Question

Rio Tinto is planning a strip-mining project that costs $90,000 initially and generates the following cash...

Rio Tinto is planning a strip-mining project that costs $90,000 initially and generates the following cash flows:

Year 1: $131,000

Year 2: $98,980

Year 3: -$147,650

Cash flow in Year 3 will be spent to restore the terrain, hence it is negative. The required return is 13.5%. Which of the following statements would you most agree with?

A. At a discount rate of 41.092%, the present value of future cash flows is close to $90,000. Hence, the breakeven rate is very high (compared to 13.5%). So, we should accept it.

B. Accept the project since it is a good investment.

C. Reject the project since it does not break even if we ignore discounting.

D. When cash flow signs change more than once, it is tricky to reach a definitive conclusion. It is too risky to accept the project in such situation.

E. Reject the project since the return 10.09%, which is lower than 13.5%.

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Answer #1
YEAR CASH FLOWS DISCOUNT FACTOR OF 13.5% DISCOUNTED CASH FLOWS DISCOUNT FACTOR OF 41.092% DISCOUNTED CASH FLOWS DISCOUNT FACTOR OF 10.09% DISCOUNTED CASH FLOWS
0 -90000 1 -90000 1 -90000 1 -90000
1 131000 0.881057269 115418.5022 0.708757407 92847.22025 0.908347716 118993.5507
2 98980 0.776261911 76834.40393 0.502337061 49721.32233 0.825095572 81667.95974
3 -147650 0.683931199 -100982.4415 0.356035113 -52568.5844 0.749473678 -110659.7886
SUM OF DISCOUNTED CASH FLOW 1270.464611 SUM OF DISCOUNTED CASH FLOW -0.041818518 SUM OF DISCOUNTED CASH FLOW 1.721896582

In the given situation , I will agree with Option A.

Here 41.092% shows internal rate of return where present value of future cash flows equals to cash out flows at year 0.

Hence we should accept the project

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