1 BUSINESS FINANCE INDIVIDUAL ASSIGNMENT THURSDAY VERSION Semester 1 2019 (40 marks worth 40%) Due Date: Week 12 In this assignment you will pull together your understanding of the main concepts in Business Finance and analyse financial statements to make some ‘real’ business decisions. Some of the figures used in the following scenario are real, some are not. The point is to analyse the figures, whether they be provided or sourced. Scenario Your financial analysis team at BLD Wealth Group has been tasked by the executive management team to provide careful financial decision analysis for its client Tesla Inc. This will require preparing a business report which will be presented to the executive management of both BLD and Tesla Inc. Background Read the following article from the Financial Review to get some background. https://www.afr.com/business/mining/kidman-resources-charges-ahead-with-3year-teslalithium-deal-20180517-h10687 (or see canvas for a pdf copy) Kidman Resources is considering a binding agreement with Tesla inc. to supply 5000 tonnes of lithium hydroxide for three years. However in order process the required amount of lithium hydroxide, Kidman Resources must consider whether to build a new refinery or outsource their supply ore (Li20). Kidman Resources has undertaken a feasibility study costing $3 million to explore these two strategies. Option 1: Building a new refinery The construction and installation of a new refinery will cost $22 million. In addition, a processing plant will also need to be constructed at a cost $4 million. This plant will need to be supplied with grinding machines, DMS flotation machines and other equipment at a total cost of $11 million. Kidman Resources’ current fleet of Haul trucks, water carts and dump trucks will meet the needs for this project, however until recently, the fleet has been earning a rental income of $140,000 per year. Under the agreement with Tesla inc., the lithium mined is expected to generate a revenue of $18 million per year, which will increase by 2.8% per annum adjusted for rising costs. Due to the additional complexities involved with the construction and management of this new refinery, 7 new engineers (yearly salary per engineer $120,000) will replace 7 existing engineers (yearly salary per engineer $140,000). All other remaining labour force required is expected to cost $3 million per annum for the 2 duration of the project. For tax reasons you will expense the cost of the processing plant immediately. The cost for the construction and installation of the new refinery and associated machines and equipment will be depreciated over three years using the straight-line method. Due to the nature of the mining project, the machines and equipment will likely have a salvage value of $10 million at the end of three years. Finally, the required net working capital is $4 million. Option 2: Outsourcing the supply of ore Alternatively, Kidman Resources can contract BHP to supply the required ore to process into lithium hydroxide. Based on the required amount of lithium hydroxide, management has quoted a total cost of $40 million. BHP has however offered this rate on the condition that Kidman Resources pays 20% of the total cost in advance in the beginning of the year, with the remaining paid in equal instalments thereafter. Kidman Resources will process the ore into lithium hydroxide using existing facilities at an expected cost of $6.4 million per year. Your task Part A: To carry out an analysis, you will need to calculate the appropriate Weighted Average Cost of Capital (WACC). Kidman Resources executive management team are particularly concerned that the WACC be accurate, thus you are expected to determine the WACC based on recent market and other data. (Read below for additional information). Part B: Carry out a detailed analysis of the two given options and make recommendations to Kidman Resources about those options. To establish the WACC you have already assembled the following information ? Previous year’s stock exchange data for the market (ASX200) and for Kidman, adjusted for dividends and capitalization (Price Index). This data is organized in the file: Project Data.xlsx. Use this dataset to calculate beta. For CAPM purposes use the return on the market (%) provided in the next section. Balance Sheet of Kidman Resources as of 30 June 2018 Extract of Balance Sheet for Kidman Resources Issued Capital $ million 405,000,000 Ordinary shares of $2.00 full paid 810.00 1,500,000 5% Preference Shares of $1.00 fully paid 1.50 Current Liabilities and Provisions Bank Overdraft 4.00 Trade Creditors 6.00 3 Unsecured Notes 7.00 Non-Current Liabilities Debentures 16.00 Term Loans 8.00 Mortgage 17.00 • The company’s