problem: You own an unused gold mine that will cost 100,000 dollar to reopen. If you do open the mine, you expect to extract 1,000 ounces of gold per year, for the next three years. After those three years the deposit will be exhausted. An ounce of gold is currently selling for 500 dollar. For each of the next 3 years, this price is equally likely to rise or fall by 50 dollar per year from its level at the start of that year. The extraction cost is estimated to be around 460 dollar an ounce, and this cost will not change over the next three years.
The demand for gold has increased tremendously in the recent years and there is a good chance that this demand will continue in the future as well. You are therefore puzzled as to whether to open the mine now or in one year in the hope that prices will move further up.
Suppose that the opportunity cost of the project is 10 percent.
Determine the NPV of opening the mine now? find out the NPV of opening the mine one year later? Should you wait?