The construction and installation of a new refinery will cost $12 million. In addition, a

processing plant will also need to be constructed at a cost $4.5 million. This plant will

need to be supplied with grinding machines, DMS flotation machines and other

equipment at a total cost of $8 million. Kidman Resources' current fleet of Haul trucks,

water carts and dump trucks will meet the needs for this project, however until

recently, the fleet has been earning a rental income of $95,000 per year.

Under the agreement with Tesla inc., the lithium mined is expected to generate a

revenue of $14 million per year, which will increase by 3.9% per annum adjusted for

rising costs. Due to the additional complexities involved with the construction and

management of this new refinery, 8 new engineers (yearly salary per engineer

$145,000) will replace 8 existing engineers (yearly salary per engineer $155,000). All

other remaining labour force required is expected to cost $4.2 million per annum for

2

the duration of the project. For tax reasons you will expense the cost of the processing

plant immediately. The cost for the construction and installation of the new refinery

and associated machines and equipment will be depreciated over three years using the

straight-line method. Due to the nature of the mining project, the machines and

equipment will likely have a salvage value of $6 million at the end of three years.

Finally, the required net working capital is $3 million which will be returned at the end

of the project's lifetime.

Option 2: Outsourcing the supply of ore

Alternatively, Kidman Resources can contract BHP to supply the required ore to

process into lithium hydroxide. Based on the required amount of lithium hydroxide,

management has quoted a total cost of $20 million. BHP has however offered this rate

on the condition that Kidman Resources pays 25% of the total cost in advance in the

beginning of the year (i.e. Y0), with the remaining paid in equal instalments thereafter.

Kidman Resources will process the ore into lithium hydroxide using existing facilities

at an expected cost of $4.8 million per year.

Your task

Part A: To carry out an analysis, you will need to calculate the appropriate Weighted Average

Cost of Capital (WACC). Kidman Resources 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).