Question

A Canadian company is presently considering undertaking a mining project to extract soda ash. The company expects to produce 300,000 tons of soda ash annually in 2021. This will meet the present annual demand in Canada. The total cost of buying the soda ash mine is $400m. This will be paid $200m now (31 December, 2019) and $200m on 31 December, 2020. The company will also purchase new machineries for the mining production at the end of 2020, which will cost $100m with salvage value of $500,000 (straight-line depreciation for the life of the soda ash mine). The tax and financial year end are set at 31 December. The before-tax income from other operations is $150m a year. The life of the soda ash mine is expected to be 10 years once it starts production. The company expects to charge a selling price of $400 per ton of soda ash. This price is the same as the current price of imported soda ash. Due to increases in worldwide supply over the next few years, the company does not expect to see an increase in the international price of soda ash in the foreseeable future. The marginal cost of production at the mine is estimated to be $40 per ton. Transport costs to the Canadian market are expected to cost $30 per ton. The company is presently importing soda ash for the total Canadian market from a US supplier, and is able to earn a net before-tax income after all costs of $27 per ton of imported soda ash. The incremental marketing cost for the mined soda ash is $10 per ton and this is the same as the marketing cost per ton for imported soda ash. This cost will remain at $10 per ton in 2019 and 2020 but will increase by 4% per year thereafter over the operational life of the mine. Marketing costs are incurred once soda ash leaves the store in Ottawa. The company has a contract to purchase 300,000 tons of soda ash per annum from its US supplier until the end of 2020, to meet demand. To allay the fears of customers regarding the future supply of soda ash, the company will keep stock levels of 150,000 tons of soda ash in Ottawa with value of $6m once the mine reaches full production in 2021. This will be recovered at the end of the project. The company uses a cost of capital of 12%. The marginal tax rate is 30%. Determine whether the company should undertake the soda ash production by calculating the project’s net present value and internal rate of return.

Answer 1

NPV - (119220124)

IRR- 5.97%