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 | $ | 140,000 | |
| Annual net cash receipts | $ | 155,000 | * |
| Cost to construct new roads in year three | $ | 48,000 | |
| Salvage value of equipment in four years | $ | 73,000 | |
*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%.
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:- a)-The net present value of the proposed mining project is ($73277).
Explanation=
| Windhoek Mines Ltd. | |||
| Net Present Value | |||
| Particulars | Cash Flows | Present Value Factor @19% | Present value |
| (a) | (b) | (c=a*b) | |
| Net cash flow per year (For 4 years) | 155000 | 2.6386 | 408983 |
| New Equipment (1st Year) | -420000 | 1 | -420000 |
| Working Capital | -140000 | 1 | -140000 |
| Cost to construct new road (in 3 years) | -48000 | 0.5934 | -28483 |
| Salvage value (4th year) | 73000 | 0.4987 | 36405 |
| ADD:- Working capital | 140000 | 0.4987 | 69818 |
| Net Present Value | -73277 | ||
b)- The project should not be accepted due to negative net present value.
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