EXERCISE: Valuing a gas pipeline
You own a gas pipeline that requires no maintenance and will produce $2 million of revenue next year. Unfortunately, after the first year the volume of gas (and thus the revenue) is expected to decline by 4.0% per year.
a. If the discount rate is 11.0% and the pipeline lasts forever, what is it worth today?
b. If the discount rate is still 11.0%, but pipeline is to be abandoned at the end of 20 years, what is it worth today?
EXERCISE: Expanding capacity in molybdenum mines
Question:
AMAX Corporation is a mining company that focuses on extraction of molybdenum-a crucial additive in the production of steel. AMAX is considering expanding its molybdenum capacity and is deciding whether to pursue one of the following investment alternatives:
a) An investment to expand capacity at its Climax mine would cost $100M today (year 0), $50M next year (year 1) and would increase capacity in years 3 to 9 by 15M pounds (note there is no cash flow in year 2).
The variable cost of extracting molybdenum at this location would be $4/pound.
[Hint: nominal annual profits from the increased capacity would therefore be given by 15M x (P - $4), where P is the price of molybdenum]
| Year |
0 |
1 |
2 |
3 |
4 |
5 |
6 |
7 |
8 |
9 |
| Investment (in $M) |
- 100 |
- 50 |
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b) An investment to expand capacity at its Henderson mine would cost $75M today (year 0), $30M next year (year 1) and would increase capacity by 13M pound per year from years 3 to 9. The variable costs of extracting molybdenum from this location would be $4.5/pound.
| Year |
0 |
1 |
2 |
3 |
4 |
5 |
6 |
7 |
8 |
9 |
| Investment (in $M) |
- 75 |
- 30 |
|
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c) Reopening of its Kitsault mine would require an investment of $25M today (year 0), $10M in year 1 and $10M in year 2 and would increase capacity in years 3 to 9 by 10M pounds. The variable cost of extraction would be $6/pound.
| Year |
0 |
1 |
2 |
3 |
4 |
5 |
6 |
7 |
8 |
9 |
| Investment (in $M) |
- 25 |
- 10 |
- 10 |
|
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If the discount rate is 16%, find the price of molybdenum above which it makes sense to do each of the investments a), b), and c).
Attachment:- financial acumen.rar