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	$	410,000
Working capital required	$	135,000
Annual net cash receipts	$	150,000	*
Cost to construct new roads in year three	$	47,000
Salvage value of equipment in four years	$	72,000

*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

1	Calculation of Net Present value of the project
			Years
		Now	1	2	3	4
	Purchase of Equipment	$     (410,000)
	Investment in working capital	$     (135,000)
	Net annual cashflow		$            150,000	$          150,000	$          150,000	$          150,000
	Cost to construct road				$          (47,000)
	Salvage value of the Equipment					$            72,000
	Working Capital released					$          135,000
	Total Cash flows (a)	$     (545,000)	$            150,000	$          150,000	$          103,000	$          357,000
	Discounting factor(18%)(b)	1.000	0.847	0.718	0.609	0.516
	Present value of Cash flow(a)x(b)	$     (545,000)	$            127,119	$          107,728	$            62,689	$          184,137
	Net Present Value	$        (63,328)
	As the investment generates a negative NPV of $63,328, the investment is not acceptable .
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