Reference no: EM133008525

Donny Industries Ltd has a mining division that has constructed a town, named Donvale, 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 bezero. They are to be depreciated on a straight line (prime cost) basis for tax purposes basedon 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. Theequipment is to be depreciated on a straight line (prime cost) basis for tax purposes basedon this life.
5) Investment in working capital is $250,000.
6) Annual cash sales are estimated to be $3,200,000.
7) Annual cash operating costs are estimated to be $2,600,000
8) Assume tax is paid one year after the year of income
9) The company tax rate is 30 per cent
10) The company required rate of return after-tax is 10 per cent.

Required:

Problem 1: Should the agricultural company undertake the project?