A mining company is deciding whether to open a strip mine, which costs

QUESTION

A mining company is deciding whether to open a strip mine, which costs 2 million. Net cash inflows of 13 million would occur at the end of Year 1. The land must be returned to its natural state at a cost of $12 million, payable at the end of Year 2.
a. Plot the projects NPV profile.
b. Should the project be accepted if WACC =10%? If WACC=20%? Explain your reasoning
c. Think of some other capital budgeting situation in which negative cash flows during or at the end of the projects life might lead to multiple IRRs.
d. What is the projects MIRR at WACC =10%? At WACC=20%? Does MIRR lead to the same accept/reject decision for this project as the NPV method? Does the MIRR method always lead to the same accept/reject decision as NPV? (Hint: Consider mutually exclusive projects that differ in size.)
The projects expected cash flows are as follows (in millions of dollars): Time Net Cash Flow 0 -$ 2.00 1 $13.00 2 -$12.00 a. NPV profile WACC NPV 0% -$1,000,000 10% -$99,174 20% $500,000 30% $899,408 40% $1,163,265 50% $1,333,333 60% $1,437,500 70% $1,494,810 80% $1,518,519 90% $1,518,006 100% $1,500,000 b. If WACC = 10%, NPV is -$99,174 hence the project should not be accepted as the NPV is negative and if WACC = 20%, NPV is $500,000 hence, the project should be accepted as the NPV is positive. c. Other possible projects with multiple rates of return could be nuclear power plants where disposal of radioactive wastes is required at the end of the projects life. d. The formula for Modified Internal Rate of Return (MIRR) is: [FV (+ve cash flows, cost of capital) / PV (-ve cash flows, Financing cost)]^(1/n) “ 1 If WACC = 10%, MIRR is 9.54%, thus the project should be rejected as MIRR

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