Annual cash receipts from sale of precious — The Perth Mining Company owns rights several tracts land which metals have — Investment equipment needed

The Perth Mining Company owns the mining rights to several tracts of land on which metals have been found in the past. The amount of precious metals on some of the tracts is somewhat marginal, and the company is unsure whether it would be profitable to extract and sell the precious metals that these tracts contain. Tract 420 is one of these, and the following information about it has been gathered:

Investment in equipment needed

For extraction work. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $400,000

Working capital investment needed. . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 55,000

Annual cash receipts from sale of precious

Metals, net of related cash operating

Expenses (before taxes) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 85,000

Cost of restoring land at completion

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Of extraction work . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 45,000

The precious metals in Tract 420 would be exhausted after eight years of extraction work. The equipment would have a useful life of 12 years, but it could be sold for only 20% of its original cost when extraction was completed. For tax purposes, the company would depreciate the equipment using a CCA rate of 20%. The tax rate is 30%, and the company’s after-tax discount rate is 12%. The working capital would be released for use elsewhere at the completion of the project.

Required:

1. Compute the net present value of Tract 420. Round all dollar amounts to the nearest whole dollar.

2. Would you recommend that the investment project be undertaken?

SOLUTION

1. The net present value analysis would be:

Items and Computations	Year(s)	(1) Amount	(2) Tax Effect	(1) × (2) After-Tax Cash Flows	Present Value of Cash Flows*
Investment in equipment	Now	$(400,000)		$(400,000)	$(400,000)
Working capital needed	Now	$(55,000)		$(55,000)	(55,000)
Net annual cash receipts	1-8	$85,000	1 – 0.30	$59,500	295,575
Cost of restoring land	8	$(45,000)	1 – 0.30	$(31,500)	(12,722)
Salvage value of the equipment	8	$80,000		$80,000	32,311
Working capital released	8	$55,000		$55,000	22,214
CCA tax shield:
Cdt × 1+ .5k – Sdt × (1+k)-n d + k 1+k d+k 400,000 × .2 × .3 × 1.06 – 80,000 × .2 × .3 × .404 .2 + .12 1.12 .2+.12	Cdt × 1+ .5k – Sdt × (1+k)-n d + k 1+k d+k 400,000 × .2 × .3 × 1.06 – 80,000 × .2 × .3 × .404 .2 + .12 1.12 .2+.12	Cdt × 1+ .5k – Sdt × (1+k)-n d + k 1+k d+k 400,000 × .2 × .3 × 1.06 – 80,000 × .2 × .3 × .404 .2 + .12 1.12 .2+.12
Cdt × 1+ .5k – Sdt × (1+k)-n d + k 1+k d+k 400,000 × .2 × .3 × 1.06 – 80,000 × .2 × .3 × .404 .2 + .12 1.12 .2+.12	Cdt × 1+ .5k – Sdt × (1+k)-n d + k 1+k d+k 400,000 × .2 × .3 × 1.06 – 80,000 × .2 × .3 × .404 .2 + .12 1.12 .2+.12	Cdt × 1+ .5k – Sdt × (1+k)-n d + k 1+k d+k 400,000 × .2 × .3 × 1.06 – 80,000 × .2 × .3 × .404 .2 + .12 1.12 .2+.12
Cdt × 1+ .5k – Sdt × (1+k)-n d + k 1+k d+k 400,000 × .2 × .3 × 1.06 – 80,000 × .2 × .3 × .404 .2 + .12 1.12 .2+.12	Cdt × 1+ .5k – Sdt × (1+k)-n d + k 1+k d+k 400,000 × .2 × .3 × 1.06 – 80,000 × .2 × .3 × .404 .2 + .12 1.12 .2+.12	Cdt × 1+ .5k – Sdt × (1+k)-n d + k 1+k d+k 400,000 × .2 × .3 × 1.06 – 80,000 × .2 × .3 × .404 .2 + .12 1.12 .2+.12
Cdt × 1+ .5k – Sdt × (1+k)-n d + k 1+k d+k 400,000 × .2 × .3 × 1.06 – 80,000 × .2 × .3 × .404 .2 + .12 1.12 .2+.12	Cdt × 1+ .5k – Sdt × (1+k)-n d + k 1+k d+k 400,000 × .2 × .3 × 1.06 – 80,000 × .2 × .3 × .404 .2 + .12 1.12 .2+.12	Cdt × 1+ .5k – Sdt × (1+k)-n d + k 1+k d+k 400,000 × .2 × .3 × 1.06 – 80,000 × .2 × .3 × .404 .2 + .12 1.12 .2+.12			64,920
= ($75,000 × .9464) – ($15,000 × .404) =$64,920	= ($75,000 × .9464) – ($15,000 × .404) =$64,920	= ($75,000 × .9464) – ($15,000 × .404) =$64,920			$( 52,702)
	*Calculated using the NPV formula in Microsoft Excel and a required return of 12%.
2.	No, the investment project should not be undertaken. It has a negative net present value.