HC, a holding company, owns a small coal mine estimated to contain 12,000,000 tonnes of coal. CM, a contract mining group, mines, processes and sells the coal and pays HC a royalty of $25.00 per tonne of coal mined. Coal is mined at a rate of 2,000,000 tonnes per year. This rate is expected to continue until the mine is exhausted, at which time the mine and equipment will have an estimated salvage value of $2,500,000. HC incurs annual costs of $500,000 for administration of permits and inspections. CM suggested that it could do these administrative tasks for $350,000 per year. HC is thinking of selling the remaining reserves to CM.
A. What is the life of the project whether or not it is bought by CM?
B. If HC’s cost of capital is 12%, what is the minimum price it should ask if it sells the mine to CM?
C. If CM’s cost of capital is 9%, what is the maximum price it should pay for the mine?
D. Suppose CM buys the coal mine for the maximum price given in c). What is the internal rate of return of the purchase “project”?