preference shares are currently trading at $0.50 each. The company’s ordinary shares are currently trading at $1.54 each. • The risk-free rate of return is 2.43 % p.a., and the return on the market is 7.90 % p.a. • Debentures have a coupon interest rate of 12% p.a. and could be re-issued at the present time at an interest rate of 8% p.a. The debentures will be redeemed at their face value in three years’ time. Face value is as per balance sheet value. • The mortgage loan is repayable in eight years’ time and the current interest rate is 5.48% p.a. The mortgage was initially negotiated at 7.15% p.a. • Term loans have a current interest rate of 6.5% p.a., but were negotiated at an interest rate of 7% p.a. They are repayable in full in three years’ time. The term loans consists of regular semi-annually interest payments with the principal repaid at maturity • Unsecured notes will mature in six months and will not be replaced. They have a current interest rate of 2.7% p.a. • The current interest rate on the bank overdraft is 7.0% p.a. • Interest on all debt securities is paid twice-yearly and the corporate tax-rate is 28 percent Your assessment requirements Part A Calculate WACC: The first part of the analysis requires you to work out the Weighted Average Cost of Capital (WACC) for Kidman Resources. With the help of the given information and given data, you need to work out the individual costs1 and value of each of the sources of capital and apply that to the WACC equation to work out the overall weighted cost. (20 marks) 1 For the cost of ordinary shares you will need to work out kidman’s Resources beta. See canvas video. 4 Part B Calculate NPV: Evaluate the two options using NPV analysis and clearly identify which of the two alternatives results in a higher valuation for Kidman Resources. Include your opinion. Beta analysis: Describe in a short paragraph (less than half a page) what risks/events may cause Kidman’s resources beta to significantly change. Assume due to some unforeseen event (as you may have described), the beta of kidman’s Resources is now 20 % higher than your original estimates. Would this change your previous analysis? Describe (16 marks) Part C Business Report overall quality. (4 marks) The assignment is to be presented as a business report to both Kidman Resources executive management and BLD management. Business reports are structured with: ? an executive summary ? table of contents ? informative headings and sub-headings ? numbered sections ? page numbering ? labelled graphs and tables (if used) ? a reference list. The main content of your report should be 3-4 pages, excluding appendix and be professionally presented. A concise, relevant and visually appealing paper is essential for business communication. Regarding the WACC calculations, whilst you need to present your final work in a table in the main body of your report, all subsidiary calculations need to be provided in an appendix. The report is to be submitted as a PDF version of your work. It must use a font/fonts suitable for business communication. The reference style to be used is Harvard style referencing (author-date). 5 More specifically, your report in this case needs to set out the following: 1. An executive summary 2. A table showing the calculation of Kidman’s WACC using market data. 3. A table(s) showing your NPV calcualtions of both Alternative 1 and Alternative 2. 4. A recommendation to Kidman Resource managements as to which alternative it should adopt. 5. An analysis of beta risk and any recommendations. 6. A reference list. 7. Appropriate appendices. Further guidelines Refer to the tutorial/additional questions for the topics – Capital Budgeting and Cost of Capital to setup your spreadsheets for WACC and NPV analysis. Please round off your values to 4 decimal places for interest rates and 2 decimal places for amounts e.g. 0.0659 or 6.59%, and $10,369.78 All assessment of numerical work is marked consequentially. So, you will be awarded marks for all correct calculations and procedures. To calculate beta please see the video on canvas. Assignment requirements This assessment contributes 40% to the total assessment for this unit. Your report must be submitted via Turnitin/CANVAS by 11.59 pm (Local Time) on the due date. Late submissions where special consideration has not been granted will be penalized. Please go through the course guide to understand the implications. You are very much encouraged to ask assignment questions in your tutorials. You are not allowed to ask any questions about this assignment in the lecture or emails. Emails regarding the assignment will not be answered. Again, please make use of the tutorials to address any questions you may have about your assignment.