. Project Information You estimate the investment required to undertake the project will be equal to 20% of the Property Plant and Equipment (PPE) shown in the Core Lithium Ltd 2023 Balance Sheet (page 5). You are also aware that Rural Services Ltd has budgeted to spend $2 million in professional, geotechnical and legal fees appraising the project before making its final decision. You estimate that the revenues in the first year of the project will equal the 2023 Revenue/Average PPE margin you have calculated for Core Lithium, shown on page 6, multiplied by the investment Rural Services will need to undertake the project. Further you are advised that the size of the resource is estimated to provide a five year life for the project and that revenues will grow by 35% in year 2, 25% in year 3, 15% in year 4 and 5% in its fifth and final year. You decide to be guided by the Cost of Sales/Revenue Ratio you have calculated for Core Lithium, as shown on page 6, which you will apply through the entire five year life of the project. Depreciation will be calculated using the diminishing value method with the aim of fully depreciating the investment by the end of the life of the project. You decide to apply the tax rate you calculated for Rural Services Ltd, shown on page 6. During the life of the project, you estimate that the firm will need to provide for an annual increase in net working capital comprising an increase in Receivables and Stock, less an increase in Payables. You have calculated the Net Working Capital/Sales Revenue Ratio of Rural Services Ltd and Core Lithium shown on page 6. You decide to use the 2023 Net Working Capital/Sales Revenue Ratio of Rural Services Ltd to estimate the annual additional amount of Net Working Capital that will be required to service the Incremental Sales Revenue of the project, estimated each year. You also assume that in the year after the final year of the project's life the firm will recover in full this net increase in working capital. In the year after the five year life of the project, you are advised that the company would need to spend $3 million in cleaning up the site and replanting. Your research also shows that the equity risk premium on the ASX is between 4 - 6%, so you decide to apply a 5% equity risk premium in your estimation of CAPM. 8 Tasks You are required to complete the following tasks. Show the formula and complete calculations for each answer you calculate. Define all variables of each formula used and show any calculations required to adjust them for use in applying the formula to solving each problem. Format your answers as defined in each task. When incorporating an answer to a prior task in a subsequent task, use the value as it has been formatted. For example, if a task required you calculate and format as a percentage to 3 decimal places, the answer should be formatted as 1.234%. If this value is subsequently included in the calculation of the answer to a subsequent task, then the value you must use is 1.234% or 0.01234. Part 1: Calculate Rural Services Ltd's Weighted Average Cost of Capital (30 marks) a) Calculate the before-tax cost of Rural Services Ltd's bank loans and corporate bonds. Show your answer formatted as a percentage to 3 decimal places. (6 marks) b) Calculate the cost of Rural Services Ltd's ordinary shares. Show your answer formatted as a percentage to 3 decimal places. (6 marks) c) Calculate the estimated market value of Rural Services Ltd's bank loans and corporate bonds. Show your answer formatted as dollar values. (6 marks) d) Calculate the estimated market value of Rural Services Ltd's ordinary shares. Show your answer formatted as dollar values. (8 marks) e) Calculate Rural Services Ltd's WACC. Show your answer formatted as a percentage to four decimal places. (4 marks) Please turn over for Part 2 INCOME STATEMENT Sales Revenue Core Lithium Ltd 2023 Financial Accounts Cost of Sales Gross Profit Interest Income Selling, General and Administrative Expenses Other Non-operating Income/(Expense) EBITDA Depreciation Interest Expense Pre-Tax Profit Tax Net Profit million 50.6 (15.8) 34.8 3.0 (21.0) (1.5) 15.4 (3.9) (2.3) 9.2 (1.6) 7.6 BALANCE SHEET million ASSETS Cash 152.8 Accounts Receivable 6.7 Inventory 28.9 Property Plant and Equipment 241.2 Other Assets 73.6 Total Assets 503.1 LIABILITIES Accounts Payable Bank Loan Other Liabilities Total Liabilities SHAREHOLDERS' EQUITY Ordinary Shares Retained Earnings Total Shareholders' Equity Total Liabilities and Shareholders' Equity 31.0 83.6 33.6 148.2 370.9 (16.0) 354.9 503.1 5 Scenario You work as a financial analyst in the Finance division of the Rural Services Ltd an Australian agribusiness company. Rural Services Ltd provides a range of products