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 ​$25,000​) and concluded the​ following: ​• You can extract ​1,000 tons of iron ore per year. ​• There are ​4,000 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 ​$100 per ton. ​• The operating cost to extract the ore will be ​$60 per ton for the next 4 years. ​• We will need to invest in the equipment for this project right now for ​$100,000. ​• The equipment will be depreciated over a period of four years using the​ straight-line method, with an assumed salvage value of zero for tax purposes. ​• At the end of year​ 4, we can sell the equipment involved in the project for ​$20,000. ​• The expansion requires additional working capital​ (NWC) of ​$10,000 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 ​40%. Your cost of capital is ​12%.

Please provide the Free Cash Flow for each year of this project​ (t=0 through​ t=4) and compute the​ project’s NPV. ​(please round all answers to the nearest​ dollar) ​

T=0 Cash​ Flow: $ _______

​T=1 Cash​ Flow: $ _______

T=2 Cash​ Flow: $ _______

​T=3 Cash​ Flow: $ _______ ​

T=4 Cash​ Flow: $ _______

The Net Present Value​ (NPV) of this project​ is: $ _______.

Based on this​ analysis, should you pursue this​ project?

Answer 1

Depreciation = 100,000 / 4 = 25000 per year (Straight line method)

after tax salvage value = 20000*(1 - 0.4) = 12000

T = 0 cash flow = -110,000

T = 1   cash flow = 34000

T = 2 cash flow = 34000

T = 3 cash flow = 34000

T = 4 cash flow = 56000

NPV = 7251.28 (rounded to two decimals)

Yes we can pursue this project because it has positive NPV.