Assignment No- 01

Case Analysis: New Earth Mining, Inc.

Prepared for:

Dr. Md. Rezaul Kabir

Course instructor: Corporate Finance (F601)

Prepared by:

Sheikh Md Shahrul Amin (ID: ZR1702010)

Md. Pappu Miah (ID: ZR1702011)
Emran Ahmed (ID: ZR1702015)
Md. Nabinauaze (ID: ZR1702020)
Md. Sajib Ahamed (ID: ZR1702030)
Rashedul Amin Yeadh (ID: ZR1702005)
Arifur Rahman (ID: ZR1601005)

Institute of Business Administration

University of Dhaka

January 18, 2019

Case Summary:

New Earth Mining, a U.S. based mining company, is one of the largest producers of precious
metals. Most of their mines were located at USA and Canada. They have also made
substantial investments in Australia and Chile in gold exploration projects.

New Earth has been enjoying rapid growth in earnings and has a large amount of cash on the
balance sheet, a simple debt structure, and a reasonable leverage ratio with no liquidity risk.
With such sound financial position, the firm considers reducing its dependence on precious
metals by diversifying into base metals and other minerals.

Now they have an investment opportunity for mining iron ore in South Africa which looks
promising but still associated with substantial risk. Civil war in neighboring countries has
been identified as a major risk factor along with strong fears that the South African
government may nationalize mining operations. The tentative financing package is complex
and creates challenges for determining a value for the project. A quantitative analysis of 4
proposals with different valuation methods is required to be conducted before making a final
recommendation.

Analysis of the various approaches:

There are 04 different approach of project valuation is available. At first, we will try to
analyze each approach and based on the analysis we recommend an approach.

Approach 1:

 As per this approach by VP operations the Net Present value of the investment is USD.
82.78 Million (@$80/Ton), USD.205.70 Million (@$100/Ton)
 New Earths Mining’s(NE) corporate WACC (14%) has been derived considering
weighted average of the cost of equity (15%) and cost of debt (10%) with leverage
assumed to be 12% of the capital structure
 All specifics on financing of New Earth South Arfica (NESA) were ignored.
 Moreover, Approach 1 unfortunately does not take into consideration that a separate
entity is undertaking the investment, and so the usage of New Earths corporate WACC
(14%) to discount the project cash flows does not seem applicable.
 In addition, this approach didn’t consider that NESA is operating Iron Ore exploration in
a politically unstable country while NE operates gold exploration in stable countries. The
risk factor in business has been totally overlooked.
 Hence this approach is not recommended.

Cont…P/2
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Approach 2:

 As per this approach by Accounting Officer the Net Present value of the investment is
USD. 28.17 Million (@$80/Ton), USD.39.50 Million (@$100/Ton)
 Approach 2 is more conservative than Approach 1 with the addition of an expected
return premium of 10% (resulting in a WACC of 24%)
 However, adding a premium does not inevitably justify that the modified WACC
accurately reflect the cost of capital for NESA.
 This approach considered NESA’s operating conditions but did not separate NESA’s
capital structure with NE’s. As a result, the equity holder’s risk remained unadjusted for
the level of debt, and leads to inappropriate discount rate.
 The specifics of the financing package were ignored as well. Hence this approach is not
recommended.

Approach 3:

 As per this approach by External Consulting Firm the Net Present value of the investment
is USD.181.50 Million (@$80/Ton), USD.352.20 Million (@$100/Ton)
 Approach 3 is better since it takes into consideration that the NESA investment was a
stand-alone project for the company with unique opportunities and leverage properties.
 However, this approach did not consider the expected changes in capital structure. The
projected principal payment on company’s debt will change the capital structure
gradually with span of time. With the decrease of loan amount the equity ratio E/V is
supposed to be increased from initial level of 20% to more than 50% in 5 years and near
about 85% in 10 years. Ignoring such change of capital structure has certainly raise
question about the precision of this approach.

Approach 4:

 As per this approach by Internal Analyst of the Firm the Net Present value of the
investment is USD.32.96 Million (@$80/Ton), USD.100.6 Million (@$100/Ton)
 The cost of equity was estimated to be approximately 24%, which is a reasonable rate
due to the risks that this investment brings to New Earth Inc.
 This approach uses the adjusted project equity cost of capital as the discount rate rather
than the company WACC, and only cash flows to equity holders are considered which
solves the complex financing arrangement as well

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 Adequately takes into consideration of the following factors:

1. The fact that an independent entity (i.e. NESA) is taking on this project rather
than New Earth Inc.,
2. Consequence of debt prepayment in capital structure
3. The special financing package
4. The high rate of return that equity investors (i.e. shareholders of New Earth Inc.)
require on this project. Its cost of equity considered the fact that equity holder
receives dividend after debt interest.
5. The approach further takes debt prepayment covenant into the equation.
Therefore the projected cash flow successfully factored the expected change in
the capital structures in each forwarding years

Recommendations:

Although every valuation approach provides its own insight, Valuation 4 seems to be the most
reliable and relevant. The Free cash flow to equity (FCFE) approach directly indicates New
Earth’s residual claim in NESA, in which the equity holders are most interested. Furthermore,
Valuation 4’s cost of equity estimate takes into consideration both the business and financial
risks associated with NESA, which Valuations 1 and 2 did not recognize. When compared to
Valuation 3, this one i.e valuation 4 is also slightly more reliable, as the cost of debt estimated
for Valuation 3 was done using a weighted average of interest method and also did not
consider the expected changes in capital structure. Hence, Valuation 4 has the least limitations
and implications on the NPV in terms of accuracy and reliability.

The quantitative conclusion is that the Kalahari in the Northern Cape of South Africa project
will add great value to the firm.

Finally, it is believed that the positive NPV iron ore expansion is well accompanied by the
qualitative needs and factors. Firstly, the iron ore line will reduce the heavy dependence on
the sustainability of gold prices. Secondly, buyers are ready for the output, which guarantees
cash inflows. Thirdly, many of the identified risks are mitigated through credit guarantees,
arrangements with insurance companies, and other factors through apparent favorable
negotiations. Finally, in addition to a value-adding and risk-mitigating financing package,
shaking hands with China, Japan, and South Korea, some of the world’s heaviest metal
consumers, will undoubtedly open up many doors for strategic partnerships and investments
in the future.