Question

Your mining company is considering an expansion of operations into iron ore. Your engineers surveyed a particular piece of land three weeks ago (the survey cost $45,000) and concluded the following:

• You can extract 2,500 tons of iron ore per year.
• There are 10,000 tons of iron ore underneath this land. Once all the ore has 
been extracted, the project will cease to produce any revenues.
• The price of ore will remain constant for the next 4 years. Currently ore sells 
for $120 per ton.
• The operating cost to extract the ore will be $80 per ton for the next 4 years.
• We can invest in the equipment for this project right now for $100,000.
• The equipment will be fully depreciated over a period of four years using the 
straight-line method.
• At the end of year 4, we can sell the equipment involved in the project for 
$25,000
• The expansion requires additional working capital (NWC) of $15,000 from 
the start (at time t=0) until the end of year 4. At time t=4, working capital 
decreases to $0.
• The tax rate is assumed to be 35%. Your cost of capital is 11%.

Please provide the Free Cash Flow for each year of this project (times t=0 through t=4) and compute the project’s NPV.

T = 0 Cash Flow: ___________

T = 1 Cash Flow: ___________

T = 2 Cash Flow: ___________

T = 3 Cash Flow: ___________

T = 4 Cash Flow: ___________

Project NPV: ___________

Answer 1

		Computation of NPV
		year	0	1	2	3	4
	i	Initial investment	(100,000)
	ii	Working capital	-15000
	A=i+ii	Initial investment	(115,000)
		operating cash flow
	i	Revenue=2500*120		300,000	300,000	300,000	300,000
	ii	cost=2500*80		200,000	200,000	200,000	200,000
	iii	depreciation=100000/4		25,000	25,000	25,000	25,000
	iv=i-iii	Profit before tax		75,000	75,000	75,000	75,000
	v=iv*35%	Tax@ 35%		26,250	26,250	26,250	26,250
	vi=iv-v	Profit after tax		48,750	48,750	48,750	48,750
	B=vi+iii	operating cash flow		73,750	73,750	73,750	73,750
		Terminal cash flow
	i	Release of working capital =					15,000
	ii	Post tax salvage value
		=25000*(1-35%)					16250
	C	NWC + salvage value					31250
	D=A+B+C	Net cash flow	(115,000)	73,750	73,750	73,750	105,000
	D	PVIF @ 11%	1.0000	0.9009	0.8116	0.7312	0.6587
	E=C*D	present value	(115,000)	66,441	59,857	53,925	69,167	134,391
		Therefore NPV =	134,391
	ans a)	Year 0 Cash flow	(115,000)
		year -1	73,750
		year -2	73,750
		year -3	73,750
		year -4	105,000
	Ans b)	NPV =	134,391