Question

Problem 13-16 Net Present Value Analysis [LO13-2]

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 $ 340,000 Working capital required $ 205,000 Annual net cash receipts $ 140,000 * Cost to construct new roads in year three $ 61,000 Salvage value of equipment in four years $ 86,000 *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

NPV IS THE EXCESS OF THE PRESENT VALUE OF THE CASH INFLOWS OVER OUTFLOWS,DISCOUNTED USING A DISCOUNT RATE.

FORMULA FOR NPV : PRESENT VALUE OF CASH INFLOWS - PRESENT VALUE OF CASH OUTFLOWS

HERE, CASH OUT FLOWS ARE :   

AT FIRST YEAR COST OF EQUIPMENT = $340000

AT FISR YEAR WORKING CAPITAL REQUIRED =$205000

IN THIRD YEAR COST OF NEW ROAD =$61000 PRESENT VALUE OF WHICH SHALL BE $61000*.6086= $37126

TOTAL CASH OUTFLOWS = $340000+$205000+$37126

=$582126

AND PRESENT VALUE OF CASH INFLOWS IS:

YEAR	CASH INFLOWS	DISCOUNT FACTOR@18%	PRESENT VALUE
I	140000	.8474	118636
II	140000	.7181	100534
III	140000	.6086	85204
IV	140000+86000+205000=	.5157	222266
TOTAL			526640

NPV IS PV OF CASHINFLOW MINUS CASH OUTFLOW

NPV = $526640-$582126

NPV = - 55486

AS PER ABOVE CALCULATION NPV IS NEGATIVE HENCE PROJECT SHOULD NOT BE ACCEPTED.