Hilly Mines, Inc., owns the mining rights to a large tract of land in a mountain

Question

Hilly Mines, Inc., owns the mining rights to a large tract of land in a mountainous area. The tract contains a mineral deposit that the company believes might be commercially attractive to mine and sell. 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 equipment required $ 800,000

Annual net cash receipts $ 305,000*

Working capital required $ 225,000

Cost of road repairs in ten years $ 66,000

Salvage value of equipment in eleven years $ 200,000

*Receipts from sales of ore, less out-of-pocket costs for salaries, utilities, insurance, and so forth.

The mineral deposit would be exhausted after eleven years of mining. At that point, the working capital would be released for reinvestment elsewhere.

The company’s required rate of return is 19%. (Ignore income taxes.) Click here to view Exhibit 11B-1 and Exhibit 11B-2, to determine the appropriate discount factor(s) using tables. Required:

a. Determine the net present value of the proposed mining project. (Negative amount should be indicated by a minus sign. Use the appropriate table to determine the discount factor(s), other intermediate calculations and final answer to the nearest whole dollar.)

New Preset Value?____________

b. Should the project be accepted?

Explanation / Answer

(a)

Annual Cash Receipts

Present Value at 10%

Present Value of Annual Cash Receipts

305000

.833

254065

305000

.694

211670

305000

.579

176595

305000

.482

147010

305000

.402

122610

305000

.335

102175

305000

.279

85095

305000

.233

71065

305000

.194

59170

305000

.161

49105

Total

1278560

Total cost = (800000 + 225000 + 66000 – 200000) = 891000

Net Present Value = 1278560 – 891000 = 387560

(b)

Yes this project should be accepted.

Annual Cash Receipts

Present Value at 10%

Present Value of Annual Cash Receipts

305000

.833

254065

305000

.694

211670

305000

.579

176595

305000

.482

147010

305000

.402

122610

305000

.335

102175

305000

.279

85095

305000

.233

71065

305000

.194

59170

305000

.161

49105

Total

1278560

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