Question

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3. Tennyson Ltd is planning to develop an iron ore mine in northwest South Australia. Based on the quantity of inferred resources and current extraction rates the consulting geologist estimates that the mine will be depleted in eight years' time. Management of Tennyson has been given the following estimates that relate to the provision of accommodation and services for the mine over its eight-year life. 1. They will purchase land for $380,000, demountable buildings for $220,000 and other equipment for $420,000. When the project ends (at the end of eight years) they expect to sell the land for $200,000, the buildings for $65,000 and the equipment for $95,000. II. The project will also require an investment in inventory of $95,000 at the start of the project. III. IV. The annual cash sales are estimated to be $1,375,000 and cash operating costs are estimated to be $895,000. Management wants to depreciate all assets over the mine life of eight years. The taxation office has provided advice that for tax purposes, buildings are depreciated over 20 years straight-line to zero and equipment at 15 years straight-line also to zero. Land cannot be depreciated for tax purposes and in this case there are no tax effects from gains and losses on land. Will the project prove worthwhile for Tennyson Ltd given that the required rate of return is 25% pa and the company tax rate is 30%?

Answer 1

Solia Land Demountable Buildings Other Equipment. 380 000 220000 420000 1020000 95000 1115000 Inventory Total Investment. Statement of Profit and lom (Annually) Annual Cash Sales 137 5000 Less: Inventory 95000 11875 8 Less: Operating cost_ 895000 PBDT 468125 Less: Debriciation:- land 360000-200000 Building 20000 - 65000 Equipment 920000-95000 22500 19375 40625 PBT 385625 Less: Tax (wn. e) 1128737.5 After Tax (PAT) 256887.5 Profit

WoNo 1 Calculation of Tax | Profit Before Depriciations Tax Less: Depriciation (As per The Taxation Office) 468125 land. 20 Buildings 220000 Equipnient 420000 PBT (As per The Taxation office 11000 ; 28000 15 429125 Tax on Profit @ 30% 128737.5 for Will the Project Prove worthwhile Tennyson Ltd. Return on Investrient :- • PAI too Total Juvestment 256887.5 too 1115000 = 23.04% Required Rate of Return is 25%

Since the return on Investment / Capital Employed (.e. 23.04%) is lower than the required rate of return (i.e. 25%) The Project will not PProve worthwhile for Tennyson Ltd.