You are considering an equity investment in a copper mining venture. The geology of the proposed mine is interesting: there is a shallow volume of copper ore (15 million tons) that is recoverable with complete certainty. However, geologists tell you that there is a 20% probability that an additional 65 million tons of ore may be located below the shallow body of ore. To mine all the ore (whether it is a little or a lot) will take 5 years. For the sake of simplicity, assume that all cash flows take place at the mid-point of the venture, that is, two and a half years from now. The cost of mining the ore and the price at which you can sell it will depend on the economy. Your in-house commodities analyst, Dusty Dave Dustwood, has prepared the following table. Since you work at a small fund, Dusty is also the in-house economist. Accordingly estimates of the market return and the risk free rate are also included in the table. Under cross-examination Dusty suggests that mining ventures of this nature should be priced using an un-levered beta of 1.5. of Probability Cost Market return Risk free rate State economy "Boom" "Bust" Ore Price Extraction (per ton) (per ton) 9 3 0.7 15% 3% 0.3 3 -5% 3% a) Calculate the expected net cash flow produced by the venture. (Hint: Start by calculating the expected net cash flows in each of the Boom and Bust states) (5 Marks] You are considering an equity investment in a copper mining venture. The geology of the proposed mine is interesting: there is a shallow volume of copper ore (15 million tons) that is recoverable with complete certainty. However, geologists tell you that there is a 20% probability that an additional 65 million tons of ore may be located below the shallow body of ore. To mine all the ore (whether it is a little or a lot) will take 5 years. For the sake of simplicity, assume that all cash flows take place at the mid-point of the venture, that is, two and a half years from now. The cost of mining the ore and the price at which you can sell it will depend on the economy. Your in-house commodities analyst, Dusty Dave Dustwood, has prepared the following table. Since you work at a small fund, Dusty is also the in-house economist. Accordingly estimates of the market return and the risk free rate are also included in the table. Under cross-examination Dusty suggests that mining ventures of this nature should be priced using an un-levered beta of 1.5. of Probability Cost Market return Risk free rate State economy "Boom" "Bust" Ore Price Extraction (per ton) (per ton) 9 3 0.7 15% 3% 0.3 3 -5% 3% a) Calculate the expected net cash flow produced by the venture. (Hint: Start by calculating the expected net cash flows in each of the Boom and Bust states) (5 Marks]
