The code for this question is CB2

Part A (6 marks)

Rio Tinto is considering buying in a new gold mine which is forecast to start earning $28,000,000 of revenue in the 2nd year of operation. Production of nickel is expected to increase by 10% p.a. after, having a consequent impact on revenue. Production costs start at 40% of the first annual revenue, increasing by an additional 1.5% of annual revenue each year after. The mine is kept for 5 years of production, after which the gold is exhausted and is expected to fetch a sale price of only $3,000,000 in the final year of production.

Setting up the mine requires $50 mil today, $38 mil in the first year of operation and $5 mil in the 2nd year of operation. 65% of capital is financed through debt which has a cost of 7% and shareholders require a 8% premium on what creditors earn. Calculate the discount rate, NPV and IRR of this project.

Part B (6 marks)

Rio Tinto is also considering upgrading a fleet of 1,000 mining trucks to an electrically powered variant that will cost $27,000 per truck at current year prices. The anticipated diesel cost-saving starts in the first half year of operation for 6 years and is $5,000 per truck, semi-annually. The cost saving is expected to diminish by 5% each semi-annual period thereafter. These mining trucks are to be used in the new gold mine proposed in Part A. At the end of 6 years of operation, the trucks will be scrapped for 30% of their initial cost.

The capital structure of Rio Tinto remains unchanged from part A. Calculate the discount rate, NPV and IRR of this project, using the project cash flows specified in this part only. Do not combine the cash flows from part A. Note: This is a project that is contingent on the project in part A going ahead i.e. if the part A project does not go ahead, neither will this project here. However, part A can go ahead, without part B.

Part C (4 marks)

Rio Tinto treasury has come up with updated cash flow forecasts for the new gold mine proposed in Part A. The sale of the mine is now expected to fetch $3.5mil in the final year of production. The proportion of debt capital used to finance the new gold mine only, can be increased to 70%. There are no other changes to the capital budgeting estimates of the project. (Part B is unaffected by any changes here.)

Re-calculate the discount rate, NPV and IRR of this project.

Part D (4 marks)

Prior to the treasury updates of mine project cash flow estimates, what is the COMBINED resulting NPV of both the new gold mine and the truck upgrade? What is the most appropriate recommendation regarding the projects to maximise NPV? (Should both projects be taken, or only one or the other or none?)

After the treasury updates of mine project cash flow estimates, what is the COMBINED resulting NPV of both the new gold mine and the truck upgrade? What is the most appropriate recommendation regarding the projects to maximise NPV? (Should both projects be taken, or only one or the other or none?)