Reference no: EM132828577

Congratulations, you've been hired by one of the world's largest gold mining companies, Barrick Gold! They want you to evaluate capital budgeting. Their biggest planned project for 2021 is to introduce a new generation of power-operated mining and excavating machinery at all their Canadian mines. While the overall figures look rosy, your predecessor obstinately refused to authorize the project, and was heard muttering something about "NWC breaking the camel's back" just before resigning. Your mission is to re-assess the project, as the company's overall cost of capital just fell from 8% to 7%.

While Barrick is listed on TSX, you are based in New York City and serve a U.S. based board. You decide to follow its quotation and financial statements on NYSE-Nasdaq for the project and operate in US dollars. Capital expenditures for the new machinery will amount to $1.5B. The R&D expense required to put the equipment into successful production will be $500M (both to be incurred this year, 2021). This generation of equipment is expected to last for 5 years, and will be sold for use by another company with a net salvage value of $500M at the end of the 6th year (i.e. 2027). First-year incremental revenues associated with the use of this equipment are estimated at $2.0B (those will take place in 2022). Thereafter they are expected to grow 25% in the 2nd year, another 20% in the 3rd, another 10% in the 4th, and decline 10% in the 5th. The board assures you that the operating costs and the net working capital requirements for this upgrade are similar to company-wide figures.

a) Obtain Barrick's financial statements (look under ticker symbol GOLD on Yahoo Finance, for example - finance.yahoo.com, search for GOLD, click 'Financials'). Make sure to get the balance sheet and the income statement for the year 2020.

b) Compute the free cash flows for all the years of the project (Hint: 0 to 6) based on Eq. 9.8 and the financial statements information. Pay attention to signs of all the flows. Assume that the project's profitability will be similar to Barrick's existing projects in 2020 and estimate costs for each year by using the 2020 ratio of non-depreciation costs to revenue (i.e. (Cost of Revenue + Operating Expense) / Total Revenue). Find the CCA rate applicable to Barrick's project and set up the CCA flows, keeping in mind the half-year rule (the equipment will be paid for at the end of 2021, but will start depreciating in 2022). Determine Barrick's tax rate and use it correctly. Determine Barrick's incremental NWC requirements for each year arising from the project (use 2020 working capital to sales ratio to estimate the required percentage), then apply the change in NWC required each year. (Hint: make sure to account for the huge final NWC entry in year 6, and also do not forget the salvage value!)

c) Determine the IRR of the project and its NPV given the cost of capital above. Will you authorize the project? Was your predecessor right or wrong?