Investment and financing decisions are vital to the survival of a business. The purpose of this assessment is to explore some advanced Capital Budgeting and Valuation techniques introduced in this subject to help make such decisions.
1.Demonstrate advanced understanding of contemporary corporate finance theory, analytical frameworks and practice.
2.Critically analyse and effectively communicate complex corporate finance issues and recommend improvements to inform professional practice.
3.Plan and undertake a substantial evidence-based corporate finance report in an ethical manner.
The coal mining industry has been hard-hit by the COVID pandemic and trade tension with trading partners. Recently, however, a combination of increased demand for coal and new pollution reduction technologies has led to improved market demand for high-quality Australian coal. PM has been approached by an Indian Electric Company with a request to supply coal for its electric generators for the next 10 years. PM does not have enough excess capacity at its existing mines to guarantee the contract. The company is considering opening a new mine in New South Wales on 5,000 acres of land purchased 10 years ago for $4 million.
Opening the new mine will cost the company $100 million to purchase the necessary mining equipment, which will be depreciated based on the straight-line method for ten years. At that time, it is expected that the coal from the site will be entirely mined. The company estimates that the equipment can be sold for 10 percent of its initial purchase price in ten years.
PM faces a tax rate of 25 percent and has a required rate return of 15 percent on the new mine project. Assume that a loss in any year will result in a tax credit. You have been approached by the president of the company with a request to analyse the project. Should Peabody Mining take the contract and open the mine?
1.Calculate the payback period, profitability index, net present value, and internal rate of return for the mining project to meet the new contract. What do these criteria say about the decision? Begin the report by briefly explaining the capital budgeting methods. Explain why net present value and internal rate of return criteria are considered superior to the accounting rate of return and payback period used by some firms.
2.Some estimates are subjective and may be prone to judgement error or uncertainty. For this reason, please conduct a sensitivity analysis of NPV to the required rate of return falling between the range of 16% to 20% p.a. (with increments of 1%) for the contract. Discuss the implications.
3.Using one relevant valuation method (Valuation by comparable/free cash flows/dividend models) introduced in week 2 of this subject, calculate the theoretical price of each of the above stocks. Explain the method chosen for the calculations, critically discuss the assumptions and validity of your result.
4.Compare the theoretical price with the current market price and explain the reasons behind the differences observed. Which stock should the firm sell to arrange the finance and why?
5.Summarise your findings, discuss any limitations of your evaluations and present your recommendations.
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