Capital Budgeting ( total up to 800 words)
Answer the following questions with the aid of excel spreadsheets. You also need to answer the below questions in your word file and refer to your excel spreadsheets as supporting documents.
All amounts are in $USD. Red River Resources is deciding between two iron ore projects in May 2017. Project A has an initial outlay of $15.75 billion and Project B has an initial outlay of $13.75 billion. Project A is projected to sell 160 million tonnes of iron ore for the next 5 years and have cost of sales equal to 50% of iron ore revenues. In addition to these cost of sales expenses Project A will use 40million barrels of crude oil each year. Project B will sell 190 million tonnes of iron ore for the next 5 years and have cost of sales equal to 45% of iron ore revenues. In addition to these cost of sales expenses Project B will use 30 million barrels of crude oil each year. Both Project A and B It will also incur additional working capital expenses at the beginning of the projects of $400,000 and recover these at the end of year 5. Assume the iron ore will stay at the price it was in Jan 2017 for the next 5 years. Assume the crude oil will stay at the price it was in Jan 2017 for the next 5 years. Both mines have depreciation costs of $2,000,000,000 a year. The tax rate is 30%. All cash flows are annual and are received/paid at the end of each year.
Useful Sources https://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=RWTC&f=D http://www.marketindex.com.au/iron-ore
(a) Red River Resources is deciding between two iron ore mining projects. Use an excel spreadsheet to find the free cash flows for the following two projects A and B described below from years 0-5.
(b) Calculate the NPV and IRR for Project A and B and advise which project should be undertaken with:
• A WACC (cost of capital) of 12%?
• A WACC (cost of capital) of 25%?
(d) Based on your analysis in a-c which project should be chosen? Justify your answer with reference to theory. (5 marks)
(e) In about 500 words write a note highlighting the current dynamics of the Australian iron ore industry. You may use historical charts and data provided on authentic sources while writing in your own words. Note that it is important to draw a conclusion from your findings.