VALUING GOLD RECLAIMED FROM OLD PERSONAL COMPUTERS: A NUMBER OF INDUSTRIAL PRODUCTS INCLUDE GOLD AND SILVER AS A COMPONENT BECAUSE THEY HAVE VERY GOOD CONDUCTIVE PROPERTIES. THE S&M SMELTING COMPANY ENGAGES IN THE RECOVERY OF GOLD FROM SUCH PRODUCTS AND IS CONSIDERING A CONTRACT TO BEGIN EXTRACTING THE GOLD FROM THE RECYCLING OF PERSONAL COMPUTERS. THE PROJECT INVOLVES CONTRACTING WITH THE STATE GOVERNMENTS OF THREE MIDWESTERN STATES TO DiSPOSE OF THEIR PCS. THE PROJECT WILL LAST FOR FIVE YEARS, AND THE CONTRACT CALLS FRO THE DISPOSAL OF 200,000 PCS PER YEAR. THERE TONS OF ELECTRONIC SCRAP CONTAINS APPROXIMATELY ONE TROY OUNCE OF GOLD. MOREOVER, EACH PC CONTAINS APPROXIMATELY 6 POUNDS OF ELECTRONIC SCRAP, AND THE PROCESSING COST INVOLVED IN EXTRACTING THE GOLD IS $67.50 PER TON OF SCRAP. IN ADDITION, THE CURRENT SPOT PRICE OF GOLD IS $592.80, AND THE FORWARD PRICE CURVE FOR THE PRICE PER OUNCE OF GOLD SPANNING THE NEXT FIvE YEARS IS AS FOLLOWS:

2011$679.40/OUNCE

2012$715.10/OUNCE

2013$750.60/OUNCE

2014$786.90/OUNCE

2015$822.80/OUNCE

S&M ESTIMATES THAT THE FIRM?S COST OF CAPITAL IS 10.5%, AND THE RISK FREE RATE OF INTEREST ON FIVE-YEAR TREASURY BONDS IS CURRENTLY 5.0%. IN ADDITION, S&M FACES A 30% TAX RATE, AND THE ENTIRE INVESTMENT OF $450,000 MADE IN THE PROJECT IN 2010 WILL BE DEPRECIATED USING STRAIGHT-LINE DEPRECIATION OVER FIVE YEARS WITH A ZERO SALVAGE VALUE.

A.ESTIMATE THE AFTER-TAX (CERTAINTY-EQUIVALENT) PROJECT FREE CASH FLOWS FOR THE PROJECT OVER ITS FIVE-YEAR PRODUCTIVE LIFE.

B.USING THE CERTAINTY-EQUIVALENT VALUATION METHODOLOGY, ESTIMATE THE NPV OF THE PROJECT.

C.IF WE ASSUME THAT GOLD PROCESS WILL INCREASE AT A RATE OF 7% PER YEAR OVER THE NEXT FIVE YEARS, WHAT IS THE NPV OF PROJECT USING THE TRADITIONAL WACC METHOD OF ANALYSIS BASED ON EXPECTED PROJECT FREE CASH FLOW, WHERE THE WACC IS ESTIMATED TO BE 10.5%? WHAT RATE OF GROWTH IN GOLD PRICES IS REQUIRED TO PRODUCE THE SAME NPV USING THE TRADITIONAL WAS APPROACH AS WITH THE CERTAINTY-EQUIVALENT APPROACH USED IN PART B?

PROBLEM 11-6 Given Initial investment Total PCs scrapped Electronic scrap per PC Gold content Life of project PCs scrapped per year Tons of scrap per year Current price of gold Cost/ton for processing Tax rate Risk free rate WACC Growth in gold prices Forward Price Curve 2011 2012 2013 2014 2015 $ $ $ 450,000 1,000,000 6 0.33 5 200,000 600 592.80 67.50 30.0% 5.0% 10.5% 7.0% Solution Legend = Value given in problem = Formula/Calculation/Analysis required = Qualitative analysis or Short answer required = Goal Seek or Solver cell = Crystal Ball Input = Crystal Ball Output units pounds ounce per ton years units per ounce Gold Expected Prices Price/Ounce per Ounce $ 679.40 $ 634.30 715.10 678.70 750.60 726.21 786.90 777.04 822.80 831.43 Solution a. Revenues Processing Costs Depreciation/ Depletion NOI NOPAT Plus: Depreciation Project FCF Revenues Year 2011 2012 2013 2014 2015 Processing Costs Depreciation/ Depletion NOI NOPAT Plus: Depreciation Project FCF Processing Costs Depreciation/ Depletion NOI NOPAT Plus: Depreciation b. NPV c. Year 2011 2012 2013 2014 2015 NPV To solve for equivalent growth rate, use the following: Year 2011 2012 2013 2014 2015 Expected Price Revenues NPV Difference Use Solver. Set difference to zero by changing growth rate cell (yellow highlighted) Project FCF