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contain operation risk, market risk, interest risk, and policy risk..

a) Related Risk
For the OPERATION RISK, since this investment would last more than 6 years, lots of problems could occur in this period and it probably causes huge loss, leading a negative cash flow in some year and a negative NPV finally. Also, the amount of the gold mine is based on our estimation, so if the estimation is not accurate, it may result in a less profit.
Outcome of the gold decreases 10% annually
Year Cost(￡/m) Revenue(￡/m) Net Income(￡/m) PV(￡/m)
2013 2 0 -2 -2
2014 1.5 0 -1.5 -1.3636
2015 1.0 1.8 0.8 0.6612
2016 1.2 2.25 1.05 0.7889
2017 1.2 2.7 1.5 1.0245
2018 1.2 2.25 1.05 0.6520
2019 0.9 0.9 0 0
Total -0.237

From the chart above, we know the NPV would be negative (-0.237).
For the MARKET RISK, the price of gold is based on the current market condition while it could be estimated that the price would not change in the future. The gold price keeps changing at any time. If the company plans to fix the price by option, it would cost a large amount of option fees.

For the INTEREST RISK, we simply assume the cost of capital is 10%, if the interest rate change, the cost of capital would change. Assumed the cost of capital rise, it may lead a negative NPV actually. After the calculation, we realize that the internal return rate is near 15.25%. Thus, the cost of capital would mislead the investor’s judgment if we ignore the change of interest rate.

IRR=15.25%
Year Cost(￡/m) Revenue(￡/m) Net Income(￡/m) PV(￡/m)
2013 2 0 -2 -2
2014 1.5 0 -1.5 -1.3021
2015 1.0 2 1 0.7535
2016 1.2 2.5 1.3 0.8503
2017 1.2 3 1.8 1.0220
2018 1.2 2.5 1.3 0.6407
2019 0.9 1 0.1 0.0428
Total 0

For the POLICY RISK, since the company mainly explores the gold mine, it would cause large eco-pollution to some extent. If the local government finds the company polluting the environment, it may put forward the new policy to ban the production and the company production would stop, causing large loss.

b) Opportunity Cost
OPPORTUNITY COST should be another problem when we make the final decision. Since the stock could bring large dividend and capital gain sometimes, if we sell the stock, he may lose the opportunity to obtain profit from equity market.

In conclusion, when making the final decision, we should consider the operation risk, market risk, interest risk, policy risk and opportunity cost.

Best regards,

Part B
1. Payback Period Calculation
Since the scrap value would be zero in the end of 5 years, we gain nothing from the machine. Besides, since we do not know the annual interest rate, we could not use the dynamic payback period to calculate and use payment period instead.

The payback period calculation:∑Ct－C0=0 and t is the time that the revenues cover the cost exactly.

For the Beck bag, the payback period would be:
Year Expected cash flows Net cash flows
0 (200,000) (200,000)
1 60,000 (140,000)
2 70,000 (70,000)
3 70,000 0
4 40,000 40,000
5 20,000 60,000
From the chart above, we know in the end of year 3, we achieve zero net cash flows, meaning the payback period is 3 year.

Sim