Subject: Business    / Finance
Question

Carraizo Mining Group (CMG) is a company that conduct geological explorations of parcels of land in Latin America to ascertain whether commercially significant metal deposits are present. Current CMG has an option to purchase outright a parcel of land for $3,000,000. If CMG purchases this parcel of land, then it will conduct a geological exploration. Prior experience suggests that for the type of parcel of land under consideration

geological explorations cost approximately one million dollars and yield significant metal deposits as follows: ?

copper .8% chance ?

aluminum 1.2% chance ?

silver 0.5% chance

Only one of these three metals is ever found (if at all), i.e. there is no chance of finding two or more of these metals and no chance of finding any other metal. If copper is found then the parcel of land can be sold for $30,000,000, if aluminum is found then the parcel of land can be sold for $250,000,000 and if silver is found the parcel of land can be sold for $150,000,000.

CMG has the option to pay $750,000 for the right to conduct a test exploration before deciding whether to purchase the parcel of land or not. Such test exploration can only give a preliminary indication of whether significant metal deposits are present or not and experience indicates that three-day test explorations cost $250,000 and indicate that significant metal deposits are present 60% of the time. If the test exploration indicates significant metal deposits then the chances of finding copper, aluminum and silver increase to 5%, 4% and 2%, respectively. If test exploration fails to indicate significant metal deposits then the chances of finding copper, aluminum and silver decrease to 0.5%, 0.05% and 0.25% respectively.

a) What would you recommend CMG should do and why?

b) A company working in a related field to CMG is prepared to pay half of all costs associated with this parcel of land in return for half of all revenues.

c) Under these circumstances what would you recommend CMG should do and why?

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