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Workbook For Students
Workbook For Students
Workbook For Students
Updated:
30 Jan 2020 WP Nel
Students’
Guide
Based on METS-3
Open Rubric
Chapter 16 Introduction to Time Value of Money and Project Selection
Dear reader
This chapter of the workbook is based on chapter 16 of the third edition of the textbook,
‘Management for Engineers, Technologists and Scientists’, which is abbreviated as “METS-3”.
Purpose of workbook
The workbook encourages an active learning process. The self-evaluation questions cover the
whole range of Bloom’s taxonomy – from questions that test basic concepts to more complex
questions that test higher levels of knowledge and thinking.
The following types of questions and information are included in the workbook:
Some of the projects and case studies will require learners to consult additional sources of
information.
Nel, W.P. 2020. Workbook for the 3rd edition of “Management for Engineers, Technologists
and Scientists”: Chapter 16 (30 Jan 2020).
I hope that this method will help you to master the chapter.
Regards
wilhelmpnel@gmail.com
Convention regarding the use of decimal commas and decimal points in this document
Please note that the decimal comma was commonly use in South Africa in the past, except in
spread sheets and some text books. I used the decimal comma in this document. Please
substitute it with the decimal point if that is the convention in your country.
For example, in South Africa we may write one and a quarter as 1,25. In a spreadsheet,
however, it may be entered as 1.25.
Errata – textbook
Please correct the two printing errors in example 16.8 (METS-3: 339).
Question
Answer
(1 + i )n − 1 (1 + 0,16)10 − 1
FVA = A x FVIFA(i, n); where FVIFA(i, n) = = = 21,32146 {2}
i 0,16
A = FVA / FVIFA(i, n) = R6 500 000 / 21,32146 = R304 857,04 (This answer may vary slightly
depending on how much the FVIFA was rounded off) {1}
(3)
(1 + i )n − 1
FVA = A x FVIFA(i, n); where FVIFA(i, n) =
i
(1 + i )n - 1
PVA = A x PVIFA(i, n); where PVIFA(i, n) = n
i(1 + i )
---------------------------------------------
16A.1 The following true/false questions are based on section 16.1 “Introduction”
(METS-3: 330-351) of the textbook.
16A.1.1 Engineering Economics is the discipline that is concerned with the cost of alternative
solutions to an engineering problem. (1)
Answer - example
16A.1.1 True, (METS-3: 330) (1)
16A.2 The following true/false questions are based on section 16.2 “Interest and time
value of money” (METS-3: 331-339) of the textbook.
16A.3 The following true/false questions are based on section 16.3 “Project selection”
(METS-3: 339-349) of the textbook.
16A.3.1 Income is usually not earned during the project phase of a new facility such as a
mine, smelter or factory. (1)
16A.4 The following true/false questions are based on section 16.4 “The selection of
new product development projects” (METS-3: 349) of the textbook.
16A.4.1 DCF techniques have limitations when used to evaluate strategic projects that may
open new opportunities in future that may currently be difficult to predict. (1)
---------------------------------------------
This section consists of multiple-choice questions. In your answer book, write down the number of
the question, and next to it the number representing the correct option, for example ‘15.9 [1]’.
16B.1 The following multiple choice questions are based on section 16.1 “Introduction”
(METS-3: 330-351) of the textbook.
16B.2 The following multiple choice questions are based on section 16.2 “Interest and
time value of money” (METS-3: 331-339) of the textbook.
16B.2.1 Peter plans to retire in ten years’ time. He plans to contribute R36 000 towards a
unit trust (collective investment scheme) at the end of each year for the next 10 years. If
Peter can earn 12% on his contributions, approximately how much will he have earned
at the end of the tenth year? (2)
[1] R631 750
[2] R203 410
[3] R111 810
[4] R403 200
16B.2.3 R10 000 is invested in a savings account at 20% per annum compound interest
for 10 years. Calculate the end value of the investment. Select the value closest to your
answer. (2)
[1] R61 740
[2] R61 920
[3] R62 290
[4] R62 470
16B.2.4 You invest R3 600 per year for 10 successive years (at the end of each year) in a
savings account at 15% per annum compound interest. Which one of the following is
closest to the end value in the savings account? (2)
[1] R73 094
[2] R74 391
[3] R83 094
[4] R93 941
16B.2.5 R10 000 is invested in a savings account for 10 years at 20% per annum compound
interest, but the interest is calculated semi-annually. What is the end value of the
investment? (2)
[1] R27 670
[2] R47 860
16B.2.6 What amount must be invested today so that it will be worth R1 700, 8 years from
now. You will earn 8% interest per annum on the amount. (2)
[1] R819
[2] R918
[3] R1 564
[4] R1 700
16B.2.7 Which one of the following most closely represents the present value of R25 000
received for 10 successive years using a discount rate of 17%? (2)
[1] R29 250
[2] R207 500
[3] R116 475
[4] R292 500
Suggested solution: [3] - Example
Short answer: PVA = R25 000 x PVIFA(i = 17%, n = 10) = R116 465,09
Longer answer:
R25 000 received for 10 years can be illustrated as follows:
Use the PVA-formula to get the present value of these 10, equal, amounts.
