In year 4 Project A will sell 100 tonnes of gold for $500 per tonne and incur co
ID: 2732591 • Letter: I
Question
In year 4 Project A will sell 100 tonnes of gold for $500 per tonne and incur costs of $10,000. The yearly depreciation on the mine is $20,000 and the corporate tax rate of 30%. What is the FCF for Project A in year 4 and how would this figure be used in an NPV analysis? (3 marks)
a) A project has an initial cost of $40,000, expected net cash inflows of $9,000 per year for 7 years, and a cost of capital of 11%. What is the NPV of the project? (2.5 marks)
b) You are evaluating two 7-year projects both with a positive NPV at a WACC of 10%. One of the projects has all positive cash flows after year 0 and one has negative cash flows in years 0-3, positive cash flows in years 4-7 and a negative cash flow in year 8. If the WACC increased to 15% would you use the IRR or NPV method to evaluate the projects and why? (2.5 marks)
Explanation / Answer
(1)
Pre-tax income = Revenue - Costs - Depreciation = (Price x Quantity) - Costs - Depreciation
= ($500 x 100) - $10,000 - $20,000 = $(50,000 - 10,000 - 20,000) = $20,000
After-tax income = Pre-tax income x (1 - tax rate) = $20,000 x (1 - 0.3) = $20,000 x 0.7 = $14,000
FCF = After-tax income + Depreciation = $(14,000 + 20,000) = $34,000
NPV will be calculated as sum of initial investment, and discounted FCF over the period of analysis.
(2) Initial cost = $40,000 & Annual cash inflow = $7,000
NPV ($) = - 40,000 + 9,000 x PVIFA(11%, 7) = - 40,000 + 9,000 x 4.7122 (From PVIFA table)
= - 40,000 + 42,409.8 = 2,409.8
Note: First 2 questions are answered.