Question 3 (5 marks)

Rump Industries Ltd has a mining division that has constructed a town, named Rumpville, 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. 1)Investment in land is $1,000,000, farm buildings $200,000 and farm equipment $400,000.
2. 2)The land is expected to have a realisable value of $500,000 in 10 years.
3. 3)The buildings have an estimated life of 20 years at which time their salvage value would be
4. zero. They are to be depreciated on a straight line (prime cost) basis for tax purposes based
5. on this life. The salvage value of the buildings after 10 years is expected to be $50,000.
6. 4)The farm equipment has an estimated life of 10 years and a zero salvage value. The
7. equipment is to be depreciated on a straight line (prime cost) basis for tax purposes based
8. on this life.
9. 5)Investment in working capital is $250,000.
10. 6)Annual cash sales are estimated to be $3,000,000.
11. 7)Annual cash operating costs are estimated to be $2,200,000
12. 8)Assume tax is paid one year after the year of income
13. 9)The company tax rate is 39 per cent
14. 10)The company required rate of return after-tax is 10 per cent.

Required:

Should the agricultural company undertake the project?