Case Background

RRWR Inc. (RRWR) is a gold mining company with operations in numerous countries.Currently, RRWR is considering the viability of a new project which involves the mining of gold in the northern region of B.C.You and your team are employed within the finance division of RRWR and have been assigned the task of advising the board of directors regarding this new ambitious project.Many of the directors are considering the expansion as a major growth opportunity.

Part I

a.The Board of Directors of RRWR come from all walks of life and most have minimal finance experience. Present, in one short paragraph for each model, discussion educating the board of directors of RRWR about the various (six) models that are commonly used in industry when making capital budgeting decisions.Incorporate any potential deficiencies and exceptions to the use of the models into your discussion (30%)

b.Suppose the acceptance of this project means the firm must retain already owned mining equipment valued at $1,00,000 which could be sold if the project is rejected.Consider the sale of the equipment as taxable at the normal corporate tax rate; the equipment has been essentially depreciated (CCA expensed) to nil even though it remains in good repair and operational.Discuss the appropriate treatment of this factor in the project evaluation?Present your arguments in one paragraph (5%).

c.Suppose this project is being considered within the mining division of the firm.In the event the project is accepted, the mining division would have to make installments to its head office in the amount of $75,000 per annum as part of the firm's accountability program.No additional expenses are expected to be incurred - ample human and other capital are already employed within head office to handle the additional work volumes. Discuss whether this payment from the mining division to its head office is a relevant cash flow in the analysis of the Northern B.C. project (one paragraph)(5%).

d.R & R Financial Advisory Services (R & R) was previously engaged by RRWR, Inc. on numerous capital budgeting projects, similar to the one being considered at the present time.They have always provided quality advice regarding financial risks related to new mining projects.As agreed, and in accordance with the engagement letter, the fee for their risk assessment specific to the Northern B.C. project was $28,600. R & R has concluded the financial risks of the Northern B.C. project are consistent with the firm's existing operations. Discuss whether this is an incremental cost of the project, and explain the appropriate treatment of the payment made to R & R relative to the project at hand.Present your arguments in one paragraph (5%).

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Part II

a.Based upon your decisions in Part 1, b, c and d above, and additional information given below, calculate and advise whether RRWRshould accept or reject the Northern B.C. project using each of the following models (ensure all math or keying sequences are shown - round to the nearest dollar and round percentages to two decimals):

i.NPV

ii.IRR

iii.PI

iv.Payback Period

v.Discounted Payback Period

Additional Information

RRWR has recently completed a forecast of cash flows relating to the Northern B.C project which it has turned over to you and your team.Cash flows for the initial outlay and operating cash flows (OCF) after-tax have been projected by the finance area of RRWR and are as shown below.In addition, the net working capital is expected to increase by $500,000 at the very start of the project for inventory purchases, but the increase will fully reverse at the end of the project as the inventory is depleted. Projected, taxable, salvage value of the new equipment that will need to be purchased is $3,000,000 if the project goes ahead.The firm's corporate tax rate is 40%.

The firm's capital financing is derived entirely from bond issues and common shareholder's equity (no preferred shares are outstanding).The outstanding $200 million (par value) bond issue is currently priced at 97%.The yield to maturity on RRWR bonds is presently 8%.The firm also has 32,000,000 common shares outstanding which are trading at $25.00 per share.RRWR shares have a beta estimated at 1.25.Consider the Government of Canada Treasury Bills are currently yielding 3% whereas the expected return for the equity market in the mining industry is 10%.

All projects accepted by this firm should be paid back within a five-year time period according to those that subscribe to the payback model.They argue that risk becomes excessive when forecasting the price of an ounce of gold any further out and further believe the requirement should remain at five years even if cash flows are discounted in the analysis.

Year Cash Flow $Description

0(50,000,000) Equipment purchase (capital expenditures)

110,000,000Operations, after tax

211,000,000Operations, after tax

312,000,000Operations, after tax

412,000,000Operations, after tax

512,000,000Operations, after tax

610,500,000Operations, after tax

717,000,000Operations, after tax

b.Present your argument to the Board of Directors of RRWR, Inc. as to whether the project should be accepted or rejected in one succinct paragraph.