Peterborough Mines Limited discovered a new lithium deposit 500 km north of Adelaide in 2016. Further testing has indicated that the lithium deposit covers a huge area constituting an ancient inland sea bed, with more finds in the vicinity possible. Given the rapid growth in demand for lithium in the production of lithium and lithium-ion batteries, the company is confident that it can sustain mining activities for a period of 20 years.

The company has spent $50 million in exploration and trial drilling since the discovery, and also has spent another $180 million developing an open cut mine, which commenced operating in 2019. The mined material is being sold to other companies for treatment and ultimate sale to largely international customers. Based on its recent experience with this arrangement, Peterborough Mines is considering constructing its own separation and refining plant to treat all the mined material and extract the lithium salts electrolytically from a mixture of lithium chloride and potassium chloride. The plant would take a year to construct and would have an engineering life of 10 years, and the company has estimated that the incremental cash flow from the plant will be $40 million annually after tax.

The company estimates that it will have to spend $60 million before tax when the plant refining operations cease to remove the plant and make safe a considerable amount of stored toxic materials.

The company has a target debt-equity ratio of 0.8, a cost of equity of 14.0%, a cost of debt of 8.0%, and is subject to a 30% corporate tax rate. The company has never built and operated a refining plant in the past, preferring to sell the mined materials to other companies for treatment and ultimate sale. Consequently, it regards this project as requiring an increase in the firms cost of capital of +2%

a) Calculate the appropriate cost of capital that the company should apply to this project? b) What is the maximum capital that the company should outlay on building the plant? c) Comment on the approach the company has used in determining the cost of capital to apply to this project? Are there other approaches that you could recommend that the company consider?