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	$	350,000
Working capital required	$	105,000
Annual net cash receipts	$	135,000	*
Cost to construct new roads in year three	$	41,000
Salvage value of equipment in four years	$	66,000

*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 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

a
	Now	1	2	3	4
Purchase of Equipment	-350000
Working Capital	-105000
Annual net cash receipts		135000	135000	135000	135000
Road construction				-41000
Working Capital released					105000
Salvage value					66000
Total cash flows	-455000	135000	135000	94000	306000
Discount factor(18%)	1	0.847	0.718	0.609	0.516
Present value	-455000	114345	96930	57246	157896
Net Present value	-28583
b
The project should not be accepted, as net present value is negative