(1 + i )n - 1
PVA = A x PVIFA(i, n); where PVIFA(i, n) = n
= 25 000 x
i(1 + i )
(1 + 0,17 )10 - 1
10
= 25 000 x 4,6586 5,88235 = R116 465
0,17(1 + 0,17 )
Method 2
16B.2.8 What amount should be invested annually (at the end of each year) for five
successive years at 12% per annum compound interest in order to yield
approximately R25 000? (2)
[1] R3 935,15
[2] R4 199,72
[3] R4 167,58
[4] R4 400,00
[5] None of the options (1, 2, 3, or 4) is correct.
16B.2.9 Calculate the interest or growth rate of the following stream of cash flows:
1992: R1 517
1991: R1 312
1990: R1 210
1989: R1 080 (2)
Required: Select the option that best represent the answer that you obtained.
[1] 6%
[2] 8%
[3] 10%
[4] 12%
[5] None of the options (1, 2, 3, or 4) is correct.
Suggested solution: [4] - Example
Reminder:
Log(x) usually implies log10(x) {the base is 10}
log(x) and 10x are inverse functions – therefore log(10x) = x or 10log(x) = x
Therefore, 1,119 = 1 + i
Reminder:
Log(x) usually implies log10(x) {the base is 10}
ln(x) implies loge(x) and is known as the natural logarithm of x {the base is e}
ln(x) and ex are inverse functions – therefore ln(ex) = x or eln(x) = x
16B.2.10 Mpho plans to fund his individual retirement account with a maximum contribution
of R2 000 at the end of each year for the next 10 years. If Mpho can earn 10 percent on
his contributions, approximately how much will he have at the end of the tenth year? (2)
[1] R12 290
[2] R20 000
[3] R31 875
[4] R51 880
[5] None of the options (1, 2, 3, or 4) is correct.
16B.2.11 Find the present value of the following stream of cash flows assuming that the
company’s opportunity cost is 9%.
Year Amount
1 to 5 R10 000
6 to 10 R16 000
(2)
[1] R10 972
[2] R13 252
[3] R79 348
[4] R141 588
[5] None of the options (1, 2, 3, or 4) is correct.
Suggested solution: [3] - Example
Method 1
Ten cash flows (CFs) are involved. They can be illustrated as follows.
Method 2
Because the first five CFs and CFs 6 to 10 are the same the PVA-formula can be used to find
their present values in a step-by-step way which follows.
PV of the first five CFs = PVA = 10 000 x PVAIF(9%, 5)
(1 + i )n - 1
Use the following formula: PVA = A x PVIFA(i, n); where PVIFA(i, n) = n
i(1 + i )
(1 + 0,09 )5 - 1
PV of the first five CFs = PVA = 10 000 x PVAIF(9%, 5) = 10 000 x 5
0,09(1 + 0,09 )
(1 + 0,09 )5 - 1
5
= 16 000 x 3,890 = R62 240
0,09(1 + 0,09 )
To get this discounted to the beginning of year 1 this single sum must be discounted as
follows: PV = FV/(1 + i)n = 62 240 / (1 + 0,09)5 = 62 240 / 1,5386 = R40 452
The present value of all 10 cash flows are 38 900 + 40 452 = R79 352
{Your answer may be slightly different. I rounded-off some of the numbers.}
16B.2.12 The rate of return earned on an investment of R50 000 today to guarantee an
annuity of R10 489 for 6 years is approximately … (2)
[1] 5%.
[2] 7%.
[3] 30%.
Suggested solution: [2] - example
Answer: [2]
R50 000 = PVAIF(Y%, 6) x 10 489
Therefore, PVAIF(Y%, 6) = 4,767
Y = 7% {Using a financial calculator}
or
(1 + i )6 - 1
4,767 = LH = 6
= RH
i(1 + i )
Trial and error: calculate the right-hand side by using different values until the value on the
left-hand side is obtained. Or using a spreadsheet and using different values for i:
I RH
3 5.4172
4 5.2421
5 5.0757
6 4.9173
7 4.7665
8 4.6229
16B.2.13 What is the average growth rate of the following stream of cash flows?
2010: R1 575
16B.2.14 The underlying annual interest rate if the future value of R1 900 invested today
grows to R2 206 in three years' time will be … (2)
[1] 3,6%
[2] 4,1%
[3] 4,6%
[4] 5,1%
[5] None of the options (1, 2, 3, or 4) is correct.
