Question 4

Capital Budgeting

An Australian gold mining company is contemplating whether to spend $210m into building a processing plant and developing a deposit that is expected to produce for 10 years. The projected schedule of production is defined as the following:

Years 1 to 3 100 000oz if the third letter of your first name is A-M and 120 000oz if N-Z. (= 120 000oz)

Years 4 to 7 130 000oz if your year of birth is even and 110 000oz if odd. (=130 000oz)

Years 8 to 10 125 000oz if your day of birth is 1st-10th, 150 000oz if 11th-20th and 145 000 if 21st - 31st . (=145000)

The projected gold price are as follows:

Years 1 to 2 - $2 200/oz if you are enrolled in the Parramatta campus, $2 050/oz if Brisbane and $2 150/oz if by distance. (=150oz)

Years 3 to 6 - $2 800/oz if your second last number of your ID is even and $2 950/oz if odd. (=$2950)

Years 7 to 10 - $3 100/oz if the product of your day of birth and year of birth is an even number and $3 300/oz if odd. (=300/0z)

Production Costs

Years 1 to 4 - $1 500/oz if your third number of your ID is even and $1 700/oz if odd. (=$1700/0z)

Years 5 to 10 - $1 700/oz if your month of birth is January to April, $1 950/oz if May to August and $1 800/oz if September to December. (=$1950/oz)

Administration Costs

Years 1 to 10 - $450/oz if your month of birth is January to April, $375/oz if May to August and $425/oz if September to December. (=$375/0z)

The capital expenditure (which will be depreciated over six years over years 5 to 10) will be incurred by the company in year 4 to expand the mine operations into the underground deposit. The cost will be:

$54m if your year of birth is before 1995, $66m if 1995 to 1998 and $72m if after 1998. (=66m)

The mine closure rehabilitation expense will be $80m at the end of the mine life. This expenditure will not be tax deductible.

The depreciation of the mine infrastructure will be using straight line depreciation and is expected to have a scrap value of $40m at the end of the ten years.

The risk-adjusted rate of return for this mine is 15%.

1. Set up an appropriate schedule for the expected production and also the cashflows relating to the project.

b.) Estimate the mines profit after tax for each year.

c.) Calculate the cashflows generated by the mine for each year after removing the effects of the non-cash adjustments.

d.) Calculate the payback period in years, correct to 2 decimal places.

e.) Calculate the discounted payback period in years, correct to 2 decimal places.

f.) Calculate the net present value correct to the nearest million dollars.

g.) Calculate the internal rate of return as a % correct to 2 decimal places.

h.) Comment on the financial viability of this project based on your answers in d.) to g.).

i.) Repeat the exercise for the case where the mine is expected to produce 10% less gold each year and the costs increase by 12%. Would your decision change regarding the financial viability of the mine?