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	$	450,000
Working capital required	$	155,000
Annual net cash receipts	$	170,000	*
Cost to construct new roads in year three	$	51,000
Salvage value of equipment in four years	$	76,000

*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 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables.

Required:

a. What is the net present value of the proposed mining project?

b. Should the project be accepted?

Answer 1

Solution a:

Computation of NPV - Windhoek Mines, Ltd
Particulars	Period	Amount	PV Factor (19%)	Present Value
Cash outflows:
Cost of equipment and timbers	0	$450,000	1	$450,000
Working capital	0	$155,000	1	$155,000
Cost to construct new roads	3	$51,000	0.609	$31,059
Present value of cash outflows (A)				$636,059
Cash Inflows:
Annual cash inflows	1-4	$170,000	2.690	$457,300
Salvage value	4	$76,000	0.516	$39,216
Release of working capital	4	$155,000	0.516	$79,980
Present value of cash inflow (B)				$576,496
NPV (B-A)				-$59,563

Solution b:

As NPV is negative, therefore project should not be accepted.