1. ZYNE is contemplating acquiring an exploration license for a gold mining location in Western Australia, with plans to extract gold. The license is priced at $10 million, while the expenses for constructing the mine are estimated to be $50 million.

There are two potential scenarios, each having an equal probability of occurring. In the favorable scenario, there will be strong demand for gold, resulting in a perpetual after-tax cash flow (after all operating and maintenance expenses) of $15 million annually. In the unfavorable scenario, demand will be weak, leading to a perpetual cash flow of only $3 million per year. The level of demand is revealed at the end of the first year and stays the same after that. All calculations will be performed using a discount rate of 12%. Assume that revenues begin the year following the construction, e.g.  if the mine is constructed at year 0, revenue starts at year 1. Additionally, ZYNE has the option to sell the license to others at a price of $4 million.

a) Suppose that in order to obtain financing to buy the license, ZYNE must construct the mine immediately. What is the NPV of the project? 

b) Suppose that ZYNE must construct mine immediately. Further, suppose that, since ZYNE is not the only interested buyer, the government has decided to auction the license. What is the maximum amount ZYNE would bid to buy the license?   

c) Suppose that ZYNE do not need to start to mine immediately. Instead, ZYNE decides to buy the license and wait one year before commencing construction.  Calculate the project NPV after one year in each of the two states respectively.  Calculate the project NPV with the option to wait.     

d) What is the value of the above option to wait?  

Answer rating: 100% (QA)

a The NPV of the project can be calculated as follows NPV Probability of Favorable Scenario x NPV of Favorable Scenario Probability of Unfavorable Sce... View the full answer