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 $ 420,000 Working capital required $ 230,000 Annual net cash receipts $ 165,000* Cost to construct new roads in three years $ 66,000 Salvage value of equipment in four years $ 91,000 *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

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a) Calculation of the net present value of the proposed mining project Year Now 1 2 3 4 Purchase of Equipment -420000 Working Capital Investment -230000 Annual Net cash receipts 165000 165000 165000 165000 Road construction -66000 Working Capital Releases 230000 Salvage value of equipment 91000 Total Cash Flows (A) -650000 165000 165000 99000 486000 Discount Factor (18%) (B) 1 0.84746 0.71818 0.60863 0.51579 [1/1.18] [1/1.18^2] [1/1.18^3] [1/1.18^4] Present value (PV) (A*B) -650000 139831 118500 60254 250673 Net Present value (Sum of PVs) -80741 b) As the NPV is negative, the project should not be accepted.

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