Basic Net Present Value Analysis [LO1]

Renfree 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 . . . . . . . . . . . . . . . . . . . . . . . $850,000 Annual net cash receipts . . . . . . . . . . . . . . . . . . . . . . . . . $230,000*

Working capital required . . . . . . . . . . . . . . . . . . . . . . . . . $100,000 Cost of road repairs in three years . . . . . . . . . . . . . . . . . . $60,000 Salvage value of equipment in fi ve 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 five years of mining. At that point, the working capital would be released for reinvestment elsewhere. The company’s required rate of return is 14%.

Required:

(Ignore income taxes.) Determine the net present value of the proposed mining project. Should the project be accepted? Explain.