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MINICASE Maxine Peru, the CEO of Peru Resources, hardly noticed the plate current price for high-quality hydrated zircon gemstones was of savory quenelles de brochet and the glass of Corton Char $3.300 per pound. lemagne 94 on the table before her. She was absorbed by the engi- Peru Resources was a family-owned business with total assets neering report handed to her just as she entered the executive of $45 million, including cash reserves of S4 million. The outlay dining room. required for the new mine would be a major commitment. Fortu- The report described a proposed new mine on the North Ridge nately, Peru Resources was conservatively financed, and Ms. Peru of Mt. Zircon. A vein of transcendental zirconium ore had been believed that the company could borrow up to $9 million at an discovered there on land owned by Ms. Peru's company. Test bor interest rate of about 8%. ings indicated sufficient reserves to produce 340 tons per year of The mine's operating costs were projected at $900,000 transcendental zirconium over a 7-year period. including $400,000 of fixed costs and $500,000 of variable costs. The vein probably also contained hydrated zircon gemstones. Ms. Peru thought these forecasts were accurate. The big question The amount and quality of these zircons were hard to predict marks seemed to be the initial cost of the mine and the selling because they tended to occur in "pockets." The new mine might price of transcendental zirconium. come across one, two, or dozens of pockets. The mining engi- Opening the mine, and providing the necessary machinery and neer guessed that 150 pounds per year might be found. The ore-crunching facilities, was supposed to cost S10 million, but cos waruns of 10% or 15% were common in the mining business In addition, new environmental regulations, if enacted, could increase the cost of the mine by $1.5 million. There was a cheaper design for the mine, which would reduce its cost by $1.7 million and eliminate much of the uncertainty about cost overruns. Unfortunately, this design would require much higher fixed operating costs. Fixed costs would increase to $850,000 per year at planned production levels. The current price of transcendental zirconium was $10,000 per ton, but there was no consensus about future prices. Some experts were projecting rapid price increases to as much as $14,000 per ton. On the other hand, there were pessimists saying that prices could be as low as $7.500 per ton. Ms. Peru did not have strong views either way: Her best guess was that price would just increase with inflation at about 3.5% per year. (Minecrating costs would also increase with inflation Ms. Peru had wide experience in the mining business, and she knew that investors in similar projects usually wanted a forecast nominal rate of return of at least 14%. You have been asked to assist Ms. Peru in evaluating this project. Lay out the base-case NPV analysis, and undertake sensi tivity, scenario, or break-even analyses as appropriate. Assume that Peru Resources pays tax at a 35% rate. For simplicity, also assume that the investment in the mine could be depreciated for tax purposes straight-line over 7 years. What forecasts or scenarios should worty Ms. Peru the most! Where would additional information be most helpful? Is there a case for delaying construction of the new mine
