There are two general methods that governments use to sell mineral rights to the private sector. One is production royalties where the private firm promises to pay a certain amount (or percentage of revenue) each year for the length of contract. The other is bonus bidding where the private company pays cash up from the mineral rights for a specified period of time.
A government is offering a 10 year contract for off-shore drilling rights. The highest bonus bid is $5 million dollars. However, another firm offers to $800,000 per year for 10 years in production royalties.
a. What is the PV of the bonus bid if the discount rate is 5%?
b. What is the PV of the production royalties if the discount rate is 5%?'