The Crescent Drilling Company owns the drilling rights to several tracts of land on which natural gas has been found. The amount of gas on some of the tracts is somewhat marginal, and the company is unsure whether it would be profitable to extract and sell the gas that these tracts contain. One such tract is tract 410, on which the following information has been gathered:
Investment in equipment needed
for extraction work. . . . . . . . . . . . . . . . . . . . . . . $600,000
Working capital investment needed . . . . . . . . . . $85,000
Annual cash receipts from sale of gas,
net of related cash operating
expenses (before taxes) . . . . . . . . . . . . . . . . . . . $110,000
Cost of restoring land at completion
of extraction work . . . . . . . . . . . . . . . . . . . . . . . $70,000
The natural gas in tract 410 would be exhausted after 10 years of extraction work. The equipment would have a useful life of 15 years, but it could be sold for only 15% of its original cost when extraction was completed. For tax purposes, the company would depreciate the equipment over 10 years using straight-line depreciation and assuming zero salvage value. The tax rate is 30%, and the company’s after-tax discount rate is 10%. The working capital would be released for use elsewhere at the completion of the project.
Required:
1. Compute the net present value of tract 410. Round all dollar amounts to the nearest whole dollar.
2. Would you recommend that the investment project be undertaken?