Question

You have recently taken over the role of the Chief Financial Officer of GT Gold Chasers Ltd. (“GT Gold”). GT Gold is junior mining company, that is hoping to hit it big with their next venture. You work out of the head office that is based out of Vancouver. GT has got a reputation in the industry for being quick to act, and the management team are known for pushing the envelope to get results.

On day two of your first week as CFO, the CEO, Manny Giterdun comes storming into your office. He has a couple of an “amazing” investment opportunities that he wants to talk to you about. Normally GT has a cost of Capital of around 10%. You normally only evaluate your investment opportunities over a five-year period and will do the same here.

Investment: NorCana Mine

GT has been offered the first rights to acquire an open-pit copper mine in Northern British Columbia, known as the NorCana Mining Project (“NorCana”). NorCana requires the investor to invest 22 million dollars upfront to get the mine ready for production. It will take a year for the mine to become operational, and there will be no revenue until year 1 is done. From year 3 to 5, there will be a requirement to invest 2.0 million dollars every year to maintain equipment.   The mine is estimated to produce 15,000 tonnes of grade copper ore. Copper ore needs to be processed down, for each ton of production, you can typically expect to get 200 ounces of pure copper. Our projections are that the price of copper will be at $3.0 per ounce on the open market. At the end of 5 years, we will sell old equipment we no longer need to excavate the mine for $1.0M.

Investment: YuDiamond Mine

YuDiamond Mine is located in the Yukon and is an operating mine. The owners are looking to exit and will redeploy their capital after the sale. Cost of the shares will be $15M upfront, and an “earnout”. The earnout will pay an additional 3.0M dollars for the shares at the end of 5 years, depending on whether the mine meets its production capacity (assume that it will). The mine produces 5,000 tonnes per year, and there are 0.5 diamond carats generated per ton. Typically, the price of this kind of diamond will fetch $2,000 per Carat.   There will also be a remediation cost on the mine at the end of 5 years for $3.0M

Requirement:

1. Prepare an NPV Analysis for each investment opportunity

Prepare a PI and Payback Analysis, and then make a recommendation to Manny on which option is the more financially-sound investment.

Question 2(a):

A while later Manny comes into your office with another proposal that came past his desk. As part of GT’s mining operations, GT produces its own mine excavator tracks. A Japanese consortium, KoBI Engineering, has approached GT to produce the excavator tracks for GT.

You pull out your general ledger report, and you review the expenses for tracks last year. GT will typically produce its 90 excavator tracks, with a cost to the end of last year as follows:

Direct Materials:   $175,000

Labour for employees working directly on the tracks: $300,000

Overhead for Factory workshop:

Annual Rent: $100,000

Annual Depreciation on factory machinery: $12,000

Factory Machine parts: $50,000

Factory Utilities: $30,000

Kobi has offered to sell GT the excavator tracks at $6,100/ unit.

The workshop is used for a number of functions outside of the manufacturing of tracks.

Requirement:

Undertake an analysis of the above costs and advise Manny on which option should be taken from a purely financial perspective .

Question 2(b):

GT has three products that it sells: Copper, Bauxite, and Gravel. Results of the fourth quarter are presented below:

                                                               Copper            Bauxite             Gravel               Total

Tonnage Sold                                10,000             20,000             20,000                       

Revenue                               $22,000,000    $40,000,000    $23,000,000    $85,000,000

Variable costs                         17,000,000      22,000,000      12,000,000      51,000,000

Direct fixed costs                      1,000,000        3,000,000        2,000,000        6,000,000

Allocated fixed costs                8,000,000        8,000,000        8,000,000    24,000,000

Net income (loss)                 $ (4,000,000) $ 7,000,000    $ 1,000,000    $ 4,000,000

The allocated fixed costs are unavoidable. Demand of individual products is not affected by changes in other product lines.

Requirement

Do a financial analysis of what will happen to profits if GT sells the copper division?

Question 2(c):

Use the financial information provided to you in part 2(b). Please do a break-even analysis on each product to confirm the level of production needed for each product line.

Answer 1

Answet to 2b:

Answer to 2(a):
Make or Buy Decision
Calculation of Cost of Manufacturing Excavator
Particulars	Amount
Direct Materials	$1,75,000
Labour	$3,00,000
Overheads:
Annual Rent	$1,00,000
Annual Depreciation	$12,000
Factory Machine Parts	$50,000
Factory Utilities	$30,000
Cost of Manufacturing Excavators	$6,67,000
No of Excavators	$90
Cost Per Unit	$7,411
Purchase Cost From Kobi	$6,100
From Financial perspective Purchasing from Kobi Excavators is better as Cost is less.
Answer to 2(b):
Overall Net Profit/(Loss)	$40,00,000
If Copper Division is Sold then Overall Profit / (Loss)
Total Revenue	$6,30,00,000
Less: Variable Costs	$3,40,00,000
Less: Direct Fixed Costs	$50,00,000
Less: Allocated Fixed Costs Unavoidable	$2,40,00,000
Overall Net Profit/(Loss)	$0
So, if Copper Division is Sold then Overall Profit will be 0 So it is not advisable to Sell Copper Division
Answer to 2©:
Break Even Points
	Copper	Bauxite	Gravel
Revenue	$2,20,00,000	$4,00,00,000	$2,30,00,000
Less: Variable Costs	$1,70,00,000	$2,20,00,000	$1,20,00,000
Contribution	$50,00,000	$1,80,00,000	$1,10,00,000
Contribution %	22.73	45.00	47.83
Fixed Costs:
Direct	$10,00,000	$30,00,000	$20,00,000
Allocated	$80,00,000	$80,00,000	$80,00,000
Total	$90,00,000	$1,10,00,000	$1,00,00,000
Break Even Point	$3,96,00,000	$2,44,44,444	$2,09,09,091
(Fixed Cost/Contribution %)