Question

Maple Leaf Oil Corp. is a Canadian natural resources company. They are considering buying the rights to a piece of land that has strong potential for gold production through surface extraction techniques. They project the following net cash flows ($ millions Canadian): Year 1: $15 Year 2: $30 Year 3: $50 Year 4: $25 After year 4, the gold field will be played out and not profitable to continue mining. The purchase price for this land is $60 million Canadian. What would the annual rate of return be on this investment?

Answer 1

The return is computed as follows:

NPV at 30% is computed as shown below:

= - $ 60 million + $ 15 million / 1.30 + $ 30 million / 1.30² + $ 50 million / 1.30³ + $ 25 million / 1.30⁴

= $ 0.801442527 million

NPV at 31% is computed as shown below:

= - $ 60 million + $ 15 million / 1.31 + $ 30 million / 1.31² + $ 50 million / 1.31³ + $ 25 million / 1.31⁴

= - $ 0.338060396 million

So, the rate will be as follows:

= Lower rate + [ (Lower rate NPV / (Lower rate NPV - Higher rate NPV) ] x (Higher rate - lower rate)

= 30 + [ ($ 0.801442527 million) / ($ 0.801442527 million - (- $ 0.338060396 million) ] x (31 - 30)

= 30 + $ 0.801442527 million / 1.139502923 million

= 30.70% Approximately

Do ask in case of any doubts.