Seth Bullock, the owner of Bullock Gold Mining, is evaluating a new gold mine in South Dakota. Dan Dority, the company’s geologist, has just finished his analysis of the mine site. He has estimated that the mine would be productive for eight years, after which the gold would be completely mined. Dan has taken an estimate of the gold deposits to Alma Garrett, the company’s financial officer. Alma has been asked by Seth to perform an analysis of the new mine and present her recommendation on whether the company should open the new mine.
Year Cash Flow
0 -$500,000,000
1 60,000,000
2 90,000,000
3 170,000,000
4 230,000,000
5 205,000,000
6 140,000,000
7 110,000,000
8 70,000,000
9 -80,000,000
Alma has used the estimates provided by Dan to determine the revenues that could be expected from the mine. She has also projected the expenses of opening the mine and the annual operating expenses. If the company opens the mine, it will cost $500 million today, and it will have a cash outflow of $80million nine years from today in costs associated with closing the mine and reclaiming the area surrounding it. The expected cash flows each year from the mine are shown in the above table. Bullock Mining has a 12 percent required return on all of its gold mines.
a. What is the payback period for this project? Show your work.
b. If we want to calculate the Net PresentValue, what discount rate would we use for the cash flows?
c. What is the NPV for this project? Show your work.
d. Using the NPV method, should Bullock Gold Mining do this project?
e. What are the advantages of the NPV method compared to the Payback method for evaluating capital budgeting projects?