16B.3 The following multiple choice questions are based on section 16.3 “Project
selection” (METS-3: 339-349) of the textbook.
16B.3.2 Read the following three statements that are based on the diagram below:
Income
R0
time
End of life
a) During the project stage of the life cycle of a mine, factory or plant, income is
generated from operations.
b) At the end of the life of a mine, plant or factory some money may have to be spent
on disposal and/or rehabilitation.
c) More money is usually earned during the life of a successful mine, plant or factory
than what was spent during the project stage.
16B.3.4 The initial investment of a project is R150 000. Using a discount rate of 16%, the
present value of cash inflows is expected to total R150 000 the internal rate of return
(IRR) of the project is … (2)
16B.3.5 ABC Ltd is evaluating two projects that are mutually exclusive with initial investments
and cash flows as follows: (2)
16B.3.6 XYZ Ltd is evaluating two projects that are mutually exclusive with initial investments
and cash flows as follows: (2)
16B.5 The following multiple choice questions are based on Chapter 16 “Time value of
money and project selection” (METS-3: 330-351) of the textbook.
---------------------------------------------
Note: The following number of questions consists mostly about calculations that you should be
able to do. Basically, you have to know when to apply a number of formulae.
16C.1 The following short and long questions are based on section 16.1 “Introduction”
(METS-3: 330-351) of the textbook.
No questions
Simple interest
In this section the following formula can be used: I = Pni (METS-3: 332, equation 16.1)
Please note that little attention is paid to simple interest in the textbook (METS-3) because
the calculations are relatively simple and secondly, because compound interest is often used
when dealing with time value of money.
Please note that in this case the following two related equations are used:
FV = PV (1 + i)n or FV = PV x FVIF (i %, n) (METS-3: 334, equation 16.2)
PV = FV/(1 + i)n or PV = FV x PVIF (i %, n) (METS-3: 335, equation 16.3)
Note that equation 16.3 can be obtained from equation 16.2 by means of simp le
mathematical manipulation.
Question 16C.2.2 - Future value of a single amount of money
Calculate the amount that will accumulate in a savings account if R8 000 is deposited into the
account today and left for four years. Interest earned is paid into the account by the bank.
The annual interest rate is 12% compounded annually. (2)
Answer 16C.2.2 - example
Calculate the average annual compounded rate at which demand is expected to grow for
each one of the three metals listed in table 1.
In their Oil 2019 report the International Energy Agency forecasts that demand for oil will
increase from 99,2 million barrels per day in 2018 to 106,4 million barrels per day by 2024
(Creamer, 2019). Calculate the average annual growth rate from this prediction and compare
it with that of Li, Co and Ni. (8)
References
Creamer, T. 2019. Petrochemicals and jet fuel to underpin oil growth as gasoline slows.
Engineering News. Available at: http://www.engineeringnews.co.za (11 March 2019).
Seddon, M. 2019 Annual battery materials outlook. Argus Webinar (1 Jul 2019)
Question 16C.2.8 [Application of “FV of single amount” formula – time needed to double an
amount]
Question 16C.2.11 [Using the FV formula of a single amount to calculate the PV]
You wish to invest a sum of money which will accumulate to R100 in 5 years’ time. How
much must be invested today, if a rate of 15% per annum is obtained from a bank? (2)
Answer 16C.11 (Invest) - example
Use any of the the following formulae:
PV = FV [( 1 ÷ (1 + k)n] ; or PV = FV x PVIFr,t
PV = 100 x [1 ÷ (1 + 0,15)5] = R49,72
or
PV = Principal Sum x PVIF(15%,5)
PV = 100 x 0,497 = R49,70
[Note: “0,497” can be obtained from a PVIF table, where the 15% interest column and the 5
year (period) row intersect.]
The present value of R2000 seven years into the future = FV/(1 + i)n = 2 000 / 1,087 = R1166,98
= ~R1167. (Note that the “~” sign is used here to mean “about”.)
It is therefore best to choose the R2000 that will be received in seven years’ time (if risk is
ignored).
[Note: One of the two amounts must be adjusted so that both are at the same point in time
when they are compared with one another. Alternatively, the future value of R1000 can be
determined and then compared with the R2000. FV of R1000 = 1000 x 1,087 = R1 713,82. The
result is however the same – it is best to choose the R2000 that will be received in seven
years’ time in a risk-free environment where you will not lose your money while you wait for it.] (2)
Question 16C.2.13
[Equivalence principle - Use of FV-formula to compare two amounts at different points in time]
(Calculations where time and multiple, equal amounts of money / deposits / instalments /
premiums are involved)
You must learn how and when to apply the following two formulae:
(1 + i )n − 1
FVA = A x FVIFA(i, n); where FVIFA(i, n) =
i
(1 + i )n - 1
PVA = A x PVIFA(i, n); where PVIFA(i, n) = n
i(1 + i )
You are 24 years old, and an entrepreneur. You wish to provide for your old age. Imagine that
you invest R36 000 per year at an effective rate of return of 9% per year for the next 40
years, with the first deposit beginning one year hence. How much money will you have after
40 years? (3)
Answer 16C.2.15 (24 yrs – How much money after 40 years?) - Example
This is a future value of an annuity problem.
