Fundamentals of Financial Management - Assignment Example

? SALAVE PROJECT Astur Gold is a gold company that is developing a fully owed Salave gold projectin Asturias, northern Spain (Asturgold, n.p). It is the largest project that will extract the biggest undeveloped gold mineralization deposits in Western Europe (Asturgold, n.p). The company submitted an application for underground mining in 2011 to the Spanish government. This report is a post investment appraisal for the project that aims at giving the detailed account of the viability of the project. Salave gold deposit includes five mineral concessions covering a 433ha land. The company has also secured an investigation permit of up to 2765ha for a total of 3198ha of highly potential gold deposits (Asturgold, n.p). The area has already been developed, and access roads, power lines, water and telephone lines are available in the area. The area is just 10 kilometers from Tapia within the province of Galicia. This region has a long coal mining history that boosts confidence on future mine developments the Salave Project. This project is viable since it has a strong geological evidence to support it. Gold deposits are in the main Salave granodiorite and surrounding regions. The deposit contains gold mineralization along numerous north to northwest irregular lenses. Salave gold deposit is one of the biggest and premier grade undeveloped gold deposits in Western Europe. It is an investment that is worthwhile and lucrative. This report will show the predicted future of the Salave project investment in such a way that the investor will see the value of investing in such promising project. Since gold is a precious stone, investing into this project is also extremely precious to both the investor and the company taking up the Salave project. All the data and relevant analysis confirm the viability of this gold mine project. Introduction The Salave project has a basis on the preliminary economic analysis of the project. This economic analysis shows the financials of the project for the next eighteen (18) years. These projections are subject to alterations in the economy and, therefore, the rational of this statement is to take into account the changes and incorporate them for investors to have total confidence in the project. The analysis of the project indicates that, over the next 18 years, the project will generate a NPV of $576 million (Asturgold, n.p). Previous metallurgical studies and tests indicate that recoveries are in the order of 90%. The region has 1.7 million oz Au and indications show that 338 thousand oz Au inferred. This is good news to any investor who wants to have the most value for their investments. The robust economy demonstrated in 2011 placed the gold price at an attractive $1,100/oz. The local community is in total support of the project and shows confidence in the mining process. Currently the drive to put Salave to production as soon as possible is enormous. This project is the best investment in Western Europe. Significance of the Salave Project The Salave project is tremendously significant in the economy of Spain and to investors and share holders of the company that runs the Salave project. The project has vast possibilities and positive rewards in the end. Many investors always seek to increase their share value. This is the business that Salave project focuses on among other key goals like to be the largest gold mine in the whole of Western Europe. This project is resistant to the economic dynamics that will make investors shy to invest in the gold business. The gold business is never low due to the constant and steady rise of the prices of gold over the years especially when inflation strikes. This analysis will show how the value of the share holders will be on the increase, and the success of the project is the main purpose of the call for investor input from all over the globe. Cash flow Analysis In the forecast of the project’s cash flows for the next two decades, the following assumptions hold: A. All factors remain constant unless stated otherwise in the analysis report. B. The rise in inflation will also remain constant and invariant. C. The initial equipment investment depreciation will take a straight line basis. The preliminary cash flow analysis predicts the project will generate a NPV of $576 million. This is fabulous news to the potential investors. In addition, the news gets better since the analysis did not consider that gold prices per oz as expected to rise by 1% annually. Analysts say that forecasted gold prices rise by an average of 10% per annum by year four (4). This shall fall by 3% per annum until year 13and rise again by 2% until the end of the project. These changes in the market make the project lucrative to investors. In the cash flow analysis, it is imperative to consider all possible changes in the future and set up a contingency plan in order to stay ahead of the competition. A company called FPL had developed a detailed capital budget for 2009 – 2011, but when the economy went downhill, the managers had a rough time making modifications Brigham & Ehrhardt, (2011, p 379.). The mistakes made by FPL can be avoided since the report considers the future uncertainties. According to biz/ed website, the main stages of capital budgeting cycle are forecasting investment needs, identifying project needs, appraising the alternatives, selecting the best alternatives, making the expenditure and monitoring the expenditure (2011). This report focuses on the Appraisal of the alternatives. This involves cash flow analysis and the forecast of the effects of the anticipated changes. In the initial cash flow analysis, the project estimates assumes all factors remain constant. The initial investment capital is $200 million. The project is to run for the next 20 years. This cash flow analysis option 1 considers the project in the first 18 years of operation. The expected output of the open pit mining is 97500 per annum for the whole project. The gold prices estimates to $1,100 per oz. The annual costs of running the project estimate to $40,852,500.00. The expected annual revenue is $107,250,000.00. The annual net revenue of the project is $66,397,500.00. The discount factor varies: in the first year is at 1, and this value reduces steadily to 0.4155 by year 18. Table #1 shows a summary of the cash flow keeping all factors constant. The second case is intriguing since external factors consider the cash flow analysis. The expected output for open pit mining does not change; it is still at 97500per annum. The gold price forecast shows a rise of an average of 10% per year by year 4, then fall by 3% per year until year 13 only to rise again by 2% until the end of the project. These changes make the expected gold prices per oz rise from $1,100 in the start of the project to $1,610.51 by