Question

Highland Mining and Minerals Co. is considering the purchase of two gold mines. Only one investment will be made. The Australian gold mine will cost $1,694,000 and will produce $359,000 per year in years 5 through 15 and $532,000 per year in years 16 through 25. The U.S. gold mine will cost $2,085,000 and will produce $295,000 per year for the next 25 years. The cost of capital is 11 percent. Use Appendix D for an approximate answer but calculate your final answers using the formula and financial calculator methods. (Note: In looking up present value factors for this problem, you need to work with the concept of a deferred annuity for the Australian mine. The returns in years 5 through 15 actually represent 11 years; the returns in years 16 through 25 represent 10 years.)
  
a-1. Calculate the net present value for each project. (Do not round intermediate calculations and round your answers to 2 decimal places.)

a-2. Which investment should be made?

	Australian mine
	U.S. mine

  
b-1. Assume the Australian mine justifies an extra 5 percent premium over the normal cost of capital because of its riskiness and relative uncertainty of cash flows. Calculate the new net present value given this assumption. (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places.)

  
b-2. Does the new assumption change the investment decision?

Answer 1

a-1)

The above NPV can also be computed by multiplying the equal annual cash flows with the respected Present value interest factor annuity (PVIFA), which is the sum of the individual year PVIFs. So, for the US mine, you add all the PVIFs from year 1 to 25. But, for the austrialian mine, you have to add PVIF of years 5 to 15 and then 16 to 25, so you get two PVIFA. And then multiply with the respective cash flows.

a-2) The investment should be made in the Australian mine as its NPV is higher.

b-1) New Discount rate for Australian mine = 11% + 5% = 16%

Same formulas as above, new NPV is as follows -

b-2) Yes, it changes the investment decision. Now, US mine is more viable option.