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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.
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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.
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