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M Peru's company. Test bor- produce 340 tons per year of car period. d hydrated zircon gemstones. ons were hard to predict, sinco The new mino might comc The current ton, but there w. were projecting ton. On the oth could be as low vicws cither wa

M Peru's company. Test bor- produce 340 tons per year of car period. d hydrated zircon gemstones. ons were hard to predict, sinco The new mino might comc The current ton, but there w. were projecting ton. On the oth could be as low vicws cither wa

FINANCIAL ACCOUNTING
FINANCIAL ACCOUNTING
10th Edition
ISBN:9781259964947
Author:Libby
Publisher:Libby
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
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addition, new cnvironmental regulations, if enacted, could increase Maxine Peru, the CEO of Peru Resources, hardly noticed tho plato of savory quenclles do brochet and tho glass of Corton Char- lemagno '94 on the table beforo her. She was absorbed by the cngi- noering roport handed to her just as she entered tho CICcutivo dining room. Tho roport described a propased new mine on the North Ridge of ML Zircon. A vain of transcendental zirconium oro had been discovered thero on land owned by M Peru's company. Test bor- ings indicated sufficient rescrves to produca 340 tons per ycar of transcendental zirconium over a 7-ycar period. The vein probably also containcd hydrated zircon gemstoncs. Tho amount and quality of thaso zircons wero hard to predict, sinco they tended to occur in "pockets." The new minc might come Across ono, two, or dozens of pockets. The mining cngineer gucssed that 150 pounds per year might be found. The current price for high-quality hydrated zircon gemstones was $3.300 pcr paund. Peru Resources was a family-owned busincss with total asscts of S45 million, including cash rescrves of SA million. The outlay required for the now mino would be a major commitment. Fortu- nately, Peru Resources was conservatively financed, and Ms. Peru belioved that the company could borrow up to $9 million at an the cost of tho mino by S1.5 million. Thero was a chcaper design for the mine, which would reduco its cost by S1.7 million and climinate much of the uncertainty about cost overruns. Unfortunately, this design wvould require much higher fixed operating costx. Fixed costs would increaso to $850,000 per ycar at planned production levels The current prico of trantcendental zirconiumn was S10,000 per ton, but thero was no consensus about futuro prices' Soma caperts wero projecting rapid price increases to as much as S14,000 per ton. On the other hand, there were pesimists saying that prices could be as low as $7.500 peT ton. Ms Peru did not have strong vicws cither way: Her best guess was that prico would just increase with inflation at about 3.5% per year. (Mine operting costs would also increase with inflation.) Ms. Peru had wide cxperienco in the mining business, and she kncw that imestors in similar projocts usually wunted a forocasted nominal rato of return of at lcast 14%. You have been asked to axtist Ms Peru in evaluating this proj- a Lay out the basc-case NPV analyxix, and undertake sensitivity. Scenario, or break-even analyses as appropriate. Assume that Pcru Resources pays tax at a 35% ratc. For simplicity, also assumo that the imestment in the mine could be depreciated for tax purposes straight-line over 7 ycan What forecasts or scenarios should worry Ms Peru the most? Where would additional information be most belpful7 Is thare a intorest rato of about 8%. The mine's opernting costs wero projected at $900,000 per ycar, including S400.000 of fixed costs and S500,000 of variable costs. M&. Peru thought theso forecaits were accurnte. The big question marks seomed to bo the initial cost of the mino and the selling prico of transcendental zirconium. case for delaying construction of the new minc? Opening the minc, and providing the necessary machincry and orc-crunching facilitics, was suppased to cost SI0 million, but cost overruns of 10% or 15% were common in the mining business. In "Thero wero DO traded forward or futus contracts oa transocndcntal zir- conium. Seo Chapter 24.
Transcribed Image Text:addition, new cnvironmental regulations, if enacted, could increase Maxine Peru, the CEO of Peru Resources, hardly noticed tho plato of savory quenclles do brochet and tho glass of Corton Char- lemagno '94 on the table beforo her. She was absorbed by the cngi- noering roport handed to her just as she entered tho CICcutivo dining room. Tho roport described a propased new mine on the North Ridge of ML Zircon. A vain of transcendental zirconium oro had been discovered thero on land owned by M Peru's company. Test bor- ings indicated sufficient rescrves to produca 340 tons per ycar of transcendental zirconium over a 7-ycar period. The vein probably also containcd hydrated zircon gemstoncs. Tho amount and quality of thaso zircons wero hard to predict, sinco they tended to occur in "pockets." The new minc might come Across ono, two, or dozens of pockets. The mining cngineer gucssed that 150 pounds per year might be found. The current price for high-quality hydrated zircon gemstones was $3.300 pcr paund. Peru Resources was a family-owned busincss with total asscts of S45 million, including cash rescrves of SA million. The outlay required for the now mino would be a major commitment. Fortu- nately, Peru Resources was conservatively financed, and Ms. Peru belioved that the company could borrow up to $9 million at an the cost of tho mino by S1.5 million. Thero was a chcaper design for the mine, which would reduco its cost by S1.7 million and climinate much of the uncertainty about cost overruns. Unfortunately, this design wvould require much higher fixed operating costx. Fixed costs would increaso to $850,000 per ycar at planned production levels The current prico of trantcendental zirconiumn was S10,000 per ton, but thero was no consensus about futuro prices' Soma caperts wero projecting rapid price increases to as much as S14,000 per ton. On the other hand, there were pesimists saying that prices could be as low as $7.500 peT ton. Ms Peru did not have strong vicws cither way: Her best guess was that prico would just increase with inflation at about 3.5% per year. (Mine operting costs would also increase with inflation.) Ms. Peru had wide cxperienco in the mining business, and she kncw that imestors in similar projocts usually wunted a forocasted nominal rato of return of at lcast 14%. You have been asked to axtist Ms Peru in evaluating this proj- a Lay out the basc-case NPV analyxix, and undertake sensitivity. Scenario, or break-even analyses as appropriate. Assume that Pcru Resources pays tax at a 35% ratc. For simplicity, also assumo that the imestment in the mine could be depreciated for tax purposes straight-line over 7 ycan What forecasts or scenarios should worry Ms Peru the most? Where would additional information be most belpful7 Is thare a intorest rato of about 8%. The mine's opernting costs wero projected at $900,000 per ycar, including S400.000 of fixed costs and S500,000 of variable costs. M&. Peru thought theso forecaits were accurnte. The big question marks seomed to bo the initial cost of the mino and the selling prico of transcendental zirconium. case for delaying construction of the new minc? Opening the minc, and providing the necessary machincry and orc-crunching facilitics, was suppased to cost SI0 million, but cost overruns of 10% or 15% were common in the mining business. In "Thero wero DO traded forward or futus contracts oa transocndcntal zir- conium. Seo Chapter 24.
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