Question

You own a coal mining company and are considering opening a new mine. The mine itself will cost $119.4 million to open. If this money is spent immediately, the mine will generate $19.2 million for the next 10 years. After that, the coal will run out and the site must be cleaned and maintained at environmental standards. The cleaning and maintenance are expected to cost $1.9 million per year in perpetuity. What does the IRR rule say about whether you should accept this opportunity? If the cost of capital is 7.8%, what does the NPV rule say? What does the IRR rule say about whether you should accept this opportunity? (Select the best choice below.) O A. There are two IRRs, so you cannot use the IRR as a criterion for accepting the opportunity. O B. Accept the opportunity because the IRR is greater than the cost of capital. O C. The IRR is r = 7.53%, so accept the opportunity. OD. Reject the opportunity because the IRR is lower than the 7.8% cost of capital. The NPV using the cost of capital of 7.8% is $ million. (Round to three decimal places.) The plot of the NPV as a function of the discount rate is n shaped. It intersects the x-axis at r= 3.27% and r= 7.53% What does the NPV rule say? (Select the best choice below.) O A. If the opportunity cost of capital is greater than r= 7.53%, the investment should be undertaken. O B. If the opportunity cost of capital is between r= 3.27% and r= 7.53%, the investment should be undertaken. O C. Reject the project because the NPV is negative. D. If the opportunity cost of capital is less than r= 3.27%, the investment should be undertaken. O

Answer 1

1.
There are two IRRs so you cannot use the IRR as a criterion for accepting the opportunity
-119.4+19.2/r*(1-1/(1+r)^10)-1.9/r*1/(1+r)^10=0
=>r=-178.665%,3.26676%,7.53047%

2.
=-119.4+19.2/7.8%*(1-1/(1+7.8%)^10)-1.9/7.8%*1/(1+7.8%)^10
=-0.890106 million

3.
If the opportunity cost of capital is between r=3.27% and r=7.53%, the investment should be undertaken