Oxford Company has limited funds available for investment and must ration the funds among four competing projects. Selected information on the four projects follows:
| Project | Investment Required |
Net Present Value |
Life of the Project (years) |
Internal Rate of Return |
||||
| A | $ | 890,000 | $ | 459,687 | 8 | 23 | % | |
| B | $ | 690,000 | $ | 227,448 | 13 | 16 | % | |
| C | $ | 590,000 | $ | 279,681 | 8 | 22 | % | |
| D | $ | 790,000 | $ | 159,067 | 4 | 19 | % | |
The net present values above have been computed using a 10% discount rate. The company wants your assistance in determining which project to accept first, second, and so forth.
Part A
Required:
1. Compute the project profitability index for each project.
project Project Probability Index
A ?
B ?
C ?
D ?
PART B
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 | $ | 310,000 | |
| Working capital required | $ | 190,000 | |
| Annual net cash receipts | $ | 125,000 | * |
| Cost to construct new roads in year three | $ | 58,000 | |
| Salvage value of equipment in four years | $ | 83,000 | |
*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 12B-1 and Exhibit 12B-2, to determine the appropriate discount factor(s) using tables.
Required:
B. What is the net present value of the proposed mining project?
| 1 | |||||
| Project Probability Index = Net Present Value /Investment Required | |||||
| Project | Project Probability Index | ||||
| A | 0.52 | =459687/890000 | |||
| B | 0.33 | =227448/690000 | |||
| C | 0.47 | =279681/590000 | |||
| D | 0.20 | =159067/790000 | |||
| Part-B | |||||
| Now | Year 1 | Year 2 | Year 3 | Year 4 | |
| Cost of new equipment and timbers | -310000 | ||||
| Working capital required | -190000 | ||||
| Annual net cash receipts | 125000 | 125000 | 125000 | 125000 | |
| Cost to construct new roads in year three | -58000 | ||||
| Salvage value of equipment in four years | 83000 | ||||
| Working capital released | 190000 | ||||
| Net cash flows | -500000 | 125000 | 125000 | 67000 | 398000 |
| Present value factor | 1 | 0.847 | 0.718 | 0.609 | 0.516 |
| Total present value | -500000 | 105875 | 89750 | 40803 | 205368 |
| Net present value | -58204 | ||||
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