(1 + i )n − 1
FVIFA(9%,40) = = (1,09 – 1)/0,09 = 337,8824
40
i
FVA = R12 163 768 (3)
(1 + i )n - 1 (1 + 0,095 )3 - 1
PVA = A x PVIFA(i, n); where PVIFA(i, n) = n
= 3
= 2,5089
i(1 + i ) 0,095(1 + 0,095 )
A = 40 000 / 2,5089 = 15 943,20 (3)
(1 + 0,015 )24 - 1
PVIFA(i = 18/12%, n = 24) = 24
= 20,0304
0,015(1 + 0,015 )
A = 240 000 / 20,0304 = R11 981,78 (3)
(1 + i )n - 1
i(1 + i )n
PVA = A x PVIFA(i, n); where PVIFA(i, n) = {1}
Step 3: How often does compounding takes place? In this case it is monthly. Convert
annual interest rate to a monthly one.
iold = 0,15/12 = 0,0125, whereas inew = 0,14/12 = 0,011667 {1}
PVIFA (0,0125;240) =
(1 + 0,0125) − 1
240
= 75,9422
0,0125(1 + 0,0125)
240
{1}
similarly, PVIFA(i = 0,011667; n= 240) = 80,4168 {1}
Old monthly payment = 650 000 / PVIFA(i = 0,0125; n = 240) = R8559,13 {1}
New monthly payment = 650 000/80,4168 = R8082,89 {1}
Reduction in monthly payment = R476,24 per month {1}
(8)
70000.00
60000.00
50000.00
40000.00
Rand
Interest
30000.00 Amortisation
20000.00
10000.00
0.00
1 3 5 7 9 11 13 15 17 19
Years
(1 + i )n - 1 (1 + 0,01 )240 - 1
PVIFA(i, n) = n
= 240
= 90,8194
i(1 + i ) 0,01(1 + 0,01 )
= 500 000 / 90,8194 = R5 505,43 (3)
b) See spreadsheet on workbook’s CD
After 3 years Susan paid 36 monthly installments to the bank of R5505,43 each or R198 195
in total. Initially only a small part of the monthly installment goes towards reducing
Adapted from: Grisky, R.G., 1997, Chemical Engineering for Chemists, American Chemical
Society: Washington DC, Chapter 8, Engineering Economics and Process Design, pp. 286
(example 8.1)
Answer 16C.2.21 (Choosing between alternatives) - example
Proposed methodology: take all costs to the same point in time (for example, year 0 which is
the same as the beginning of year 1) and compare.
(1 + i )n - 1
Use the following formula: PVA = A x PVIFA(i, n); where PVIFA(i, n) = n
to
i(1 + i )
calculate the present value of all maintenance costs.
(1 + 0,12 )10 - 1
PVIFA(i = 12%, n = 10) = 10
= 5,65022 {2}
0,12(1 + 0,12 )
Present value of a machine’s life cycle cost = PV of purchasing price + PV of all maintenance
costs.
