Wooster Ltd is considering the purchase of an exploration license for an iron ore mining site in
Question:
Wooster Ltd is considering the purchase of an exploration license for an iron ore mining site in South Australia,upon which Wooster Ltd will mine iron ore. The price of the license is $20m. The mine construction cost is $50m.There are two possible states of the world, each occurring with equal probability. In the good state, demand foriron ore will be high and the perpetual after-tax cash fl ow (after all operating and maintenance expenses)generated by the mine will be $15m/year. In the bad state, demand will be low, and the perpetual cash fl ow willbe only $3m/year. The level of demand is revealed at the end of the fi rst year and stays the same after that. Use adiscount rate of 10% in all calculations. Assume that revenues begin the year following the construction, e.g. ifthe mine is constructed at year 0, revenue starts at year 1. Further assume that Wooster Ltd can choose to resalethe license to others at $10m.
a.
Suppose that to obtain fi nancing to buy the license, Wooster Ltd must construct the mine immediately.What is the NPV of the project? (2 marks)
b.
Suppose that Wooster Ltd must construct mine immediately. Further, suppose that since Wooster is notthe only interested buyer, and the government has decided to auction the license. What is the maximumamount Wooster Ltd would bid to buy the license? (2 marks)
c.
Suppose that Wooster Ltd do not need to start to mine immediately. Instead, Wooster decides to buy thelicense and wait one year before commencing construction. Calculate the project NPV after one year ineach of the two states respectively. Calculate the project NPV with the option to wait. (3 marks)
d.
What is the value of the above option to wait? (1 marks)
Statistics The Art and Science of Learning from Data
ISBN: 978-0321997838
4th edition
Authors: Alan Agresti, Christine A. Franklin, Bernhard Klingenberg