000	$25,000
Restoration costs	$45,000	$40,000
Total Fixed costs	$435,000	$495,000
Total tons of ore that can be extracted over the life of the mine:	210,000	150,000

BHP Billiton demands a return of 20% of the market price of iron ore.

Instructions:

1. If the current market price of iron ore is $9 per ton, what is BHPs target cost per ton?
2. Given the $9 market price, should either of the mines be opened?
3. The engineer working on Site B believes that if a custom conveyor system is installed, the variable extraction cost could be reduced to $3.25 per ton. The purchase price of the system is $30,000, but the costs to restore the site will increase to $45,000 if it is installed. Given the current $9 market price, should BHP install the conveyor and open Site B?