3) A mineral property is producing at a rate that will generate $5 million in annual operating profit (revenue minus operating costs) during the next year (assume end of year 1). Escalation of operating costs is expected to be offset by sales escalation in future years, so that annual end-of- year operating profit will remain constant at $5 million each year until mineral reserves are depleted. At the current production rate, mineral reserves will be depleted at the end of 10 years from now. An increase in the annual production rate is being considered by incurring a $2 million equipment and development cost now (time 0) and a $4 million equipment and development cost a year from now (year 1). These expansion costs would permit increasing mineral production to give projected total operating profit of $6 million at year 1 and $8 million per year at years 2 through 8 when reserves will be depleted at the increased production rate. Use NPV analysis to evaluate the economic desirability of the expansion investment for a minimum rate of return of 20%
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