The company is considering opening a strip mine in The Gunnedah Basin on 5,000 acres of land purchased 10 years ago for $12 million. Based on a recent appraisal, the company feels it could receive $15.5 million if it sold the land today. Because it is currently operating at full capacity, WHC will need to purchase additional necessary equipment, which will cost $77 million. To get the equipment in running order, there would be a $2 million shipping fee and a $3 million installation charge. The equipment will be depreciated to zero on a straight-line basis over its economic life of 15 years. The contract runs for only eight years. At that time the coal from the site will be entirely mined. The company feels that the equipment can be sold for 10 percent of its initial purchase price in eight years. However, WHC plans to open another strip mine at that time and will use the equipment at the new mine. The equipment also requires staff to be specially trained; fortunately, a similar equipment was purchased a year ago, and at that time the staff went through the $500,000 training program needed to familiarise themselves with the type of equipment. WHC’s management is uncertain whether to charge half of this $500,000 training fee to the new project. The equipment also requires annual maintenance cost of $325,000. The contract calls for the delivery of 500,000 tons of coal per year at a price of $93 per ton. WHC feels that coal production will be 620,000 tons, 680,000 tons, and 730,000 tons, respectively, over the first three years, and 590,000 tons per year over the remaining years. The excess production will be sold in the spot market at an average of $75 per ton in Year 1 with an expected decrease of 2% per annum in the following years. Variable costs amount to $35 per ton in Year 1 with an expected increase of 5% per annum in the following years. Fixed costs are $5,000,000 per year. The mine will require a net working capital investment of 5 percent of sales. The net working capital will be built up in the year prior to the sales. WHC will be responsible for reclaiming the land at termination of the mining. The company uses an outside company for reclamation of all the company's strip mines. It is estimated the cost of reclamation will be $2.5 million. In order to get the necessary permits for the strip mine, the company agreed to donate the land after reclamation to the state for use as a public park and recreation area. This will occur in Year 9 and result in a charitable expense deduction of $15.5 million. Required: If WACC is 2.45%, evaluate the project using NPV analysis and make recommendation to WHC. (show calculations)
The company is considering opening a strip mine in The Gunnedah Basin on 5,000 acres of land purchased 10 years ago for $12 million. Based on a recent appraisal, the company feels it could receive $15.5 million if it sold the land today. Because it is currently operating at full capacity, WHC will need to purchase additional necessary equipment, which will cost $77 million. To get the equipment in running order, there would be a $2 million shipping fee and a $3 million installation charge. The equipment will be
However, WHC plans to open another strip mine at that time and will use the equipment at the new mine. The equipment also requires staff to be specially trained; fortunately, a similar equipment was purchased a year ago, and at that time the staff went through the $500,000 training program needed to familiarise themselves with the type of equipment. WHC’s management is uncertain whether to charge half of this $500,000 training fee to the new project. The equipment also requires annual maintenance cost of $325,000.
The contract calls for the delivery of 500,000 tons of coal per year at a price of $93 per ton. WHC feels that coal production will be 620,000 tons, 680,000 tons, and 730,000 tons, respectively, over the first three years, and 590,000 tons per year over the remaining years. The excess production will be sold in the spot market at an average of $75 per ton in Year 1 with
an expected decrease of 2% per annum in the following years. Variable costs amount to $35 per ton in Year 1 with an expected increase of 5% per annum in the following years. Fixed costs are $5,000,000 per year. The mine will require a net working capital investment of 5 percent of sales. The net working capital will be built up in the year prior to the sales.
WHC will be responsible for reclaiming the land at termination of the mining. The company uses an outside company for reclamation of all the company's strip mines. It is estimated the cost of reclamation will be $2.5 million. In order to get the necessary permits for the strip mine, the company agreed to donate the land after reclamation to the state for use as a public park and recreation area. This will occur in Year 9 and result in a charitable expense deduction of $15.5 million.
Required: If WACC is 2.45%, evaluate the project using
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