What is the maximum amount pg would bid to buy the license

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Reference no: EM132762897

PG is considering the purchase of an exploration license for a gold mining site in WA, upon which PG will mine gold. The price of the license is $10m. The mine construction cost is $40m. There are two possible states of the world, each occurring with equal probability. In the good state, demand for gold will be high and the perpetual after-tax cash flow (after all operating and maintenance expenses) generated by the mine will be $12m/year. In the bad state, demand will be low and the perpetual cash flow will be only $2m/year. The level of demand is revealed at the end of the first year and stays the same after that. Use a discount rate of 10% in all calculations. Assume that revenues begin the year following the construction, e.g. if the mine is constructed at year 0, revenue starts at year 1. Further assume that PG can choose to resale the license to others at $5m.

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

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

Problem c. Suppose that PG do not need to start to mine immediately. Instead, PG 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.

Problem d. What is the value of the above option to wait?

Reference no: EM132762897

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