Stake Gold Mines Has the Option to Purchase a Parcel

question 10

Essay

Stake Gold Mines has the option to purchase a parcel of land adjacent to its current mining operations in a Western state. The seller's best and final price is $3 million. If the land has commercial mineral deposits, Stake Gold estimates its value at $5 million. If there are no deposits, the estimated value is $2 million. A preliminary look at the land leads Stake Gold to believe that the chance of mineral deposits is 50:50.
(a) Given this information, should Stake Gold purchase the land? For a fee of $200,000, the seller has agreed to let Stake Gold collect extensive mineral samples on the site. Based on past experience, if there are minerals present, the samples will provide a favorable indication 80% of the time. If no minerals are present, the samples will (falsely) give a favorable reading 40% of the time. Determine Pr(M|F) and Pr(M|U). (Here, M denotes mineral deposits, NM denotes no mineral deposits, F denotes favorable samples, and U denotes unfavorable samples.)
(b) Should Stake Gold pay $200,000 for the right to collect samples?

---

Definitions:

Internal Rate

A variation of the Internal Rate of Return (IRR), focusing on the rate at which a series of cash flows would result in a net present value of zero.

Payback Period

The length of time it takes for an investment to generate cash flows sufficient to recover its initial cost.

Payback Period

The length of time it takes for an investment to recover its initial outlay in terms of profits or savings, used as a measure of investment risk.

Cash Operating Expenses

Costs directly associated with the operation of a business that require cash payment, excluding non-cash expenses such as depreciation.