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 $410,000
Working capital required: $225,000
Annual net cash receipts: $160,000*
Cost to construct new roads in year three: $65,000
Salvage value of equipment in four years: $90,000
*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 19%.
Required:
a. What is the net present value of the proposed mining project?
b. Should the project be accepted?
(1) Required Rate of return= 19%
Initial Investment= cost of new equpment and timber + working capital
= 410,000 $ + 225,000 $= 635,000 $
Calculation of yearly cash flow and their present value: -
| Particulars | Year 1 | Year 2 | Year 3 | Year 4 |
| Annual net cash receipts | 160,000 $ | 160,000 $ | 160,000 $ | 160,000 $ |
| Less:- Cost of construction of road | (65,000) $ | |||
| Add:- salvage value | 90,000 $ | |||
| Add: working capital inflow | 225,000 $ | |||
| Nrt cash flow | 160,000 $ | 160,000 $ | 95,000 $ | 475,000 $ |
| PV @ 19% | 134,453.78 $ | 112,986.37 $ | 54,374.50 $ | 236.867.66 $ |
Net inflow= 538,682.31 $
Net present value= 635,000 $ - 538.682.31 $
= -96,317.69 $
(2) The project should not be accepted as it has negative present value.
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