Question

A mining company has constructed a town near the site of a rich mineral discovery in a remote part of Australia. It is expected the mineral deposit will be exhausted in 10 years and mining operations will cease and the town will be abandoned after the 10-year period. You have been asked by an agricultural company to evaluate an associated project that involves supplying the mining town with meat and agricultural produce for the 10-year period by developing nearby land. Costs, sales and operating expenses relating to the project are: 1) Investment in land is $1,000,000, farm buildings $200,000 and farm equipment $400,000. 2) The land is expected to have a realisable value of $500,000 in 10 years. 3) The buildings have an estimated life of 20 years at which time their salvage value would be zero. They are to be depreciated on a straight line (prime cost) basis for tax purposes based on this life. The salvage value of the buildings after 10 years is expected to be $50,000. 4) The farm equipment has an estimated life of 10 years and a zero salvage value. The equipment is to be depreciated on a straight line (prime cost) basis for tax purposes based on this life. 5) Investment in working capital is $250,000. This will be recovered at the end of the project’s life. 6) Annual cash sales are estimated to be $3,000,000. 7) Annual cash operating costs are estimated to be $2,200,000 8) Assume tax is paid one year after the year of income 9) The company tax rate is 39 per cent 10) The company required rate of return after-tax is 10 per cent.

Required: Should the agricultural company undertake the project?

Answer 1

Solution:

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