Problem 1

Seth Bullock, the owner of Bullock Gold Mining, is evaluating a new gold mine in South Dakota. Dan Dority, the company's geologist, has just finished his analysis of the mine site. He has estimated that the mine would be productive for five years, after which the mine would be worth nothing. Dan has taken an estimate of the gold deposits to Alma Garrett, the company's financial officer. Alma has been asked by Seth to perform an analysis of the new mine and present her recommendation on whether the company should open the new mine.

Alma has used the estimates provided by Dan to determine the revenues that could be expected from the mine. She has also projected the expense of opening the mine and the annual operating expenses. If the company opens the mine, it will cost $45 million today, and the expected cash flows each year from the mine are shown in the table. Bullock Mining has a 10% required return on all of its gold mines.

QUESTIONS

1.Construct a spreadsheet using Excel to calculate the net present value, and internal rate of return of the proposed mine.

2.Calculate the payback period, with a cutoff of 4 years.

3.Based on your analysis, should the company open the gold mine based on the following methods?

a)Payback

b)NPV

c)IRR

Year = 0 Year = 1 Year = 2 Year = 3 Year = 4 Year = 5

-$45,000,000 +$6,300,000 +$8,500,000 +$15,000,000 +$95,000,000 +$7,500,000