A mining company has constructed a town near the site of a rich mineral discovery in a remote part of Australia. It is expected the mineral deposit will be exhausted in 10 years and mining operations will cease and the town will be abandoned after the 10-year period.

You have been asked by an agricultural company to evaluate an associated project that involves supplying the mining town with meat and agricultural produce for the 10-year period by developing nearby land. Costs, sales and operating expenses relating to the project are:

1) Investment in land is $1,000,000, farm buildings $200,000 and farm equipment $400,000.

2) The land is expected to have a realisable value of $500,000 in 10 years.

3) The buildings have an estimated life of 20 years at which time their salvage value would be zero. They are to be depreciated on a straight line (prime cost) basis for tax purposes based on this life. The salvage value of the buildings after 10 years is expected to be $50,000.

4) The farm equipment has an estimated life of 10 years and a zero salvage value. The equipment is to be depreciated on a straight line (prime cost) basis for tax purposes based on this life.

5) Investment in working capital is $250,000. This will be recovered at the end of the project's life.

6) Annual cash sales are estimated to be $3,000,000.

7) Annual cash operating costs are estimated to be $2,200,000

8) Assume tax is paid one year after the year of income

9) The company tax rate is 39 per cent

10) The company required rate of return after-tax is 10 per cent.

Required:

Should the agricultural company undertake the project?

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I have find out the example answer on the Internet but I still not understand how to do that.

A proposal is made that a manufacturer produce a new product. An evaluation of the proposal is to be made on the assumption that sales of the product will commence in year 1 and terminate after 12 years. An investment in machinery and equipment of $90,000 is required. An estimated life of 12 years with $12,000 terminal salvage value will be used in the economic study. Straight-line depreciation will be used for tax purposes. The total of a group of non-recurrent outlays at time zero is $20,000. All of these are chargeable as current expenses for tax purposes in year 1. At time zero, an addition of $30,000 to net working capital is required. It is assumed that this will be fully recovered at the end of the 12 years. Estimated receipts from the sale of the product are $60,000 in year 1, $90,000 in year 2, and $120,000 a year from years 3 to 12. Estimated operating costs are $48,000 in year 1, $65,000 in year 2, and $80,000 a year from years 3 to 12. These cost figures include materials, labour, current payments of indirect manufacturing expenses including rental of factory space, incremental costs of general administration, and marketing expenses. An income tax rate of 39 per cent is to be used in the study; tax is paid in the year of income. The additional finance will be obtained from a new share issue with issue costs being $6,000. The cost of capital is 10 per cent (after tax). Required: Provide management with a recommendation as to whether or not to produce the new product. (this means do a NPV analysis)Depreciation = 1/12 * Purchase Price = 1/12 x 90,000 = 7,100 Depn Tex Shield = Depreciation * Tax Rate = 7,100 * 0.39 = 2,925 Book Value = 0 Book Gain = Salvage Value - Book Value = 12,000-0 = 12,000 Tix on Book Guin = Book Guin x Tex Rate = 12,000 * 0.39 = 4,680 Tex shield on Non-Recurrent Outley = Non-Recurrent Outley x Tex Rate = 20,000 * 0.39 = 7,800 Tex shield on Share Issue Costs = Share Issue Costs * Tax Rate = 6,000 * 0.39 = 2,340 Year Receipts Tax Payable 1 60.000 60,000 x 0.39 = 23.400 2 90,000 90,000 x 0.39 = 35,100 3- 12 120.000 120,000 x 0.39 = 46,800 Year Operating Costs Tax Payable 1 48.000 65,000 48,000 x 0.39 = 18.720 65,000 x 0.39 = 25,350 3 80,000 ITEM 12 Initial Outlay Depreciation Tax Shield 2.925 Salvage Value 12.000 Tax on gain on sale (4.680) Non-Recurrent Outlay Tax Shield Working Capital 30.000 Sales Receipts 120.000 Tax Payable (46.800) Operating Costs (BUTOOD] Tax Shield 25,350 31.200 31.200 Share Issue Costs Tax Shield 2.340 Net Cash Flow (146,000) 20,335 18,175 27,325 64.645 The cash flow in years 3 - 11 represent a deferred annuity, a 9-year annuity deferred by 2 years. This is because the first payment in the annuity is at the end of Year 3, and hence the present value of the annuity is at the beginning of the annuity period: ie.the beginning of Year 3 or the end of Year 2. It must be discounted by a further 2 years in order to find the present value of the annuity at t=0. NPV - -146,000+ 20385 18,175 +27.3254 x (1]) + + 64.645 (11) + (11) - -145,000+ 20,385 18,175 64.645 (11) + 27.325 01 - -145,000 +18532 +15.021+ 157,365 08264 130.054 + 20598 - -145,000+184.205 - 38.205 As the INPV is positive, the company should undertake the project