Riskiness and the relative uncertainty of cash flows

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Question: Highland Mining and Minerals Co. is considering the purchase of two gold mines. Only one investment will be made. The Australian gold mine will cost $1,600,000 and will produce $300,000 per year in years 5 through 15 and $500,000 per year in years 16 through 25. The U.S. gold mine will cost $2,000,000 and will produce $250,000 per year for the next 25 years. The cost of capital is 10 percent.

a. Which investment should be made? (Note: In looking up present value factors for this problem, you need to work with the concept of a deferred annuity for the Australian mine. The returns in years 5 through 15 actually represent 11 years; the returns in years 16 through 25 represent 10 years.)

b. If the Australian mine justifies an extra 5 percent premium over the normal cost of capital because of its riskiness and the relative uncertainty of cash flows, does the investment decision change?

Reference no: EM131788511

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