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	$360,000
Working Capital Required	$110,000
Annual net cash receipts	$140,000*
Cost to construct new roads in year three	$42,000
Salvage value of equipment in four years	$67,000

*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 19%.

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
Purchse of Equipment	-360000
Working Capital	-110000
Annual net cash receipts		140000	140000	140000	140000
Road construction				-42000
Working Capital released					110000
Salvage value					67000
Total cash flows	-470000	140000	140000	98000	317000
Discount factor(19%)	1	0.840	0.706	0.593	0.499
Present value	-470000	117600	98840	58114	158183
Net Present value	-37263
b
The project should not be accepted, as net present value is negative