Maxine Peru, the CEO of Peru Resources, hardly noticed the plate of savory quenelles de brochet and the glass of Corton Charlemagne '94 on the table before her. She was absorbed by the engineering report handed to her just as she entered the executive dining room. The report described a proposed new mine on the North Ridge of Mt. Zircon. A vein of transcendental zirconium ore had been discovered there on land owned by Ms. Peru's company. Test borings indicated sufficient reserves to produce 340 tons per year of transcendental zirconium over a 7-year period. The vein probably also contained hydrated zircon gemstones. The amount and quality of these zircons were hard to predict because they tended to occur in "pockets." The new mine might come across one, two, or dozens of pockets. The mining engineer guessed that 150 pounds per year might be found. The current price for high-quality hydrated zircon gemstones was $3,300 per pound. Peru Resources was a family-owned business with total assets of $45 million, including cash reserves of $4 million. The outlay required for the new mine would be a major commitment. Fortunately, Peru Resources was conservatively financed, and Ms. Peru believed that the company could borrow up to $9 million at an interest rate of about 8%. The mine's operating costs were projected at $900,000 per year, including $400,000 of fixed costs and $500,000 of variable costs. Ms. Peru thought these forecasts were accurate. The big question marks seemed to be the initial cost of the mine and the selling price of transcendental zirconium. Opening the mine, and providing the necessary machinery and ore-crunching facilities, was supposed to cost $10 million, but cost Page 331 overruns of 10% or 15% were common in the mining business. In addition, new environmental regulations, if enacted, could increase the cost of the mine by $1.5 million. There was a cheaper design for the mine, which would reduce its cost by $1.7 million and eliminate much of the uncertainty about cost overruns. Unfortunately, this design would require much higher fixed operating costs. Fixed costs would increase to $850,000 per year at planned production levels. The current price of transcendental zirconium was $10,000 per ton, but there was no consensus about future prices. Some experts were projecting rapid price increases to as much as $14,000 per ton. On the other hand, there were pessimists saying that prices could be as low as $7,500 per ton. Ms. Peru did not have strong views either way: Her best guess was that price would just increase with inflation at about 3.5% per year. (Mine operating costs would also increase with inflation.) Ms. Peru had wide experience in the mining business, and she knew that investors in similar projects usually wanted a forecast nominal rate of return of at least 14%. You have been asked to assist Ms. Peru in evaluating this project. Lay out the base-case NPV analysis, and undertake sensitivity, scenario, or breakeven analyses as appropriate. Assume that Peru Resources pays tax at a 30% rate. For simplicity, also assume that the investment in the mine could be depreciated for tax purposes straight-line over 7 years. What forecasts or scenarios should worry Ms. Peru the most? Where would additional information be most helpful? Is there a case for delaying construction of the new mine?

Leroy Mining Company purchased land containing an estimated 10,000,000 tons of ore for a cost of $750,000. The land without the ore is estimated to be worth $150,000 (the residual value). The company expects that all the usable ore can be mined in eight years. During its first year of operation, the company mined 1,000,000 tons of ore and at the end of the year had an inventory of 200,000 tons Determine the following amounts for the first year: (a) depletion charge per ton; (b) depletion expense for year;

Your client, Piano Keys Inc., owns and operates a piano repair shop in Albany, New York.  Piano Keys specializes in the repair and restoration of pianos. In November of last year, the roof over two-thirds of the Piano Keys building collapsed due to the weight of the snow on the roof. Since then, the portion of building damaged by the roof collapse has been demolished, an addition was built onto the undamaged portion (one-third) of the building, and Piano Keys reopened for business on September 1st of this year. The following data includes financial information regarding the matter provided by the client.     The fair market value of the building (immediately before the roof collapse): $1,800,000 Piano Keys adjusted basis in the building: $300,000 Fair market value of the building immediately after the roof collapse was $600,000. Insurance proceeds due to the destruction of his building: $1,200,000 Demolition and construction costs:  $1,500,000.  ($1,200,000 of the insurance proceeds…

in the new building? 40. In January, Prahbu purchased for $90,000 a new machine for use in an existing production line of his manufacturing business. Assume that the machine is a unit of property and is not a material or supply. Prahbu pays $2,500 to install the machine, and after the machine is installed, he pays $1,300 to perform a critical test on the machine to ensure that it will operate in accordance with quality standards. On November 1, the critical test is complete, and Prahbu places the machine in service on the production line. On December 3, Prahbu pays another $3,300 to perform periodic quality control testing after the machine is placed in service. How much will Prahbu be required to capitalize as the cost of the machine? Donn 11 LO 2-1 resear