Question

1. Company A wishes to purchase a small operating mine, which has a remaining production life of 5 years, from Company B. Company B’s selling price for the mine is $10,000,000. Company A also plans to invest $2,500,000 in upgrading the mine and its infrastructure in the first year, and no production will occur during the first year. Based on recent history and future projections, the mine is expected to generate an annual, before-tax profit of $5,000,000 for its remaining life, after the upgrades and starting in year 2. At the end of mine’s production life, it is expected to cost $4,000,000 to close the mine, which will be incurred at the end of the 7^th year. The salvage value of the mine’s equipment is expected to be $1,500,000, which will also occur at the end of the 7^th year. Company A requires a minimum rate of return of 15%.
2. 1. Determine if the purchase of this mine is a good investment using NPV.
   2. What is the PVR
   3. Draw a Cumulative NPV diagram for the project
   4. What is the Discounted Payback?

Answer 1

Particulars	Year	Cash Inflows	Cash Outflows	Net Cashflows	PV of Net Cashflows
Purchase of Mine	0		$    10,000,000.00	$   (10,000,000.00)	$         (10,000,000.00)
Upgrading the Mine	1		$      2,500,000.00	$      (2,500,000.00)	$           (2,173,913.04)
Income	2	$    5,000,000.00		$        5,000,000.00	$             3,780,718.34
Income	3	$    5,000,000.00		$        5,000,000.00	$             3,287,581.16
Income	4	$    5,000,000.00		$        5,000,000.00	$             2,858,766.23
Income	5	$    5,000,000.00		$        5,000,000.00	$             2,485,883.68
Income	6	$    5,000,000.00		$        5,000,000.00	$             2,161,637.98
Salvage Value and Cost of Closure	7	$    1,500,000.00	$      4,000,000.00	$      (2,500,000.00)	$               (939,842.60)
Net Present Value					$             1,460,831.74

a) yes, it is a good purchase due to positive NPV

b) PVR is 1.1461

c) d)  Discounted Payback is 4.90