Problem 13-16 Net Present Value Analysis [LO13-2] Windhoek Mines, Ltd., of Namib
ID: 2527985 • Letter: P
Question
Problem 13-16 Net Present Value Analysis [LO13-2]
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 $ 340,000 Working capital required $ 205,000 Annual net cash receipts $ 140,000 * Cost to construct new roads in year three $ 61,000 Salvage value of equipment in four years $ 86,000 *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 13B-1 and Exhibit 13B-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?
Explanation / Answer
NPV IS THE EXCESS OF THE PRESENT VALUE OF THE CASH INFLOWS OVER OUTFLOWS,DISCOUNTED USING A DISCOUNT RATE.
FORMULA FOR NPV : PRESENT VALUE OF CASH INFLOWS - PRESENT VALUE OF CASH OUTFLOWS
HERE, CASH OUT FLOWS ARE :
AT FIRST YEAR COST OF EQUIPMENT = $340000
AT FISR YEAR WORKING CAPITAL REQUIRED =$205000
IN THIRD YEAR COST OF NEW ROAD =$61000 PRESENT VALUE OF WHICH SHALL BE $61000*.6086= $37126
TOTAL CASH OUTFLOWS = $340000+$205000+$37126
=$582126
AND PRESENT VALUE OF CASH INFLOWS IS:
NPV IS PV OF CASHINFLOW MINUS CASH OUTFLOW
NPV = $526640-$582126
NPV = - 55486
AS PER ABOVE CALCULATION NPV IS NEGATIVE HENCE PROJECT SHOULD NOT BE ACCEPTED.
YEAR CASH INFLOWS DISCOUNT FACTOR@18% PRESENT VALUE I 140000 .8474 118636 II 140000 .7181 100534 III 140000 .6086 85204 IV 140000+86000+205000= .5157 222266 TOTAL 526640