Windhoek Mines, Ltd., of Namibia, is contemplating the purchase of equipment to

Question

Windhoek Mines, Ltd., of Namibia, is contemplating the purchase of equipment to exploit a mineral deposit on land to which the company has mineral rights. An engineering and cost analysis has been made, and it is expected that the following cash flows would be associated with opening and operating a mine in the area: Cost of new equipment and timbers $ 440,000 Working capital required $ 150,000 Annual net cash receipts $ 165,000* Cost to construct new roads in three years $ 50,000 Salvage value of equipment in four years $ 75,000 *Receipts from sales of ore, less out-of-pocket costs for salaries, utilities, insurance, and so forth. The mineral deposit would be exhausted after four years of mining. At that point, the working capital would be released for reinvestment elsewhere. The company’s required rate of return is 18%. Click here to view Exhibit 11B-1 and Exhibit 11B-2, to determine the appropriate discount factor(s) using tables. Required: a. Determine the net present value of the proposed mining project. (Any cash outflows should be indicated by a minus sign. Use the appropriate table to determine the discount factor(s).) b. Should the project be accepted? Yes No

Explanation / Answer

A)

COST OF NEW EQUIPMENT & TIMBER $ 440000

WORKING CAPITAL REQUIRED $150000

ANNUAL NET CAH RECEIPTS(AFTER ALL EXPENSES) $ 165000

COST OF CONSTRUCTING ROADS IN 3 YEARS $ 50000

SALVAGE VALUE OF EQUIPMENT IN FOURTH YEAR $ 75000

LIFE OF MINING PROJECT 4 YEARS

COMPANY'S REQUIRED RATE OF RETURN 18%

NET PRESENT VALUE(NPV) = PRESENT VALUE OF   MINUS PRESENT VALUE OF CASH CASH INFLOW OUTFLOW

COMPUTATION OF NPV OF THE PROPOSED MINING PROJECT

Total of Present value of cash inflow =$ 559950

-50000

Total of present value of cash outflows = $ 640000

NET PRESENT VALUE(NPV)   = PRESENT VALUE OF   MINUS PRESENT VALUE OF CASH CASH INFLOW OUTFLOW

NPV = $ 559950- $640000

= -$80050

Note: Assume cost of constructing roads in 3 years is onetime paid at starting of the mining project.

B)    Since the net present value of the Mining project is negative -$80050, the project should not be accepted.

As present value of cash outflows are more than present value of cash inflows.

CASH INFLOWS TIME AMOUNT($) PRESENT VALUE FACTOR AT 18% PRESENT VALUE OF CASH INFLOWS Annual cash inflow 1-4 165000 2.69 443850 working capital (released) 4 150000 0.516 77400 salvage value of equipment 4 75000 0.516 38700

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