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 $ 390,000 Working capital required $ 125,000 Annual net cash receipts $ 140,000 * Cost to construct new roads in year three $ 45,000 Salvage value of equipment in four years $ 70,000 *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 21%. Click here to view Exhibit 12B-1 and Exhibit 12B-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)

Description	Now	Year 1	Year 2	Year 3	Year 4
Purchase of equipment	($390000)
Working capital investment	($125000)
Annual net cash receipts		$140000	$140000	$140000	$140000
Road construction				($45000)
Working capital released					$125000
Salvage value of equipment					$70000
Total cash flows (A)	($515000)	$140000	$140000	$95000	$335000
Discount factor (21%) (B)	1.000	0.826	0.683	0.564	0.467
Present value [A * B]	($515000)	$115640	$95620	$53580	$156445
Net present value	($93715)

Ans :- The net present value of the proposed mining project is ($93715) .

b) Due to negative net present value , the project should not be accepted .