New Earth Mining, Inc. is currently evaluating an investment opportunity in South Africa's iron ore exploration. Even if the project looks promising, the company is cautious of substantial risks. This case study allows students to review the financing strategies, assumptions, and the valuation of this project and whether the project is worth the risk.
William E. Fruhan and Wei Wang
Harvard Business Review (913548-PDF-ENG)
March 11, 2013
Case questions answered:
- What are the economic and financing strategies which enhance the value of the South African Project for New Earth Mining, Inc. beyond its operating characteristic?
- What questions would you have to the financial analyst presenting the forecasted cash flows in Exhibit 3?
- Which method of analyzing the value of the project, including the value of enhancing strategies, is most reasonable? Why?
For valuation approaches 1 and 2 the results are specified in the case. Here is additional information for valuation approaches 3 and 4:
a. For valuation Approach 3, the external consulting firm estimated the cost of capital (WACC) as 9.42% based on the table below. Given this discount rate, the project would have an NPV of $182 million.
b. For valuation Approach 4, the internal analyst estimated NESA’s cost of equity to be 24%. Given this discount rate and the cash flows in Exhibit 7 the project would have an NPV of $ 32.9 million.
- Should New Earth Mining, Inc. make the investment?
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Case answers for New Earth Mining, Inc.
This case solution includes an Excel file with calculations.
South Africa Iron Ore Investment Opportunity for New Earth Mining, Inc.
New Earth Mining, Inc. is currently evaluating an investment opportunity in South Africa’s iron ore exploration. Our team is tasked to review the financing strategies, assumptions, and the valuation of this project.
We recommend New Earth to proceed with the investment as it generates a positive NPV and aligns well with the firm’s long-term operation diversification strategy.
Before delving into specific financial assumptions, we believe New Earth’s economic and financing strategies enhanced the project value beyond its operation in the following ways.
First, New Earth Mining, Inc. was able to secure a few large international steel producers as major customers. By having a tentative long-term supply contract to these customers, the uncertainty from demand fluctuation after 2016 is effectively mitigated.
Also, New Earth obtained credit guarantees to mining operations in less developed countries from China, Japan, and South Korea. This significantly reduces the risk of political uncertainty.
From the financing perspective, $160M out of the $200M funding New Earth needs is tentatively secured with overseas buyers and domestic lenders. Additional $40M funding is pre-negotiated with loan leaders to reduce the risk of cost overrun. Not only this provides a reliable source of funding, but also the tax shield from the debt borrowing would positively influence the project NPV.
Despite New Earth Mining, Inc.’s internal pro forma profitability of this project (Exhibit 3 of Case) showing consistent positive cash flow from 2015, it has several questionable assumptions worthy of further discussion.
Firstly, iron ore pricing is assumed to remain $80/$100 per ton for the entire investment horizon, which is very unlikely, given the…