Question

a. The initial cost of the extraction equipment is $2,500,000. In addition to this cost, the equipment will require a large concrete foundation at a cost of $300,000. The vendor has quoted an additional cost of $200,000 to install and test the equipment. These costs are all considered part of the cost of acquiring the equipment.

b.The useful life of the equipment is 10 years with no salvage value at the end of this period. However, for tax purposes, the equipment will be classified as 7year property and use the following MACRS depreciation allowances (half year convention) for computing tax depreciation deductions:

Percentage Of Original Year Cost

1 . . . . . . . . . . 14.3%

2 . . . . . 24.5

3 . . . . . . . . . . 17.5

4 . . . . . . . . . . 12.5

5 . . . . . . . . . . 8.9

6 . . . . . . . . . .8.9

7 . . . . . . . . . . 8.9

8 . . . . . . . . . .4.5

100.0%

c. Using the new equipment, 250 pounds of platinum can be extracted annually for the next 10 years from the previously inaccessible area of the mine.

d.The cost to extract and separate platinum from the ore is $4,000 per pound of platinum. After separation, the platinum must undergo further processing and testing that costs $1900 per pound of platinum. These are all out of pocket, variable costs.

e.Two skilled technicians will be hired to operate the new equipment. The total salary and fringe benefit expense for these two employees will be $200,000 annually over the 10 years.

f.Periodic maintenance on the equipment is expected to cost $175,000 per year.

g.The project requires an investment in additional working capital of $300,000. This working capital would be released for use elsewhere at the conclusion of the project in 10 years.

h.Environmental and safety regulations require that the mine be extensively restored and toxic substances be safely disposed at the conclusion of the project. The cost of environmental remediation work is expected to be $4,500,000

i.The current market price of platinum is 12,800 per pound

j.The tax rate is 21% and it uses an 18% after tax discount rate (minimum required rate of return)

Question:

2. Capital investment evaluation

Determine the following for the proposed extractoin equipment investment and specify whether or not the investment is acceptable under each of the following approaches. Assume a minimum payback period of 2 years is required

a. Net Present Value (NPV)

b. Internal rate of return (IRR) [Under TOOLS select GOAL SEEK and SET CELL for NPV equal to "0" - by changing after-tax discount rate 18%

c. Payback (in years) - round to nearest whole year

2.

				After-tax		Present Value of
Description	Year(s) Ending	Amount ($)	Tax effect (%)	Cash Flows ($)	Discount Factor	Cash Flows ($)
Equipment cost	Now
Working capital	Now
Revenue	1-10	3,200,000	79%	2,528,000	4.4941
Processing & Testing	1-10
Salaries & benefits	1-10
Maintenance	1-10
PV of depr shield	1-8					365,342
Release of W.C.	10	-			0.1911
Site Remediation	10
				(a)	NPV ($) =
					check figure:	1236370

Answer 1

Answer (a)

Equipment cost = 2500000 + 300000 + 200000 = $3,000,000

NPV = $1,236,370

Workings:

Answer (b):

IRR = 31.82%

To use goal seek pl see below the above excel with 'show formula':

Discount factor is at cell F2:

On use goal seek (SET CELL G12 for NPV equal to "0" - by changing after-tax discount rate CELL F2) we get IRR = 31.82%

Answer (c):

Payback (in years) = 3 years

Working: