Question 3 Tin Resources (TR), an all-equity firm, is considering purchasing the rights to operate an iron ore mine in the Pilbara region of Western Australia. Acquiring the rights will cost $60,000 today but will also oblige TR to pay substantial environmental rehabilitation costs of $250,000 when the mine is shut down in 3 years' time. While in operation, the mine is expected to produce 20,000 tonnes of iron ore per year, with extraction costs running at $93 per tonne. Although TR knows it can sell iron ore in the market for $100 per tonne in the first year, it faces considerable uncertainty regarding the future iron ore price, which is equally likely to rise by 10% or fall by 15% in each of the subsequent two years. There are no taxes or any other costs. Unless otherwise stated, assume any cash flows occur at the end of each year. Use a discount rate of 20% for all cash flows. Show your calculations. Required: a) Draw a binomial tree depicting the possible market prices of iron ore during the mine's operating life. Remember, the price in year 1 is known with certainty. What is the expected market price of iron ore in years 2 and 3? (6 marks) b) Calculate the NPV of the project. Should TR purchase the rights? (6 marks) Now assume that TR has the ability to temporarily halt extraction operations if iron ore prices move adversely. However, by doing so, it cannot avoid paying the environmental rehabilitation costs at the end of the mine's life. c) When will TR choose to exercise this option? Explain fully. (4 marks) d) Determine the value of the abandonment option. (4 marks) [Total: 20 Marks) Question 4 Cygnus plc is a company that wholesales non-electrical office equipment. The company has only one warehouse and has requested a term loan of 6 million (five- year floating rate) at an initial interest rate of 12% per annum in order to purchase new computer equipment to maintain its inventory and other records. The computer equipment will not materially change the company's current average percentage return on investment. Cygnus' revenue increased by 9% during the last financial year. The financial statements for Cygnus are as follows: Balance Sheet as at 31 March 2020 '000 2019 '000 16.060 14.380 Non-current assets Property, plant & equipment Current assets Inventories Receivables Investment Cash and cash equivalents 31,640 21,860 24,220 17,340 8,760 10,060 1,700 960 66,320 50,220 82,380 64,600 Current liabilities Overdraft Trade payables Current taxation 16,340 13,220 20,920 15,280 2,420 2,800 39.680 31.300 Non-current liabilities Long-term borrowings Debentures Share capital and reserves Equity share 10 p each (38 million shares) Retained profit Total equity 6,000 16,000 16,000 22.000 16.000 3,800 3,800 16,900 13,500 20,700 17,300 82.380 64.600 Extract information from the Income Statement for year to 31 March 2020 Revenue Operating profit Finance costs Profit before income tax Income tax Profit for the year Dividend paid in the year '000 99,360 10,760 (3,840) 6,920 (2,420) 4,500 1,100 Comparative ratio information for Cygnus' industry (averages) Price Earnings Ratio Gearing Ratio (%) Current Ratio Acid Test Ratio Return on Capital Employed (%) Operating Margin (%) Cygnus' shares are currently traded at 15.0 p. 2020 20 52.4 1:1 1:1 16.5 9.0 Required: a) You are a consultant for Cygnus plc. Calculate the following ratios for Cygnus for the financial years ended 31 March 2019 and 2020 where possible: 1. Return on Capital Employed 2. Operating Margin 3. Current Ratio 4. Acid Test Ratio 5. Inventory Holding Period 6. Creditors Payment Period 7. Gearing Ratio 8. Price Earnings Ratio (15 marks) b) Prepare a short report (with five meaningful comments) based on ratios calculated for part a) to present to Cygnus' directors in support of the new term loan. Use industry averages as benchmarks for your analysis whenever possible. (5 marks) [Total: 20 Marks]
