Objective The objective of this exercise is to enhance students understanding of some of the main issues in corporate finance and related business decision-making process. In this project students are required to prepare a business report based on a case study. Details about the case study and its requirements are set out below. Scenarios It is 31st December 2019. Your team of four people form a financial analysis team at Aussie Finance Consulting (AFC), a renowned financial institution. The executive management of AFC has assigned you a task to carry out a special project for its client Whitehaven Coal Limited (WHC), which requires preparing a business report. This report will be presented to AFC executive management and the senior management of WHC. Whitehaven Coal Limited (WHC) is a New South Wales based coal producer, with operations and development projects in The Gunnedah Basin. WHC has a portfolio of producing mines including the Werris Creek Mine, the Narrabri Underground Mine Stage 3 Extension Project, the Maules Creek Project and other projects. The coal mining industry has been hard-hit by environmental regulations. Recently, however, a combination of increased demand for coal and new pollution reduction technologies has led to an improved market demand for coal. WHC has just been approached by Mid-Cen Electric Company with a request to supply coal for its electric generators for the next eight years. WHC does not have enough excess capacity at its existing mines to guarantee the contract. The company is considering opening a strip mine in The Gunnedah Basin on 5,000 acres of land purchased 10 years ago for $12 million. Based on a recent appraisal, the company feels it could receive $15.5 million if it sold the land today. Strip mining is a process where the layers of topsoil above a coal vein are removed and the exposed coal is removed. Some time ago, the company would simply remove the coal and leave the land in an unusable condition. Changes in mining regulations now force a company to reclaim the land; that is, when the mining is completed, the land must be restored to near its original condition. The land can then be used for other purposes. Because it is currently operating at full capacity, WHC will need to purchase additional necessary equipment, which will cost $77 million. To get the equipment in running order, there would be a $2 million shipping fee and a $3 million installation charge. The equipment will be depreciated to zero on a straight-line basis over its economic life of 15 years. The contract runs for only eight years. At that time the coal from the site will be entirely mined. The company feels that the equipment can be sold for 10 percent of its initial purchase price in eight years. However, WHC plans to open another strip mine at that time and will use the equipment at the new mine. The equipment also requires staff to be specially trained; fortunately, a similar equipment was purchased a year ago, and at that time the staff went through the $500,000 training program needed to familiarise themselves with the type of equipment. WHCs Corporate Finance (BAFI1059) S2 2020 Page 3 of 9 management is uncertain whether to charge half of this $500,000 training fee to the new project. The equipment also requires annual maintenance cost of $325,000. The contract calls for the delivery of 500,000 tons of coal per year at a price of $93 per ton. WHC feels that coal production will be 620,000 tons, 680,000 tons, and 730,000 tons, respectively, over the first three years, and 590,000 tons per year over the remaining years. The excess production will be sold in the spot market at an average of $75 per ton in Year 1 with an expected decrease of 2% per annum in the following years. Variable costs amount to $35 per ton in Year 1 with an expected increase of 5% per annum in the following years. Fixed costs are $5,000,000 per year. The mine will require a net working capital investment of 5 percent of sales. The net working capital will be built up in the year prior to the sales. WHC will be responsible for reclaiming the land at termination of the mining. The company uses an outside company for reclamation of all the company's strip mines. It is estimated the cost of reclamation will be $2.5 million. In order to get the necessary permits for the strip mine, the company agreed to donate the land after reclamation to the state for use as a public park and recreation area. This will occur in Year 9 and result in a charitable expense deduction of $15.5 million. You are required to analyse the project and make recommendations to WHC whether they should take the contract and open the mine. For the purpose of the analysis, you have already assembled the following information: Balance Sheet of WHC as of 31 December 2019 Assets Cash at Bank $121,345,000 Accounts receivable $142,393,000 Inventory $101,884,000 Marketable securities $788,000 Plant, machinery and equipment $4,070,382,000 Intangible assets $22,946,000 Exploration and evaluation $570,194,000 Total Assets $5,029,932,000 Liabilities Accounts payable $214,564,000 Bank overdraft $550,000 Commercial bills (due 31st Dec 2020) $119,253,000 4.75% Coupon bonds (due Dec 2029 issued @$100 each) $1,439,226,000 Shareholders' Fund Common stock 1,026,250,427 shares @ $2.927 each $3,003,835,000 Retained Earnings $252,504,000 Liabilities + Shareholders' Fund $5,029,932,000 Corporate Finance (BAFI1059) S2 2020 Page 4 of 9 Additional Information: The applicable interest rate on bank overdraft is 3.25% per annum and has monthly compounding. The commercial bills are currently yielding 3.75% per annum with quarterly compounding. They will mature on 31st December 2020 however, will be replaced by newer issues on that date. Thus, commercial bills may be assumed to run in perpetuity. The bonds are currently priced at $98 each and pay coupons semi-annually on 30th June, and 31st December. The coupon payment due to be paid on 31st December 2019 has been paid. The applicable company tax rate is 30% and the proportion of tax collected from the company and is claimed by shareholders is 0.50. The current yield on Australian Government 10-year bonds is 1.95% per annum. The expected market return including franking premium is 8.35% per annum. Requirements You are required to advise the company on the following: a) Capital Budgeting Decision (35 marks) (i) Should WHC take the contract and open the mine? Steps in part (a): The first part of the analysis requires you to work out the Weighted Average Cost of Capital (WACC) for WHC with the help of the given information. As a part of the WACC calculation, you will need to collect monthly adjusted closing stock prices of WHC and index values of the All Ordinaries Index for the 2015-2019 period from the Yahoo Finance website or MorningStar DatAnalysis Premium database accessed via RMIT library website. (15 marks) Secondly, evaluate the project using NPV analysis and make recommendation to WHC. (20 marks)