the sixth year. Unfortunately, the gold prices per oz will drop to $1,224.36 by year 13. These prices will rise again to $1,351.79 by the end of the project. Considering these changes, the cost per oz will also rise from $419 to $501 at the start of the project and the close of the project respectively. This translates to increased total revenues and increased net value. The discounted factor remaining unchanged, the Net Present Value of the project will raise to $852,891,946.05. The difference between the two cases is extremely significant in the consideration of investing in this project. Table #2 shows a summary of the cash flow analysis in the second case. The Astur Gold share prices are also supremely valuable. In the first case, when all remains constant, the share prices since 1994 can be summarized as follows: In January 1994, the share prices opened at a high of 0.69 and closed at a low of 0.54. Over the years, the share prices of Astur Gold have been on the increase, and by January 2012, the shares were opening at 1.25. Table #3 shows a summary of the share prices since the year 1994. To show that increase in the share prices more vividly, Graph #3 indicates the steady growth in share prices. Cost of Equity of the project Calculation of the project’s cost of equity will help in the evaluation of the project for potential investors. According to Brigham & Ehrhardt, (2010), the cost of equity can be calculated in three different methods: Capital Asset Pricing Model (CAPM), the Discounted Cash Flow (DCF) and over-own-bond-yield-plus- judgment-risk-premium approach. These methods have their pros and cons. For the purposes of this project, the Capital Asset Pricing Model (CAPM) is appropriate. Cost of Equity = (rs) = (rRF+ (RPm) ?) According to Shim & Siege (2008), companies use capital budgeting process in making long –term decisions that expands the company goals. The tasks involved are cash flow analysis, estimation of cost of equity and applying a decision rule to come up with the best alternative. The Project’s Discount Factor The project’s discount factor will vary from the weighted average cost of capital (WACC) due to inflation. From the calculations, the project’s discount factor steadily decreases form the start of the project to the close. In general, if the interest rate is r, then the present value of a sum of money X due in t years time is {X? (1+ r )t} (Investment Appraisal, n.d, p 86). Table # 4 shows that calculated discount factors for the entire period of the project. Project evaluation Using Capital Budget Techniques This project can be evaluated using six methods, which are, the Net Present Value (NPV), Internal Rate of Return (IRR), Modified Internal Rate of Return (MIRR), Profitability Index (PI), Regular Payback and Discounted Payback Approach, (Brigham & Ehrhardt, 2010), although they agree that NPV is the most reliable method. I will use NPV, IR, PI and Regular Payback methods for the evaluation of this project. From the results, it can be concluded that the Net Present Value of the project is $576 million. According to Brigham & Ehrhardt (2010), a project with a positive NPV increases the shareholders’ value. This project has a positive NPV; therefore, it will increase the share holder’s value. MIRR can correct some of the constraints with the regular IRR; management, therefore, should use the MIRR because it is a better estimate than the regular IRR. In this project, I used NPV and IRR, sufficient despite the problems associated with IRR (Huston, n.d). However, if both IRR and NPV apply, the project will still be sufficiently evaluated to the levels that can be used to make a decision. According to Brigham & Ehrhardt (2010), “managers should question any project with a large NPV, a high IRR or PI. In a perfectly competitive economy, there would be no positive-NPV. Projects and all companies would have similar opportunities, and competition would quickly eliminate any positive NPV" (p439). Sensitivity of the Project Analysis The sensitivity of this project will focus on how the NPV changes with the different scenarios of the market. In the cash flow analysis, the two cases show that the project is stable, and changes is the market trends will not adversely affect the share holder’s value. The share prices in table #3 are the same in both cases when all factors remain constant and when the market forces apply. The conclusion based on the sensitivity of the project is favorable to the investors. Evaluation of the Riskiness of the Project From the sensitivity analysis, the project has positive NPV; it is less sensitive since the projects NPV does not change much with the changes in the market patterns. The project is not risky since it deals with gold and the chances that the project’s success is unusually high. The main reason why the project is less risky is because the projected cash flow for the next 20 years is satisfactory and the project has stability. According to Brigham & Daves, (2010), diversification lowers the riskiness of a project or business. The project has a high probability of succeeding even if there is no diversity to cater for uncertainties of the future if all factors remain constant. In the sensitivity analysis, the project is viable and has a low risk. Since there are high chances of the project surviving adverse economic conditions, the project’s chance of success compared to the chance of failure seem bias towards success (“Little K,” 2010). Under favorable conditions, the project would be extraordinarily successful, and there would be high profit margins. This project is a low risk for Astur Gold and should be adopted. There is a provision of room for diversification to help cushion the uncertainties that exist (Eugene & Philip, 2010). Based on the sensitivity analysis at average demand level, the project overall has a low sensitivity to changes in price of gold per oz. Recommendation Based on the analysis of the overall success chances of the project, Salave Gold project welcomes investors, and are confident that the value of their shares is going to rise. All the investors who have already shown interest in the project will now have the assurance that their investment is in the right place. Considering that the investment has an anchor in the biggest undeveloped gold mine, in Western Europe, the project’s success guarantees the profitability of this project. Appendix: Tables, Charts and Graphs Chart #1: Annual Net Revenue for Salave Project Graph #3: Works Cited Astur Gold Corp. - Home Page - Sat Apr 14, 2012. (n.d.). Retrieved from http://www.asturgold.com/s/Home.asp Astur Gold Corp. – Salave Gold Project, Spain - Sat Apr 14, 2012. (n.d.). Retrieved from http://www.asturgold.com/s/SalaveProject.asp Astur Gold Corp. – News Releases - Sat Apr 14, 2012. (n.d.). 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