Gold Creek Mining Company has two competing proposals: a processing mill and an

Question

Gold Creek Mining Company has two competing proposals: a processing mill and an electric shovel. Both pieces of equipment have an initial investment of $706,316. The net cash flows estimated for the two proposals are as follows:

The estimated residual value of the processing mill at the end of Year 4 is $270,000.

Determine which equipment should be favored, comparing the net present values of the two proposals and assuming a minimum rate of return of 10%. Use the present value table appearing above.

Which project should be favored?

Net Cash Flow Year      Processing Mill      Electric Shovel 1 $215,000 $269,000 2 191,000 249,000 3 191,000 230,000 4 153,000 237,000 5 116,000 6 97,000 7 84,000 8 84,000

Explanation / Answer

Calculation of present value of net cash flows:

It is assumed that residual value of electric shovel at end of year 4 is $ 270,000

Present Value of residual value = 270000/1.104 = 184414

Total present value of electric shovel = 784796 + 184414 = 969210

Electric Shovel to be favored

Processing Mill Net Cash Flow (A) Electric Shovel Net Cash Flow (B) Present Value Factor 10%(C) Present Value of Processing Mill Net Cash Flow (A*C) Present Value of Electric Shovel Net Cash Flow (B*C) 215000 269000 0.909 195435 244521 191000 249000 0.826 157766 205674 191000 230000 0.751 143441 172730 153000 237000 0.683 104499 161871 116000 0.621 72036 97000 0.564 54708 84000 0.513 43092 84000 0.467 39228 TOTAL 810205 784796

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