In: Accounting
1. 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 $ 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 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?
What is the net present value of the proposed mining project? (Enter negative amount with a minus sign. Round your final answer to the nearest whole dollar amount.)
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2.
Problem 13-24 Simple Rate of Return; Payback Period; Internal Rate of Return [LO13-1, LO13-3, LO13-6]
The Elberta Fruit Farm of Ontario always has hired transient workers to pick its annual cherry crop. Janessa Wright, the farm manager, just received information on a cherry picking machine that is being purchased by many fruit farms. The machine is a motorized device that shakes the cherry tree, causing the cherries to fall onto plastic tarps that funnel the cherries into bins. Ms. Wright has gathered the following information to decide whether a cherry picker would be a profitable investment for the Elberta Fruit Farm:
Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor using tables.
Required:
1. Determine the annual savings in cash operating costs that would be realized if the cherry picker were purchased.
2a. Compute the simple rate of return expected from the cherry picker.
2b. Would the cherry picker be purchased if Elberta Fruit Farm’s required rate of return is 11%?
3a. Compute the payback period on the cherry picker.
3b. The Elberta Fruit Farm will not purchase equipment unless it has a payback period of six years or less. Would the cherry picker be purchased?
4a. Compute the internal rate of return promised by the cherry picker.
4b. Based on this computation, does it appear that the simple rate of return is an accurate guide in investment decisions?
Determine the annual savings in cash operating costs that would be realized if the cherry picker were purchased.
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Compute the simple rate of return expected from the cherry picker. (Round your percentage answer to 2 decimal places.)
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Compute the payback period on the cherry picker. (Round your answer to 2 decimal places.)
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Compute the internal rate of return promised by the cherry picker.
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a | |||||
Now | 1 | 2 | 3 | 4 | |
Purchase of Equipment | -390000 | ||||
Working Capital | -125000 | ||||
Annual net cash receipts | 140000 | 140000 | 140000 | 140000 | |
Road construction | -45000 | ||||
Working Capital released | 125000 | ||||
Salvage value | 70000 | ||||
Total cash flows | -515000 | 140000 | 140000 | 95000 | 335000 |
Discount factor(21%) | 1 | 0.826 | 0.683 | 0.564 | 0.467 |
Present value | -515000 | 115640 | 95620 | 53580 | 156445 |
Net Present value | -93715 | ||||
b | |||||
The project should not be accepted, as net present value is negative |
1 | ||
Present cost of transient workers | 230000 | |
Less: Out of pocket fixed costs | ||
Cost of an operator and assistant | 93000 | |
Insurance | 2000 | |
Fuel | 10000 | |
Maintenance contract | 13000 | 118000 |
Annual savings in cash operating costs | 112000 | |
2 | ||
Annual savings in cash operating costs | 112000 | |
Less: Depreciation expense | 67000 | =670000/10 |
Annual incremental net operating income | 45000 | |
Annual incremental net operating income | 45000 | |
Divide by Investment cost | 670000 | |
Simple rate of return | 6.72% | |
2b | ||
NO, as simple rate of return is less than 11% | ||
3a | ||
Investment cost | 670000 | |
Divide by Annual savings in cash operating costs | 112000 | |
Payback period | 5.98 | years |
3b | ||
Yes, as payback period is less than 6 years | ||
4a | ||
Investment cost | 670000 | |
Divide by Annual savings in cash operating costs | 112000 | |
PV factor for internal rate of return | 5.982 | |
The PV factor 5.982 for 10 years is closest to 11% | ||
Internal rate of return = 11% | ||
4b | ||
No, simple rate of return is not an accurate guide in investment decisions. |