Question 3

James Taylor, the owner of JT Gold Mining, is evaluating a new gold mine. The companys geologist has just finished his analysis of the mine site. He has estimated that the mine would be productive for eight years, after which the gold would be completely mined. The geologist has taken an estimate of the gold deposits to you, the companys chief financial officer. You have been asked by James to perform an analysis of the new mine and present your recommendation on whether the company should open the new mine. Your assistant has used the estimates provided by the geologist to determine the revenues that could be expected from the mine. The assistant has also projected the expense of opening the mine and the annual operating expenses. If the company opens the mine, it will cost $700 million today, and it will have a cash outflow of $95 million nine years from today in costs associated with closing the mine and reclaiming the area surrounding it. The expected net cash flows each year from the mine are shown in the table. JT Mining has a 10% required return on all of its gold mines.

Year	Net Cash Flow ($)
0	-700,000,000
1	75,000,000
2	120,000,000
3	160,000,000
4	210,000,000
5	240,000,000
6	160,000,000
7	130,000,000
8	90,000,000
9	-95,000,000

Questions: 1. What are the problems associated with using the payback period to evaluate cash flows? What are the advantages of using the payback period to evaluate cash flows? Are there any circumstances under which using payback might be appropriate? Explain. 2. What conceptual advantage does the discounted payback method have over the regular payback method? Can the discounted payback ever be longer than the regular payback? Explain. 3. If a project with conventional cash flows has a payback period less than the projects life, can you definitively state the algebraic sign of the NPV? Why or why not? If you know that the discounted payback period is less than the projects life, what can you say about the NPV? Explain. 4. Why NPV is considered a superior method of evaluating the cash flows from a project? 5. What is the relationship between IRR and NPV? Are there any situations in which you might prefer one method over the other? Explain. 6. Construct a spreadsheet to calculate the payback period, discounted payback period, net present value, and internal rate of return of the proposed mine. Based on your analysis, should JT Gold Mining open the mine?