PV of machine A’s life cycle cost = R200 000 + 5,6022 x R40 000 = R426 009 {1}
PV of machine B’s life cycle cost = R150 000 + 5,6022 x R50 000 = R432 511 {1}
Choose machine A because its total life cycle cost is lower. {1}
(5)
(1 + i )n − 1 1,038 − 1
a) FVA = A x = 8 000 x 0,03 = 8 000 x 8,8923 = R71 139 {2}
i
(1 + i )n - 1 (1 + 0,03 )8 - 1
b) PVA = A x n
= 8 000 x 8
= 8 000 x (0,26677/0,038)
i(1 + i ) 0,03(1 + 0,03 )
PVA = R56 157 {2}
(5)
(1 + k )n - 1 (1 + 0,015) 36 − 1
PVA = A n
= A PVIFA r ,t = A
k(1 + k ) 0,015(1,015) 36
Or
Where: k = 0,18/12 = 0,015
n = 3 x 12 = 36 [3]
(1 + i )n − 1 (1 + 0,12)4 − 1
FVA = A x FVIFA(i, n); where FVIFA(i, n) = =
i 0,12
= 4,7793 {2}
FVA = 2 000 000 = A x FVIFA(12%, 4)
A = 2 000 000 / 4,7793 = R418 468,87 {1}
(3)
Question 16C.2.36 [FVA – sinking fund]
Given:
Required:
What amount must be set aside monthly to make the purchase of the equipment
possible? (4)
(1 + i )n − 1 (1 + 0,01)36 − 1
Where, FVIFA(i, n) = = = 43,077 (when rounded off)
i 0,01
If R69 642,93 is deposited into a savings account that accrue interest at 1% per month
compounded, then after 3 years the amount accumulated in that account will be:
(1 + 0,01)36 − 1
69 642,93 x = 69 642,93 x 43 07687… = R3m (4)
0,01
Question 16C.2.38 [Sinking fund for rehabilitation at the end of the life of a mine]
It is estimated that a quarry will have to spend R1 650 000 in 10 years’ time on rehabilitation
when it closes. Calculate the uniform series of equal payments that this quarry will have to
make at the end of each year for a period of ten years in order to have saved up the R1 650
000 that is required for rehabilitation. An interest rate of 12% per year, compounded annually,
applies. (3)
Question 16C.2.39 [Sinking fund for the rehabilitation of a mine at the end of its life –
quarterly compounding]
A small mine, which was placed on care and maintenance during a period when low
mineral prices were experienced, just re-opened as mineral prices improved. The mine will
resume contributions of R750 000 per quarter to its rehabilitation fund. The estimated
remaining life of the mine (LOM) is five years. Calculate by how much the rehabilitation
fund would have increased after five years if it is assumed that an interest rate of 12% per
year will apply, compounded quarterly. (4)
(1 + i )n − 1 (1 + 0,03)20 − 1
FVA = A x FVIFA(i, n); where FVIFA(i, n) = = = 26,87 {2}
i 0,03
FVA = R750 000 x 26,87 = R20 152 781 {1}
(4)
16C.3 The following short and long questions are based on section 16.3 “Project
selection” (METS-3: 339-349) of the textbook.
R850
0 1 2 3 4
Time
(years)
R400 R400 R400 R400
Allocation of marks
1 mark for 4 x R850’ cash inflows
1 mark for R2 500’ cash outflow
1 mark for R1 100’ cash inflow
1 mark for 4 x R400 cash outflows (4)
Disposal
and/or
rehabilitation
Income
R0
time
End of life
Money is usually spend during the project stage – investment in physical infrastructure.
During the operational phase, products and services will be produced. From this an income
and cash inflow will be generated.
At the end of the facility’s life some money may be required for rehabilitation or renewal.
During the operational phase various cash outflows may occur, for example when equipment
is replaced and plants are maintained. Usually more cash, however, will flow in resulting in a
positive cash (in)flow.
The breakeven point is achieved after a while (breakeven period).
All cash flows over both the project and operational stages will be estimated and evaluated
before a decision is made to implement such a project.
Often the assumption is made that cash flows will happen at the end of a month or year for
project evaluation purposes. (7)
0 1 2 3 4
Time
(years)
Net cash outflows R400
per year
(thousands) R6 000
Decision: Do not invest in this venture because it is estimated to have a significant negative
net present value (-R 681 000). If any of the assumptions, on which the cash flow estimates
were based, change in future then the proposed venture can be re-evaluated. ✔ (6)
Cash inflow (at the end of year 3): R450 000 (3)
Answer 16C.3.11 - example
NPV = -850 000 + 200 000 / 1,27 + 350 000 / (1,27)2 + 450 000 / (1,27)3 = -R255 834
NPV < 0, therefore the project should be abandoned. (3)
Equipment Equipment
A B
Year Cash flow Cash flow
-
0 10000000 -10000000
1 2000000 500000
2 2500000 1000000
3 3500000 3500000
4 3500000 5000000
5 3500000 5000000
5000000 5000000
(Adapted from: SACMA, 2005, Surface Strip Coal Mining Handbook, p. 8-8) (5)
NPV=300/(1+0.08)^5+300/(1+0.08)^6+300/(1+0.08)^7+300/(1+0.08)^8+300/(1+0.08)^9+300/
(1+0.08)^10+500/(1+0.08)^11+500/(1+0.08)^12
=204+189+175+162+150+138+128+119
=1265
=1657+1265
=R2922
NPV FOR PROJECT Y
NPV=700/(1+0.1)^1+700/(1+0.1)^2+700/(1+0.1)^3+700/(1+0.1)^4+700/(1+0.1)^5
+700/(1+0.1)^6+700/(1+0.1)^7+700/(1+0.1)^8+700/(1+0.1)^9+700/(1+0.1)^10
+700/(1+0.1)^11
=636+579+526+478+435+395+359+327+297+270+245
=R4547 (5)
The CC’s cost of capital is 10%. Calculate the net present value of each project. Which
project will you invest in if you could only raise R50 000 to invest in one of the two projects? (5)
Question 16C.3.18
The estimated dividends of a JSE-listed company for the next 10 years are expected to be as
follows:
Cents /
Year share
1 26
2 34
3 42
4 48
5 48
6 48
7 42
8 42
9 42
10 42
Calculate the present value of this flow of dividends. Use a discount rate of 9%. (5)
Mega Power Industries (MPI) is an independent power producer (IPP) that sells electricity to
Eskom at 60 cents per unit (kWh). MPI is considering purchasing a 3MW turbine and operate
it over a period of 30 years. The capital cost of purchasing and installing the turbine is
R20 000 000. The running cost of the turbine is 20 cents per unit.
