Read the Heru Mining Case Study and answer the questions at the bottom of the case utilizing this spreadsheet: Heru Case Study .xlsx

The Opportunity

Heru Mining Case Study

Nadine Heru, the CEO of Heru Resources, hardly noticed the time as she was reviewing the engineering report just handed to her.The report described a proposed new mine on the North Ridge of Mt. Zircon.A vein of transcendental zirconium ore had been discovered there on land

owned by Ms. Herus company. Test borings indicated sufficient reserves to produce 340 tons per year of transcendental zirconium over a 7-year period. The vein probably also contained hydrated zircon gemstones. The amount and quality of these zircons were hard to predict, since they tended to occur in pockets. The new mine might come across one, two, or dozens of pockets. The mining engineer guessed that 150 pounds per year might be found. The current price for high-quality hydrated zircon gemstones was $3,300 per pound.

Heru Resources was a family-owned business with total assets of $45 million, including cash reserves of $4 million. The outlay required for the new mine would be a major commitment. Fortunately, Heru Resources was conservatively financed, and Ms. Heru believed that the company could borrow up to $9 million at an interest rate of about 8 percent. The mines operating costs were projected at $900,000 per year, including $400,000 of fixed costs and $500,000 of variable costs. Ms. Heru thought these forecasts were accurate. The big question marks seemed to be the initial cost of the mine and the selling price of transcendental zirconium.

Opening the mine, and providing the necessary machinery and ore crunching facilities, was supposed to cost $10 million, but cost overruns of10 percent or 15 percent were common in the mining business.There was a cheaper design for the mine, which would reduce its cost by $1.7 million and eliminate much of the uncertainty about cost overruns. Unfortunately, this design would require much higher fixed operating costs. Fixed costs would increase to $850,000 per year at planned production levels. The current price of transcendental zirconium was $10,000 per ton, but there was no consensus about future prices. Some experts were projecting rapid price increases to as much as $14,000 per ton. On the other hand, there were pessimists saying that prices could be as low as $7,500 per ton. Ms. Heru did not have strong views either way: her best guess was that price would just increase with inflation at about 3.5 percent per year. (Mine operating costs would also increase with inflation.) Ms. Heru had wide experience in the mining business, and she knew that investors in similar projects usually wanted a forecasted nominal rate of return of at least 14 percent.

You have been asked to assist Ms. Heru in evaluating this project. Lay out the base-case NPV analysis and undertake sensitivity, scenario, or breakeven analyses as appropriate. Assume that Heru Resources pays tax at a 35 percent rate. For simplicity, also assume that the investment in the mine could be depreciated for tax purposes straight-line over 7 years.

The Challenge

You have been hired as a consultant to advise Heru Resources on the opening of a new mine. Details of the project can be found below. The attached spreadsheet calculates the projections based on the base scenario presented. There are two sets of financials that are the same to start. As you adjust the inputs you will be able to see a side by side comparison of the projections. You can manipulate the information in the green input cells to adjust projections to the income statement. You will need to create formulas to calculate the NPV and IRR calculations. Use the spreadsheet and any other resources you would like to complete the following:

1. Is this project financially feasible given the base scenario? Why or why not. Be sure to include a discussion of NPV and IRR. How does the lifetime income compare to the initial investment? 5 points

2. What are at least three risk factors that Heru should be considering in evaluating the project? What types of risk do they represent? 5 points

3. Is there one scenario or input that has more impact on the forecast than others? 5 points

4. Which scenario is a better financial decision for the company based on the information in the case; pay a higher opening cost and lower operating expenses, or a lower opening cost, and higher operating expense. 5 points

5. Looking at the base scenario, at what discount rate is the project feasible? What information did you use to determine that it would be feasible? 5 points

6. Using the spreadsheet, change the inputs to reflect the best and worst case scenario using the information in the text. Resubmit the excel sheet showing the side by side comparison. Include a brief explanation of how you changed the

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