Problem
Herr Mining Company plans to open a new coal mine. Developing the mine will cost $9 million right away, but cash flows of $3 million will arrive starting in one year and then continuing for the next four years(i.e., years 2 through 5). After that, no coal will remain, and Herr must spend $23 million to restore the land surrounding the mine to its original condition.
1. Construct a timeline showing the cash flows starting at time zero and extending until time 6.
2. What is the total undiscounted cash flow associated with this project over its 6-year life? Given this answer, do you think there is any way that the project can be financially attractive to Herr Mining? Why or why not?
3. Calculate the present value of the project's cash flows, assuming the company's opportunity cost is 5%. What if the opportunity cost is 11%?