Calculate:
a) the energy produced by the turbine per year if the capacity factor of the turbine is
25% - the turbine is 25% of the time available to produce 3MW. {1}
b) the net present value (NPV) of the turbine project if the discount rate is 6% per
annum. State whether the turbine project should go ahead or not and motivate
your answer. Ignore taxation. {4}
Adapted from Andrews & Jelly, Energy Science, Ch 12, p. 380. (5)
(1 + i )n - 1
PVA = A x PVIFA(i, n); where PVIFA(i, n) = n
(given)
i(1 + i )
(1 + 0,06 )30 - 1
PVA = R2 628 000 x 30
= R2 628 000 x 13,76483 {1}
0,06(1 + 0,06 )
NPV = -R20m + 36,174m = R16,174m {1}
Decision, go ahead with the turbine project because the NPV > 0. {1}
(5)
Operating cost
3 x 3 x 8 500 = 76 500 p.m.
3 x 1 x 15 000 = 45 000 p.m.
3 x 2 x 12 000 = 72 000 p.m.
Total 193 500 p.m.
Total 2 322 000 p.a.
Labour cost reduction (by replacing the old with the new system) = 351 000 – 193 500 = 157
500 p.m. or 1 890 000 p.a. {2}
Or
a) Calculate the net present value (NPV) for project A. Use a discount rate of 24%. {3}
b) Advise Company XYZ Ltd. on whether it should invest in project A (base your
advice on the NPV calculation in question (a). {1}
(4)
35000 -3020.07
Or
c) (NPV) r = 14%
Year Project A Discount PV of
Factor cash flow
0 -880000 1 -880000
1 220000 0.877193 192982.46
2 220000 0.769467 169282.86
5
3 220000 0.674971 148493.73
5
4 220000 0.592080 130257.66
3
0 1 2 3 4 5
Time
(years)
In the following spreadsheet each cash flow is discounted (taken to year 0) and then these
values are added together to get the net value which is the net present value.
NPV = 625 000 + 558 035,71 + 498 246,17 + 444 862,65 + 737 654,91 - 2 500 000
NPV = R363 799,44
NPV Method 3 – Calculator – Use annuity formula because of four similar cash flows
Because four of the cash inflows have the same value, the PVA formula could be used to discount
them to the present. An additional cash flow is generated at the end of the 5-year period and that
can be discounted by means of the “PV of a single sum” formula. {1}
NPV = 700 000 x PVIFA(n=4; i=12%) + (700 000 + 600 000) x PVIF(n=5; i=12%) - I
(1 + 0,12 )4 - 1
NPV = 700 000 x 4
+ (700 000 + 600 000)/(1 + 0,12)5 - 2 500 000 {1}
0,12(1 + 0,12 )
= (700 000 x 3,03734) + 737 654,91 – 2 500 000 = R363 799,46 {1}
(3)
CF / (1 + r ) − I = 0
n
t
following equation illustrates it mathematically: t {Equation 16.10 -
t =1
METS-3: 345} [Please note that in this case the initial investment takes place in year 0. This
simplify things. In reality, investment in the construction of a new factory, smelter or mine may
take months or years and therefore negative cash flows may occur at different time periods.]
Please note that cash flows generated by the mine, smelter or any other facility will usually be
positive (cash inflows) while the initial investment is a negative cash flow (cash outflow).
From answer b) we know that when the discount rate is 12% then the NPV is positive. This
means that the IRR will be greater than 12%.
Use a discount rate of 20% (I just chose a value bigger than 12%) .
(1 + 0,2 )5 - 1
Now do the NPV calculation for this discount rate: NPV = 700 000 x 5
+ 600 000/(1
0, 2(1 + 0, 2 )
+ 0,12)5 - 2 500 000 = -R165 445
Start to record your results as follow:
i (%) NPV (thousands of rands)
12 R364
20 -R165
IRR? 0
From this table it is clear that the IRR will be somewhere between 12% and 20% because the value
changed from positive to negative.
Choose any value for i between 12% and 20%, say 16%, then
(1 + 0,16 )5 - 1
For 16% the NPV = = 700 000 x 5
+ 600 000/(1 + 0,12)5 - 2 500 000 = R77 673
0,16(1 + 0,16 )
Add the latest data to the table. Then,
i (%) NPV (thousands of rands)
12 R364
16 R78 (about)
20 -R165
IRR? 0
{This is what we want to determine, our goal}
This table provides three data points which could be plotted on a graph.
