CASE 3: CARSON MINING Christa Carson is the new Chief Financial Officer (CFO) of Carson Mining. Her father, Grant, and uncle, Enzo, founded the company fifty years ago. Since Grants death twelve years ago, Enzo had been the companys CEO and things had been run largely through his vision. Unfortunately, the company had run into troubles with failed projects and low commodity prices. Last year, Enzo had succumbed to a lengthy bout with cancer and his son Harrison had taken over as the companys Chief Executive Officer. Christa had been the VP of Finance and was promoted to the CFO role. Neither Harrison nor Christa come from a strictly accounting background, so they have been learning a lot about numbers on the job. Christa has been looking through the companys current projects and has found two major mining ventures which account for nearly all of the firms cashflows. She wants to make a budgeted income statement for each project, as well as one for the firm. Budgeting hasnt been a regular practice at Carson Mining, so Christa is largely starting from scratch. Here are some numbers from last year: Primavera Lama Copper mine in Chile Sales Revenues $741,000 Copper production in pounds 260,000 Expected growth (in pounds) in copper production, year over year * -2.10% Equipment rental expense ** $180,000 Salary expense *** $355,000 Other operating costs **** $67,000 Jacobston Silver mine in Yukon Sales Revenues $1,992,000 Silver production in ounces 80,000 Expected growth (in ounces) in silver production, year over year * -4.70% Equipment rental expense ** $296,000 Salary expense *** $712,000 Other operating costs **** $102,000 Other expenses Carson Mining Fixed selling expenses $130,000 Executive salary $750,000 Administrative expenses $145,000 Tax expenses $24,000 * This year, Christa anticipates the copper price to average out to $3.10 per pound and the silver price to average out to $26.25 per ounce. ** Christa expects equipment rental expense to increase by 2% this year. *** Historically, the firms salary expenses are well-correlated with the Canadian minimum wage. The minimum wage will increase from $12.65 to $13.20 this year. **** Christa expects other operating costs to increase or decrease in line with the actual production/output of each project. Christa notes that both mines have declining yields, but are expected to continue producing output for the next ten years. She expects production to decline at a roughly constant rate and for expenses to follow the same recent trend. The tough part is figuring out the future commodity prices, so Christa is leaning towards keeping her expected prices constant (refer to * note above). She suspects that she can sell the mines in any given year at that years expected revenue level (ex. the Primavera Lama mine could have been sold last year for $741,000). Christa wants to avoid holding a mine beyond the point where the projects operating expenses exceed its revenues. After the budget is made, Christa wants to analyze a couple of investment opportunities for the firm. Harrison has expressed a desire to make a big splash in his first year, but Christa is concerned about the companys health. It currently holds about $220,000 in cash. There is $190,000 of long-term debt (7.25% interest rate). Carson Mining would be able to comfortably raise $260,000 more through debt at the same interest rate. In addition, it can raise $500,000 in equity (the estimated cost of equity is 12%). There are potentially two projects which the company can acquire: a) A copper mine in Peru with a cost of $630,000. This mine is expected to produce 200,000 pounds of copper per year for ten years. The costs are expected to be 60% of the Primavera Lama project. b) A silver and copper mine in Ontario with a cost of $780,000. This 10-year project would require an additional $100,000 in upfront project development investment. After this, operational costs would be identical to the Primavera Lama project. In its first year, the Ontario mine would produce 50,000 pounds of copper and 20,000 ounces of silver. Copper production would double in the second year and double again in year three, then remain constant for the next seven. Silver production will increase by 1,000 ounces per year for the life of the mine. Prepare a business report for Christa. Discuss all relevant issues, including pros and cons of each course of action. Outline any questions/inquiries which should be directed to Christa and why the information is important to certain decisions.