Question

Question:

Building a new refinery

The construction and installation of a new refinery will cost $22 million. In addition, a processing plant will also need to be constructed at a cost $6 million. This plant will need to be supplied with grinding machines, DMS flotation machines and other equipment at a total cost of $16 million. Kidman Resources' current fleet of Haul trucks, water carts and dump trucks will meet the needs for this project, however until recently, the fleet has been earning a rental income of $120,000 per year.

Under the agreement with Tesla inc., the lithium mined is expected to generate a revenue of $15 million per year, which will increase by 2.8% per annum adjusted for rising costs. Due to the additional complexities involved with the construction and management of this new refinery, 5 new engineers (yearly salary per engineer $160,000) will replace 5 existing engineers (yearly salary per engineer $120,000). All other remaining labour force required is expected to cost $3 million per annum for the duration of the project.

For tax reasons you will expense the cost of the processing plant immediately. The cost for the construction and installation of the new refinery and associated machines and equipment will be depreciated over three years using the straight-line method. Due to the nature of the mining project, the machines and equipment will likely have a salvage value of $10 million at the end of three years. Finally, the required net working capital is $2 million.

Calculate Net Present Value given rate of return = 10% and tax rate= 30%

Answer 1

Formula	Year (n)	0	1	2	3
New refinery cost & equipment cost	Initial investment (II)	(38,000,000)
Increasing at 2.8% p.a.	Revenue ('R)		15,000,000	15,420,000	15,851,760
	Opportunity cost of rental income lost (O)		(120,000)	(120,000)	(120,000)
Annual salary increase from 120,000 to 160,000 for 5 engineers	Salary cost increase (S)		(200,000)	(200,000)	(200,000)
	Labor force cost (L)		(3,000,000)	(3,000,000)	(3,000,000)
(II/3)	Depreciation (D)		(12,666,667)	(12,666,667)	(12,666,667)
	Processing plant cost (P)	(6,000,000)
(R-O-S-L-D-P)	EBIT	(6,000,000)	(986,667)	(566,667)	(134,907)
(30%*EBIT)	Tax @30%	1,800,000	296,000	170,000	40,472
(EBIT - Tax)	Net income (NI)	(4,200,000)	(690,667)	(396,667)	(94,435)
	Add: depreciation (D)	-	12,666,667	12,666,667	12,666,667
(NI+ D)	Operating Cash Flow (OCF)	(4,200,000)	11,976,000	12,270,000	12,572,232
NWC will be recovered in Year 2	Increase in NWC	(2,000,000)			2,000,000
salvage value*(1-Tax rate)	Salvage value (after-tax) SV)				7,000,000
(II + OCF + NWC + SV)	Free Cash Flow (FCF)	(44,200,000)	11,976,000	12,270,000	21,572,232
1/(1+d)^n	Discount factor @10%	1.000	0.909	0.826	0.751
(FCF*Discount factor)	PV of FCF	(44,200,000.00)	10,887,272.73	10,140,495.87	16,207,537.19
Sum of all PVs	NPV	(6,964,694.21)

This project has a negative NPV of - 6,964,694.21