and services, across rural Australian towns, through a common distribution channel, including beef cattle feedlots, agricultural retail products, agency services, real estate services and financial services. A deposit of lithium ore has been discovered recently on rural property owned by the company. Lithium is a critical element used in various applications, especially in the production of rechargeable batteries, which are used in a wide range of devices such as electric vehicles, smartphones, laptops, and energy storage systems. Additionally, lithium is also used in other industries, including aerospace, ceramics, glass, and pharmaceuticals. The company is in the process of deciding whether or not to develop a mine on the property to extract the lithium to supply the rechargeable battery market in light of the increasing demand for rechargeable batteries. Your company's Chief Financial Officer has asked you to make a recommendation as to whether or not the company should proceed with such a project, notwithstanding the significant diversification such an investment would represent for the company from its core activities. In order to analyse the financial viability of the project you obtain the 2023 Income Statement and Balance Sheet for Rural Services Ltd. Moreover, in order to analyse the risk and return of this project, which is so different from the current activities of Rural Services Ltd, you also obtain the 2023 Income Statement and Balance Sheet for Core Lithium Ltd, a small lithium miner listed on the ASX. These financial statements are provided on pages 4 and 5. You calculate some financial ratios to compare the financial performance of the two companies, which are presented on page 6. You also collect some interest rate information, which is presented on page 7. Financial Analysis of Rural Services Ltd and Core Lithium Ltd 2023 FINANCIAL ANALYSIS Sales Revenue/Average PPE Margin Cost of Sales/Revenue Ratio Gross Margin Tax Rate Net Margin Rural Services Ltd Core Lithium Ltd 164% 31% 80% 31% 20% 69% 30% 17% 3% 15% Net Working Capital/Sales Revenue Ratio 15% 9% Net Profit/Equity Return Debt/Equity Ratio 13% 74% 24% 26 2% Credit Rating Beta BB BB 0.51 2.31 6 Rural Service Ltd 2023 Financial Accounts INCOME STATEMENT Sales Revenue million 1,000.0 800.0) Cost of Sales Gross Profit 200.0 Selling, General and Administrative Expenses (100.0) EBITDA 100.0 Depreciation (50.0) Interest Expense (7.5) Pre-Tax Profit 42.5 Tax Net Profit BALANCE SHEET (12.8) 29.8 million ASSETS Cash 10.0 Accounts Receivable 200.0 Inventory 150.0 Property Plant and Equipment 250.0 Total Assets 610.0 LIABILITIES Accounts Payable Bank Loan Corporate Bonds Total Liabilities SHAREHOLDERS' EQUITY Ordinary Shares Retained Earnings Total Shareholders' Equity Total Liabilities and Shareholders' Equity 200.0 25.0 150.0 375.0 400.0 (165.0) 235.0 610.0 Notes 1. The interest rate on the bank loan is 6.00% p.a. 2. The corporate bonds have a credit rating of BB and have 5 years to maturity. They make quarterly coupon payments at a coupon rate of 4% p.a. 3. The ordinary shares are shown on the balance sheet at their book value of $1 per share. They have a beta of 0.51. In 2023, they paid a dividend of $0.03 per share. The dividend is expected to grow at 5% p.a. for the next 3 years, after which it will grow at a constant 3% p.a. in perpetuity. 4 Interest Rates Based on the current yields at which the 5-year and 10-year Government bonds are trading you assume that the 5-year risk-free rate is 3.974% and the 10-year risk-free rate is 4.315%. The current corporate credit spreads are as presented in the table below. Rating Aaa/AAA Aa2/AA A2/A Baa2/BBB Ba2/BB B2/B Caa2/CCC Ca/CC Maturity 1 8 28 52 80 201 319 852 1,207 2 22 33 59 87 201 319 852 1,207 3 35 39 65 93 201 319 852 1,207 4 48 44 71 100 201 319 852 1,207 5 45 46 76 108 201 319 852 1,207 6 42 48 82 117 201 319 852 1,207 7 49 53 88 123 201 319 852 1,207 8 57 57 94 129 201 319 852 1,207 9 65 62 100 135 201 319 852 1,207 10 63 63 99 135 201 319 852 1,207 11 61 63 99 136 201 319 852 1,207 12 60 64 99 136 201 319 852 1,207 13 58 64 98 136 201 319 852 1,207 14 57 65 98 136 201 319 852 1,207 15 55 65 97 137 201 319 852 1,207 16 53 66 97 137 201 319 852 1,207 17 52 66 96 137 201 319 852 1,207 18 50 67 96 138 201 319 852 1,207 19 49 67 95 138 201 319 852 1,207 20 47 68 95 138 201 319 852 1,207 21 45 68 94 139 201 319 852 1,207 22 44 69 94 139 201 319 852 1,207 23 42 69 93 139 201 319 852 1,207 24 40 69 93 139 201 319 852 1,207 25 39 70 92 140 201 319 852 1,207 26 37 70 92 140 201 319 852 1,207 27 36 71 91 140 201 319 852 1,207 28 34 71 91 141 201 319 852 1,207 29 32 72 90 141 201 319 852 1,207 30 31 72 90 141 201 319 852 1,207 Average 45 61 89 129 201 319 852 1,207 7