Mining, income taxes, inflation, sensitivity analysis. (CMA, adapted) VanDyk Enterprises has been operating a large gold mine for many years. The company wants to acquire equip¬

ment that will allow it to extract gold ore from a currently inaccessible area ofthis mine. Rich Salzman, VanDyk s controller, has gathered the following data to analyze the investment.

The initial cost of acquiring and installing the equipment is $3.6 million. The useful life of the specialized equipment is five years with no salvage value at the end of this period.

VanDyk uses the straight-line amortization method for this equipment for financial reporting purposes.

Using the equipment, VanDyk estimates that an additional 300 pounds of gold (16 ounces per pound) will be extracted annually for the next five years. Salzman plans to use an estimated market price of $420 per ounce of gold in his analysis based on expert information.

The price of gold is determined by many factors and represents a significant risk factor in this analysis.

The out-of-pocket variable costs to extract, sort, and pack the gold is $120 per ounce.

Allocated fixed overhead costs are $48 per ounce.

Two skilled technicians will be hired to operate the new equipment. The total salary and fringe benefit costs for these two employees will be $132,000 annually over the next five years. Periodic maintenance on the equipment is expected to cost $60,000 per year in out-ofpocket costs.

When analyzing projects of this kind, VanDyk uses a 12% after-tax required rate of return and a 40% tax rate. The equipment qualifies for a 30% declining balance capital cost allowance rate.

Required 1. Determine the payback period.

2. Calculate the after-tax net present value for VanDyk’s proposed acquisition of the extrac¬

tion equipment.

3. Determine the revenue per ounce of gold at which VanDyk’s acquisition of the extraction equipment will break even from a net present value perspective where VanDyk earns the 12% after-tax required rate ofreturn.

4. $alzman feels that inflation will occur and persist for die next five years at the rate of 2%

per year. Assume all the data given in the problem are already in nominal dollars and that the 12% minimum desired rate of return already includes an element attributable to anti¬

cipated inflation. Repeat requirement 2, to take inflationary effects into consideration.