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. Alma has used the estimates provided by Dan to determine the revenues that could be expected from the mine. She has also projected the expense of opening the mine and the annual operating expenses. If the company opens the mine, it will cost $525 million today, and it will have a cash outflow of $35 million 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 table.
Bullock Mining has a required return of 12 percent on all of its gold mines.
| Provided Table below | |
| Year | Cash Flow |
| 0 | -$525,000,000 |
| 1 | $74,000,000 |
| 2 | $97,000,000 |
| 3 | $125,000,000 |
| 4 | $157,000,000 |
| 5 | $185,000,000 |
| 6 | $145,000,000 |
| 7 | $125,000,000 |
| 8 | $102,000,000 |
| 9 | -$35,000,000 |
1. Please calculate the profitability index and show all work.
Profitabilty index= Present value of future cash flows/ Initial Investment
Initial investment= $525000000
Present value of future cash flows = $ 595701975.2( please see the calculation below)
PI = $ 595701975.2 / $525000000
= 1.134670429
proftability index of the project is 1.134670429
This project will create an additional value of $0.13 for every $1 invested in the project.
| Year | Cash flows | Present value of $1 @12% discount rate | Present value of Net cash flows(cash flows * discount factor)($) |
| 1 | 74000000 | 0.892857143 | 66071428.57 |
| 2 | 97000000 | 0.797193878 | 77327806.12 |
| 3 | 125000000 | 0.711780248 | 88972530.98 |
| 4 | 157000000 | 0.635518078 | 99776338.31 |
| 5 | 185000000 | 0.567426856 | 104973968.3 |
| 6 | 145000000 | 0.506631121 | 73461512.57 |
| 7 | 125000000 | 0.452349215 | 56543651.92 |
| 8 | 102000000 | 0.403883228 | 41196089.25 |
| 9 | -35000000 | 0.360610025 | -12621350.87 |
| present value of future cash flows | 595701975.2 |
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