I'm trying to figure part 1 of this question right now. I was able to calculate the discount rate of 13.9%, but am struggling to calculate the Cashflows & NPV based on the information provided. How do you calculate the exact time and amount of all expected cash flows project?
Alchemy Mines is considering an investment in the rights to a silver mine.
The owner of the mine will sell the rights to Alchemy Mines at a cost of $1,000,000 payable immediately. Purchase of the rights entitles Alchemy Mines to all mining rights provided mining commences within one year and continues without interruption until the entire deposit is recovered and the land restored in compliance with regulatory requirements. If mining does not commence in one year, the title to the mine reverts to the seller.
Expected operating variables
The firm has made the following assumptions regarding operating cash flows for the mine:
Recoverable silver: 750,000 ounces
Current market price of silver: $16.03 per ounce
Expected price of silver in one year: $16.50 per ounce
Expected fixed costs of mining and refining: $1,500,000
Expected variable costs of mining and refining: $12.50 per ounce
Cost to restore the land and remediate environmental damage: $500,000
No taxes are paid on profits from the project
If the firm decides to mine the silver, it must escrow all funds necessary to pay the costs of mining, refining and restoration upon commencement of mining.
The firm will only mine the silver if it is able to pre-sell the entire recoverable production and receive payment upon commencement of mining.
As a result, for net present valuation purposes, all cash flows for the project occur either at time 0 (the initial payment for the rights) or in 1 year (all other expected cash inflows and outflows for the project).
The firm estimates additional economic variables as follows:
Risk free interest rate equals 2.5%
Expected market return: 12.2%
Beta for silver mining and smelting: 1.175
Standard deviation of annual returns on silver prices: 23.25%