Reference no: EM132001498

Question: A mining company operates an open pit mine. Very large trucks move ore from the pit to the processing facilities. The road that the trucks travel on is gravel and, because of poor road building, there is excessive wear on the tires. A proposal has been made to crush the gravel prior to laying the road. The finer gravel should reduce tire wear significantly. The proposal calls for a mobile crusher that can provide the correctly sized gravel at the point where road repair or road building is happening. The Projects Department, who performs the economic analysis for operational decisions on the mine, has two alternatives for the provision of the crusher. The mine can purchase it or it can outsource the entire function to a contractor. The outsource option is preferred because there are limitations on the capital budget because of poor operational performance over the last few years.

The capital cost of the mobile crusher is $285,714 and the annual maintenance and operating costs are estimated to be $51,714. The equipment can be depreciated over five years on a straight-line basis. The cost of tire replacement is $3,101,071 a year and it is estimated that this cost can be reduced by 10% with better road maintenance. The inflation rate is 7% and the company's nominal discount rate is 15%. The applicable tax rate is 30%.As mentioned above, the project can be implemented by outsourcing provision of the service to a contractor. The contractor will purchase the equipment, maintain it, and provide trained personnel for its operation. The contractor has quoted a price of$125,000 per year for the five-year contract.

What decision should the mining company make?