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 | $ | 440,000 | |
| Working capital required | $ | 150,000 | |
| Annual net cash receipts | $ | 165,000 | * |
| Cost to construct new roads in year three | $ | 50,000 | |
| Salvage value of equipment in four years | $ | 75,000 | |
*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 7B-1 and Exhibit 7B-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?
a.
| Computation of NPV - Windhoek Mines ltd. | ||||
| Particulars | Period | Amount | PV factor at 18% | Present Value |
| Cash outflows: | ||||
| Cost of new Equipment and timber | 0 | -$4,40,000 | 1 | -$4,40,000 |
| Working capital needed | 0 | -$1,50,000 | 1 | -$1,50,000 |
| Cost to Construct new roads | 3 | -$50,000 | 0.609 | -$30,450 |
| Present Value of Cash outflows (A) | -$6,20,450 | |||
| Cash Inflows | ||||
| Net Annual cash receipts | 1-4 | $1,65,000 | 2.690 | $4,43,850 |
| Salvage value | 4 | $75,000 | 0.516 | $38,700 |
| Release of working capital | 4 | $1,50,000 | 0.516 | $77,400 |
| Present Value of Cash Inflows (B) | $5,59,950 | |||
| Net Present Value (NPV) (B-A) | -$60,500 |
b.
No, the project should not be accepted
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