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Masai is a small country with agriculture as its main economic activity. A recent geological survey concluded that there may be a rich deposit of copper available to be mined in the north-east of the country. In a meeting between the Masai government and Shalimas BoD, the Masai government offered Shalima exclusive rights to mine the copper. It is expected that there are enough deposits to last at least 15 years.

Initial estimates suggest that the project will generate free cash flows of RM4 million in the first year, rising by 100% per year in each of the next two years, and then by 15% in each of the two years after that. The free cash flows are then expected to stabilise at the year-five level for the remaining 10 years. The cost of the project, payable at the start, is expected to be RM150 million, comprising machinery, working capital and the mining rights fee payable to the Masai government. None of these costs is expected to be recoverable at the end of the projects 15-year life.

The Masai government has offered Shalima a subsidised loan over 15 years for the full RM150 million at an interest rate of 3% instead of Shalimas normal borrowing rate of 7%. The interest payable is allowable for taxation purposes. It can be assumed that Shalimas business risk is not expected to change as a result of undertaking the Masai project.

Other Information Shalimas closest competitor is Almas Berhad, a listed company which mines metals worldwide. Shalimas directors are of the opinion that after listing Shalimas cost of capital should be based on Almas ungeared cost of equity. Almas cost of capital is estimated at 9.4%, and its pre-tax cost of debt is estimated at 4.76%. These costs are based on a capital structure comprising of 200 million shares, trading at RM7 each, and RM1,700 million 5% irredeemable bonds, trading at RM105 per RM100. Both Almas and Shalima pay tax at an annual rate of 25% on their taxable profits.

It can be assumed that all cash flows will be in RM instead of the Masai currency and therefore Shalima does not have to take account of any foreign exchange exposure from this venture.

Question :

1. What is the adjusted present value (APV) of undertaking the Masai project?

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