KTC Mining Inc. has discovered a small copper deposit neighboring its existing silver mine site. It has been estimated that there is a ten-year supply of copper in the deposit that would return $13.5 million annually to KTC. The estimated cost of developing the site is $63.6 million and could be financed by the issuance of shares. The firm has experienced significant growth, and this is reflected in a cost of equity of 21.6%. After analyzing the returns of the project, the firm's CFO, David Lamb, recommends to the board not to continue with it as it is not profitable to the firm. However, in speaking with an investment dealer the following week, David is told that it would be possible to float bonds for up to $42 million carrying a coupon of 12%. The flotation costs for debt and equity are both 1.2% and the marginal tax rate for the firm is 40%. Required: a) Is it profitable for KTC to continue with the project now? Assume both debt and equity flotation costs can be amortized over the life of the project. Show detailed and clear calculations of all components. b) What would be the marginal benefit to KTC if it could obtain a government loan for $42 million at 8.4% that has a balloon payment for the full amount at the end of 10 years. Assume there are no flotation costs for this loan.
KTC Mining Inc. has discovered a small copper deposit neighboring its existing silver mine site. It has been estimated that there is a ten-year supply of copper in the deposit that would return $13.5 million annually to KTC. The estimated cost of developing the site is $63.6 million and could be financed by the issuance of shares. The firm has experienced significant growth, and this is reflected in a
Required:
a) Is it profitable for KTC to continue with the project now? Assume both debt and equity flotation costs can be amortized over the life of the project. Show detailed and clear calculations of all components.
b) What would be the marginal benefit to KTC if it could obtain a government loan for $42 million at 8.4% that has a balloon payment for the full amount at the end of 10 years. Assume there are no flotation costs for this loan.
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