The above graph shows that the interest rate that will cause the NPV to be 0 (defined as the IRR)
is somewhere between 17% and 18%
Answer: 17% < IRR < 18%
[Note: This is sufficient. We will not spend more time to determine a more accurate value for the
IRR because that can be done, easily, by means of a spread sheet.] (5)
16C.4 The following short and long questions are based on section 16.4 “The selection
of new product development projects” (METS-3: 349) of the textbook.
No questions
16C.5 The following short and long questions are based on Chapter 16 “Time value of
money and project selction” (METS-3: 330-351) of the textbook.
Option B
Total reserve base 80 million tons
Capital required R2 000 million
Mining rate 8 million tons per year
Yield 70%
Production cost R35,00 per ROM ton
Beneficiation cost R45,00 per ROM ton
Transport cost R30,00 per sales ton
Sales price US$ 40 per ton
Exchange rate R7,00 per US$
Tax rate 30%
NPV R192 million
IRR 23%
a) Which option will you choose? Give reasons for your answer. (2)
b) What is the payback period in years for both options? (5)
Question 16C.5.4
Table 1 - National Energy Regulator (NERSA) renewable energy feed-in tariff (REFIT) for
2009 (http://www.nersa.org.za)
Technology Tariff (R/kWh)
Wind R1,25
Small hydro R0,94
Landfill gas R0,90
Concentrated solar R2,10
a) What monthly amount will your company have to pay during the life of the wind farm to a
bank from whom they obtained the money (R21m) to built the wind farm? The annual
interest rate is 12%. {3}
b) In addition to the monthly cash outflow of the above amount (calculated in a)), other fixed
costs of R75 000 per month are also incurred. Will the wind farm be profitable if the unit
variable cost is 15c per kWh? Calculate the monthly profit or loss. {5}
c) How will an increase in interest rates affect the viability/feasibility of the wind farm? {1}
[9]
Question 16C.5.5
{Adapted from: Unisa, Financial Management MNF2023}
You plan to retire exactly 20 years from today. Your goal is to create a fund that will allow you
to receive R20 000 at the end of each year for the estimated 30 years between retirement
and death. You estimate that you will be able to earn 11% per year during the 30 year
retirement period.
a) How large a fund will you need when you retire in 20 years’ time to provide the 30-year,
R20000 retirement annuity? (3)
b) How much will you need today as a single amount to provide the fund calculated in part
(a) if you earn only 9% per year during the 20 years preceding retirement? (2)
Question 16C.5.6 [Payment on house bond and household budgeting – application of PVA]
Mr and Mrs Khumalo plans to buy a house and stop renting. Their total take-home pay and
household expenditure are as follows:
Per month
Total take-home pay: R18 600
Current rent paid: R4 600
Food and clothing: R2 600
Water and electricity: R750
Short-term insurance: R700
Transportation: R4 200
School fees: R800
Entertainment: R500
a) Determine the maximum price of the house that they can afford if the interest rates were i)
10%, and ii) 12% per year. Assume that they will pay the bank monthly instalments over a
period of 20 years. State all assumptions that you may make. (6)
b) How will the value of the house that the Khumalos can afford change if they buy a number
of items on credit and consequently an amount of R2 400 per month is deducted from Mr
Khumalo’s salary as a result of a garnishee order that has been issued? (3)
[“…when an individual owes money but has for a source of income only a salary, a
creditor might initiate garnishment proceedings. If the creditor is successful, a certain
portion of the debtor's salary will be automatically sent to the creditor from each
paycheck.” (Source: http://legal-dictionary.thefreedictionary.com)]
[9]
Surface
Shaft
Plug
Accumulated
water
PAT (pump as
turbine)
Shaft bottom
Assume the following simplified electricity rates and other information to determine if
this scheme will be economically viable:
Peak Off-peak
Hours 6:30 – 9:30, and 19:30 – 6:30 (11
17:30 – 19:30 hours per day)
(5 hours in total per day)
Rates 250 c/kWh 50 c/kWh
References
• Nel, WP. 2015. The power of the worked-out mine: Conceptual designs for mine-
based pumped-storage hydroelectricity, in Proceedings of the 23rd International
Symposium on Mine Planning and Equipment Selection (MPES 2015), The Southern
African Institute of Mining and Metallurgy, edited by C Musingwini, S Rupprecht, B
Genc & RK Singhal: 723 – 736. Available online at:
https://www.researchgate.net/publication/283643054_The_power_of_the_worked-
out_mine_Conceptual_designs_for_mine-based_pumped-storage_hydroelectricity
• Please note that Eskom’s electricity tariffs can be obtained from www.eskom.co.za
(http://www.eskom.co.za/CustomerCare/TariffsAndCharges/WhatsNew/Documents/
ScheduleStdPrices2015_16_27Feb2015.pdf ). Please have a look at the Megaflex
tariff.
