You are considering an investment in gold mines in China. Your expectations are that you will take losses initially, but once infrastructure is built, the project will become more profitable very quickly. You have estimated that the initial revenues will be $50 mm per year and grow at a rate of 60% per year for four years. Due to political risk, you decide to use only a four-year horizon for planning purposes. Variable costs are expected to be 42% of sales; fixed costs are projected to be $12mm per year. Initial cost of machinery, land, equipment and other things amounts to $100mm. This $100mm will be depreciated straight-line to zero over a seven year accounting life. However, the expected market value of the fixed assets at the end of four years is $50mm. Net working capital requirements are minimal, just $11mm at the beginning of the project, all of which will be recovered at termination. Tax rate of your company is 30%.
This project will be financed with both debt and equity. The plan is to mirror the firm’s target capital structure by issuing 15 million shares of stock priced at $10.00 a share and $170mm face value of 10-year bonds which will be priced at 94% of par if a coupon of 7% is offered to investors. The company will pay dividends of $3.50 per year (starting in one year), and increase the dividend by 4% per year indefinitely. Treasury bills offer 4% return and the expected market returns are 12% per year. The stock’s beta is 1.8. Assume flotation costs are 6% for debt and 18% for equity, and are incurred only for the $100mm outlay for fixed assets. Create an Excel template where all the necessary calculations are made.
. What are the cash flows each year from this project?
. What is the WACC?
. What is the total initial cost after adjusting for flotation costs?
. What are the NPV, IRR, PI and simple (not discounted) payback period for the project