EXERCISE: Valuing a gas pipeline You own a gas pipeline that requires no maintenance and will produce $2 million of revenue next year. Unfortunately, after the first year the volume of gas (and thus the revenue) is expected to decline by 4.0% per year. a. If the discount rate is 11.0% and the pipeline lasts forever, what is it worth today? b. If the discount rate is still 11.0%, but pipeline is to be abandoned at the end of 20 years, what is it worth today? EXERCISE: Expanding capacity in molybdenum mines Question: AMAX Corporation is a mining company that focuses on extraction of molybdenum-a crucial additive in the production of steel. AMAX is considering expanding its molybdenum capacity and is deciding whether to pursue one of the following investment alternatives: a) An investment to expand capacity at its Climax mine would cost $100M today (year 0), $50M next year (year 1) and would increase capacity in years 3 to 9 by 15M pounds (note there is no cash flow in year 2). The variable cost of extracting molybdenum at this location would be $4/pound. [Hint: nominal annual profits from the increased capacity would therefore be given by 15M x (P - $4), where P is the price of molybdenum] Year 0 1 2 3 4 5 6 7 8 9 Investment (in $M) - 100 - 50 b) An investment to expand capacity at its Henderson mine would cost $75M today (year 0), $30M next year (year 1) and would increase capacity by 13M pound per year from years 3 to 9. The variable costs of extracting molybdenum from this location would be $4.5/pound. Year 0 1 2 3 4 5 6 7 8 9 Investment (in $M) - 75 - 30 c) Reopening of its Kitsault mine would require an investment of $25M today (year 0), $10M in year 1 and $10M in year 2 and would increase capacity in years 3 to 9 by 10M pounds. The variable cost of extraction would be $6/pound. Year 0 1 2 3 4 5 6 7 8 9 Investment (in $M) - 25 - 10 - 10 If the discount rate is 16%, find the price of molybdenum above which it makes sense to do each of the investments a), b), and c).