Rio Tinto is considering a construction proposal to expand the Western Turner Syncline Phase 2 mine. The additional iron ore will feed into Rios production of the Pilbara Blend and maintain its iron ore production capacity for raw materials used to make steel. However in order to proceed with this expansion, Rio Tinto must construct a new Crusher, an ammonium nitrate and fuel oil (ANFO) facility, and a 13-kilometre conveyor to link the greater Tom Price sites two mines. Rio Tinto has undertaken a feasibility study costing $2.9 million to explore their options. The required tax rate for both options can be found in the details under the balance sheet. [For simplicity we will assume a project life time of 3 years that is Year 0, Year 1, Year 2 and Year 3]

Option 1: Building a Crusher and 13-kilometre Conveyor The construction and installation of a new Crusher and 13-kilometre conveyor will cost $18 million. In addition, an ANFO facility will also need to be constructed at a cost $6.4 million. This facility will need to be supplied with slurry pumps, mixed flotation systems and other equipment at a total cost of $7 million. Rio Tintos reserve fleet of autonomous Caterpillar Haulage trucks will meet the needs for this project, however until recently, the fleet has been earning a rental income of $860,000 per year.

The additional iron ore mined is expected to generate a revenue of $33 million per year, which is forecasted to decrease by 5.3% per annum due to slowing demand from China. As a result of the additional complexities involved with the construction and management of this project, 10 new engineers (yearly salary per engineer $145,000) will replace 8 existing engineers (yearly salary per engineer $115,000). The 1000 additional construction labour required for this project is expected to cost $3.7 million per annum for the duration of the project. For tax reasons you will expense the cost of the ANFO facility immediately. The cost for the construction of the new Crusher, 13-kilometre conveyor and associated slurry pumps, mixed floatation systems and other equipment will be depreciated over three years using the straight-line method. Due to the nature of the mining project, the crusher and associated systems and equipment will likely have a salvage value of $9 million at the end of three years. Finally, the required net working capital is $4.5 million which will be returned at the end of the projects lifetime.

Your task Part A: To carry out an analysis, you will need to calculate the appropriate Weighted Average Cost of Capital (WACC). Rio Tinto executive management team are particularly concerned that the WACC be accurate, thus you are expected to determine the WACC based on recent market and other data. (Read below for additional information). Part B: Carry out a detailed analysis of the two given options and make recommendations to Rio Tinto about those options. To establish the WACC you have already assembled the following information Previous years stock exchange data for the market (ASX200) and for Rio Tinto, adjusted for dividends and capitalization (Price Index). This data is organized in the file: Project Data.xlsx. Use this dataset to calculate beta. For CAPM purposes use the return on the market (%) provided in the next section.

Balance Sheet of Rio Tinto as of 31 December 2019 Extract of Balance Sheet for Rio Tinto ($ in millions) 33,020,000 Ordinary shares of $86.0 fully paid $2839.72 7,400,000 3.3% Preference Shares of $84.0 fully paid $621.60

Current Liabilities and Provisions

Bank Overdraft $87.00 Trade Creditors $46.00 Unsecured Notes$ 63.00 Non-Current Liabilities Debentures $94.00 Term Loans $72.00 Mortgage $89.00 The companys preference and ordinary shares are currently trading at $91.28 each. The risk-free rate of return is 1.05 % p.a., and the return on the market is 5.90 % p.a. Debentures have a coupon interest rate of 8% p.a. and could be re-issued at the present time at an interest rate of 6.5% p.a. The debentures will be redeemed at their face value in five years time. Face value is as per the balance sheet. The mortgage loan is repayable in six years time and the current interest rate is 4.35% p.a. The mortgage was initially negotiated at 6.90% p.a. Term loans have a current interest rate of 5% p.a., but were negotiated at an interest

Part A Calculate WACC: The first part of the analysis requires you to work out the Weighted Average Cost of Capital (WACC) for Rio Tinto. With the help of the given information and given data, you need to work out the individual costs1 and value of each of the sources of capital and apply that to the WACC equation to work out the overall weighted cost.

Part B Calculate NPV: Evaluate the two options using NPV analysis and clearly identify which of the two alternatives results in a higher valuation for Rio Tinto. Include your opinion. Iron Ore price analysis: Describe in a short paragraph (less than half a page) your predictions on iron ore prices. Assume due to some event (maybe related to your predictions), the price of iron ore will decrease by 30% per annum during the lifetime of the project. Assume quantity demanded of iron ore during the lifetime of this project remains consistent, would this change your previous analysis? Describe. rate of 6% p.a. They are repayable in full in four years time. The term loans consists of regular semi-annually interest payments with the principal repaid at maturity Unsecured notes will mature in six months and will not be replaced. They have a current interest rate of 2.86% p.a. The current interest rate on the bank overdraft is 4.20% p.a. Interest on all debt securities is paid twice-yearly and the corporate tax-rate is 33 percent