A forecasted increase in metal prices has encouraged the Delta Resource Company to consider the expansion of the capacity in one of its open pit mine operations in Northern Ontario. For this purpose, the following after tax cash flow estimates have been made.
Existing Capacity: Positive after tax annual cash flows of $12.5 million over the remaining 10-year mine life.
Expanded Capacity: $40 million capital expenditure now (time 0), followed by positive annual cash flows of $20 million over the remaining 8-year mine life.
a) Determine the distribution of after-tax cash flows, as well as the rate of return associated with the considered incremental investment for expanding the production capacity.
b) If the company's cost of capital is 30% and it is considering selling the mine, what should its minimum acceptable selling price be? What capacity option did you choose? Explain your answer.