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Base Case more expensive design Year P+E Units (TZO) SP (TZO) Units (HZG) SP (HZG) Rev. V.C. F.C. Dep. EBIT Tax NI Dep. Reverse CFO PV of CF NPV 11131232 1131232 0 10000000 340 10000 150 3300 3895000 500000 400000 1428571 1566429 548250 1018179 1428571 2446750 340 10350 150 3300 4014000 517500 414000 1428571 1653929 578875 1075054 1428571 2503625 340 10712.25 150 3300 4137165 535612.5 428490 1428571 1744491 610571.9 1133919 1428571 2562491 340 11087.18 150 3300 4264641 554358.9 443487.2 1428571 1838223 643378.1 1194845 1428571 2623417 340 11475.23 150 3300 4396578 573761.5 459009.2 1428571 1935236 677332.6 1257903 1428571 2686475 340 11876.86 150 3300 4533133 593843.2 475074.5 1428571 2035644 712475.5 1323169 1428571 2751740 340 12292.55 150 3300 4674468 614627.7 491702.1 1428571 2139567 748848.4 1390718 1428571 2819290 1 2 3 4 5 6 7

Assumptions - No NWC - CoC = Minimum Nominal RoR = 14% Equations SP(TZO)= 10000 x 1.035^(n-1) Revenue= (SP(TZO)xUnits(TZO)) + (SP(HZG)xUnits(HZG)) VC= 500000 x 1.035^(n-1) FC= 400000 x 1.035^(n-1)

Depreciation= 10000000/7 *Straight-line EBIT= Rev. VC FC Depreciation Tax= EBIT x 0.35 NI= EBIT Tax CFO= NI + Dep. Reverse PV of CF= (CFn/1.14^n) NPV= PV of CF P+E

Scenario Two - Cheaper Design Year P+E Units (TZO) SP (TZO) Units (HZG) SP (HZG) Rev. V.C. F.C. Dep. EBIT Tax NI Dep. Reverse CFO PV of CF NPV Assumptions - No NWC - CoC = Minimum Nominal RoR = 14% Equations SP(TZO)= 10000 x 1.035^(n-1) Revenue= (SP(TZO)xUnits(TZO)) + (SP(HZG)xUnits(HZG)) VC= 500000 x 1.035^(n-1) FC= 850000 x 1.035^(n-1) 9397409 1097409 0 8300000 340 10000 150 3300 3895000 500000 850000 1185714 1359286 475750 883535.7 1185714 2069250 340 10350 150 3300 4014000 517500 879750 1185714 1431036 500862.5 930173.2 1185714 2115888 340 10712.25 150 3300 4137165 535612.5 910541.3 1185714 1505297 526853.9 978443 1185714 2164157 340 11087.18 150 3300 4264641 554358.9 942410.2 1185714 1582157 553755.1 1028402 1185714 2214117 340 11475.23 150 3300 4396578 573761.5 975394.6 1185714 1661708 581597.8 1080110 1185714 2265824 340 11876.86 150 3300 4533133 593843.2 1009533 1185714 1744043 610414.9 1133628 1185714 2319342 340 12292.55 150 3300 4674468 614627.7 1044867 1185714 1829259 640240.7 1189018 1185714 2374733 1 2 3 4 5 6 7

Depreciation= 8300000/7 *Straight-line EBIT= Rev. VC FC Depreciation Tax= EBIT x 0.35 NI= EBIT Tax CFO= NI + Dep. Reverse PV of CF= (CFn/1.14^n) NPV= PV of CF P+E

Sensitivity Analysis:

The expected price of transcendental zirconium is $10000(its current price which Ms. Peru expects to simply increase in line with inflation). An optimistic price predicted by experts is $14000 while pessimists say a fall as low as $7500. - More expensive mine design Range Net Present Value Pessimistic Expected Optimistic Pessimistic Expected Optimistic $13,000,000 $10,000,000 N/a -$1,225,523 $1,131,232 N/a

Variable Initial cost Price of transcendental zirconium

$7500

$10000

$14000

-$2,106,854

$1,131,232

$4,053,296

The expected cost of the mine is $10m. Cost overruns for the initial cost of the mine of 10% or 15% are common in the mining business. For a pessimistic estimate for the investment this adds a further $1.5m in cost($10mx0.15) to the expected $10m cost. Pessimists will also account for the new environmental regulation that may be enacted, adding a further $1.5m to the expected cost. Together this takes the pessimistic estimate of the initial cost to $13m. It is not likely that the new mine could cost less than $10m so an optimistic cost figure is not applicable as we know the result will be a positive net present value and greater than $1.13m anyway. - Cheaper design Range Expected $8,300,000 Net Present Value Optimistic Pessimistic Expected Optimistic N/a -$809,685 $1,097,409 N/a

Variable Initial cost Price of transcendental zirconium

Pessimistic $9,800,000

$7500

$10000

$14000

-$2,140,677

$1,097,409

$4,019,473

The expected cost of the mine is $8.3m (cheaper design reduces cost by $1.7m). Most of the uncertainty of cost overruns is eliminated so pessimists will only account for the new environmental regulation that may be enacted, adding $1.5m to the expected cost, making the pessimistic estimate of the initial cost $9.8m. It is not likely that the new mine could cost less than $8.3m so an optimistic cost figure is not applicable as we know the result will be a positive net present value and greater than $1.10m anyway. The expected net present values for the more expensive design and cheaper design are approximately $1.13m and $1.10m respectively. The optimistic net present values for the more expensive design and cheaper design are approximately $4.05m and $4.02m respectively. These figures are all positive net present values and quite significant amounts too, especially with respect to the optimistic figures. Both the expected and optimistic net present values with respect to price and initial cost for the two designs end up with very close in value net present values, so the factor here in a decision as to which design comes down to the pessimistic net present values.

The pessimistic price of transcendental zirconium of $7500 gives resultant net present values of approximately -$2.11m and -$2.14m for the more expensive and cheaper design respectively. Once again these figures are close in value and since both are negative, the investment for either the cheaper or more expensive design with a pessimistic price would not go ahead. A pessimistic initial cost gives a net present value of approximately -$1.23m for the more expensive mine and -$0.81m for the cheaper design. The risk to invest in the more expensive mine design is not worth it since a pessimistic initial cost which is quite possible will give a much higher negative net present value of the investment. The positive net present values for this design are also not significantly higher enough than those of the cheaper design to take this risk, i.e. the rate of return for such a level of risk is not sufficient for the more expensive design. The only forecast that should worry Ms. Peru is the pessimists saying that prices could be as low as $7500/ ton. This is the absolute worst case scenario that could occur and give the cheaper design a negative net present value. Additional information would therefore be most helpful on future prices of transcendental zirconium, although Ms. Peru did not have a strong view that this was likely and expects price to simply increase with inflation. The only case for delaying construction of the new mine is therefore only with respect to what direction the price of transcendental zirconium will move in. The only reason to keep delaying construction is whether the price will fall or not. With respect to cost overruns and if the new environmental regulation will be enacted or not, there is not really a case for delaying construction. Time is unlikely to decide whether there will be cost overruns and with the cheaper design, most of the uncertainty over cost overruns is eliminated, and even if the environmental regulation was enacted, the net present value of the investment would still be positive.