Question 16C.5.8
Use a scoring model to choose between three mining projects (A, B and C). The ore reserves
are in three different countries. Each country consumes only a small percentage of the
product that they have in abundance. A score of 1 to 10 has been allocated to each project
for each criterion in the table below. A weight has been allocated to each criterion by a panel
of experts. The materials involved are bulky (e.g. iron ore or coal) and therefore
transportation infrastructural capacity to a harbour for the export of the minerals is important.
Criterion Weight Project
A B C
Risk of mineral resource nationalism. A score of 1 0,3 7 2 5
indicates that there is a high probability that the ruling
political party may implement policies such as mine
nationalisation, indigenisation or windfall taxes.
Labour supply and productivity. A score of 10 means that 0,15 8 6 5
experienced and skilled labour is available and that little
labour unrest and disease impacts on labour productivity.
Transportation and other infrastructure. A score of 1 0,15 7 5 8
means that the country is land-locked and little rail, road
and other infrastructural capacity exists for transport to
the nearest harbour.
Financials. A score of 10 means that the quality of the ore 0,4 6 9 7
body is such that good profit and return on investment can
be realised if the above factors are not considered.
A score of 1 means high risk, least favourable return on investment or least favourable
conditions and investment climate. A score of 10 means least risk, most favourable return on
investment or most favourable conditions and investment climate. Determine in which project
your company should invest. Motivate your answer and show all calculations. (8)
{Similar to Example 16.9, (METS-3: 340)}
Do an NPV analysis to determine whether your employer should implement the tunnel project
or not. If implemented, the construction of the tunnel will take a number of months. For
calculation purposes you may assume that the total development cost is incurred at the
beginning of year 1 of the 25-year period that the tunnel will be in operation. (6)
---------------------------------------------
Section 16 D – Mini-projects
Note: You will find general guidelines for the answering of projects and the writing of reports
in Annexure C of the workbook.
From the tons mined from the quarry, only 30% is recoverable. This quantity is then cut and
polished, and this results in 80% of the recovered tons being saleable.
The sales price is estimated to be R400 per ton in year 1, rising by R10 per annum.
The mining cost is R40 per ton mined, the cutting and polishing cost is R10 per ton cut, and
the distribution and marketing cost of the product is R120 per ton moved.
Operating costs are expected to inflate at 7%.
The real cost of capital is 5%, and the tax rate is 26%. Assume that capital (including the
purchase price) is appropriated.
Using a Discounted Cashflow analysis, is this worth pursuing or not. Explain your answer.
(40 marks)
Suggested solution
Year: 0 1 2 3 4 5 6
Mined Tonnes
(million) 3 4 5 5 5 5 Tax shi
Capital Expenditure
(Rm) -85 -65 -40 0
Recoverable tonnes
(million) 0.9 1.2 1.5 1.5 1.5 1.5 1 1
Saleable tonnes
(million) 0.72 0.96 1.2 1.2 1.2 1.2 2
Sales price (R/t) 400 410 420 430 440 450 3
Mining cost (R/t) 40.00 42.80 45.80 49.00 52.43 56.10 60.03
Cutting and
polishing cost (R/t) 10 10.70 11.45 12.25 13.11 14.03 15.01
Distr & Marketing
Cost (R/t) 120 128.40 137.39 147.01 157.30 168.31 180.09
R
NPV (Rm) 3.31
IRR (%) 14%
a) Calculate the Net Present Value (NPV) in R million for a small gold project called
GoldMin with the following details. Use year-end convention and year 0 as the base
year for calculations.
b) If there is an alternative investment opportunity with the same capital requirements as
GoldMin but with a NPV of R70 million, will you advise your company to invest in
GoldMin? Support your answer using the calculated NPV value.
Information provided
Measured reserves (recoverable): 1 110 000oz
Annual production starting in year 3 (Refer to table below for more information on production)
Inflation rate (CPI): 5%
Both Rand price and Rand cost per oz will rise with inflation, adjusted for escalation.
Additional escalation for price per oz: 2%
Additional escalation for cost per oz: 3%
Nominal gold price at end of year 0: US$ 600/oz
Estimated operating costs at end of year 0: R3 500/oz
Exchange rate at end of year 0: R7,5:$1
Royalties will be paid at 5% of revenue.
Year 3 4 5 6 7
Production (oz) 180 000 250 000 250 000 250 000 180 000
Notes
Work to 2 decimal places and report your cashflows in R million.
Development capital should be split as per debt:equity ratio.
Capex is redeemed in each year of expenditure and any unredeemed capex is carried over.