Question

Windhoek Mines, Ltd., of Namibia, is contemplating the purchase of equipment to exploit a mineral deposit on land to which the company has mineral rights. An engineering and cost analysis has been made, and it is expected that the following cash flows would be associated with opening and operating a mine in the area:

Cost of new equipment and timbers	$	430,000
Working capital required	$	145,000
Annual net cash receipts	$	160,000	*
Cost to construct new roads in year three	$	49,000
Salvage value of equipment in four years	$	74,000

*Receipts from sales of ore, less out-of-pocket costs for salaries, utilities, insurance, and so forth.

The mineral deposit would be exhausted after four years of mining. At that point, the working capital would be released for reinvestment elsewhere. The company’s required rate of return is 18%.

Click here to view Exhibit 7B-1 and Exhibit 7B-2, to determine the appropriate discount factor(s) using tables.

Required:

a. What is the net present value of the proposed mining project?

b. Should the project be accepted?

Answer 1

a		Now	1	2	3	4
	Purchase of equipment	-430000
	Working capital investment	-145000
	Annual net cash receipt		160000	160000	160000	160000
	Road construction				-49000
	Working capital released					145000
	Salvage value of equipment					74000
	Total cash flow	-575000	160000	160000	111000	379000
	discount factor 18%	1	0.8475	0.7188	0.6086	0.5158
	Present value = total cash inflow*discount factor	-575000	135600	115008	67554.60	195488.20
	Net present value= sum of present value of cash flow	-61349.20
B	No, as its NPV is negative.