addition, new cnvironmental regulations, if enacted, could increaseMaxine Peru, the CEO of Peru Resources, hardly noticed tho platoof 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 CICcutivodining room.Tho roport described a propased new mine on the North Ridgeof ML Zircon. A vain of transcendental zirconium oro had beendiscovered thero on land owned by M Peru's company. Test bor-ings indicated sufficient rescrves to produca 340 tons per ycar oftranscendental 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, sincothey tended to occur in "pockets." The new minc might comeAcross ono, two, or dozens of pockets. The mining cngineer gucssedthat 150 pounds per year might be found. The current price forhigh-quality hydrated zircon gemstones was $3.300 pcr paund.Peru Resources was a family-owned busincss with total assctsof S45 million, including cash rescrves of SA million. The outlayrequired for the now mino would be a major commitment. Fortu-nately, Peru Resources was conservatively financed, and Ms. Perubelioved that the company could borrow up to $9 million at anthe cost of tho mino by S1.5 million.Thero was a chcaper design for the mine, which would reducoits cost by S1.7 million and climinate much of the uncertaintyabout cost overruns. Unfortunately, this design wvould require muchhigher fixed operating costx. Fixed costs would increaso to$850,000 per ycar at planned production levelsThe current prico of trantcendental zirconiumn was S10,000 perton, but thero was no consensus about futuro prices' Soma capertswero projecting rapid price increases to as much as S14,000 perton. On the other hand, there were pesimists saying that pricescould be as low as $7.500 peT ton. Ms Peru did not have strongvicws cither way: Her best guess was that prico would just increasewith inflation at about 3.5% per year. (Mine operting costs wouldalso increase with inflation.)Ms. Peru had wide cxperienco in the mining business, and shekncw that imestors in similar projocts usually wunted a forocastednominal 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 PcruResources pays tax at a 35% ratc. For simplicity, also assumo thatthe imestment in the mine could be depreciated for tax purposesstraight-line over 7 ycanWhat forecasts or scenarios should worry Ms Peru the most?Where would additional information be most belpful7 Is thare aintorest 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 questionmarks seomed to bo the initial cost of the mino and the selling pricoof transcendental zirconium.case for delaying construction of the new minc?Opening the minc, and providing the necessary machincry andorc-crunching facilitics, was suppased to cost SI0 million, but costoverruns 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.

Net present value is the net present worth of a project computed by deducting the initial cash…

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

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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