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This case is a summarized and adapted version of Harvard Business School Case 9-913548, "New Earth Minin, Inc.", 2013, by W.E. Fruhan, and W. Wang.
three loans, totaling $ 160 million. The remaining $ 40 million would be provided as equity by New Earth itself, paid from its cash position. As the revenues from the venture would be in USD, the loans would also be given in USD. The spreadsheet "Debt" shows when the loans would be provided as well as the repayment schedule. The senior secured and unsecured debt would be normal coupon-paying debt, whereas the senior subordinated debt would be a zero-coupon loan, implying that in 2024 both the principal of $ 60 million as well as the accrued interest would be paid. The spreadsheet "Market Rates" shows current interest rates in the U.S. and South Africa, the exchange rate, the iron price, as well as stock market data. New Earth wants to answer the following questions: 1. What is the net present value of the project? (They wonder whether the WACC or the APV methodology is the right approach.) a. Briefly explain why you recommend WACC or APV. b. Calculate the appropriate discount rate. c. Calculate the net present value of the project. d. Calculate the value of the tax shield from the loans. 2. As part of the investment needs to be made early 2014 in ZAR, the company wants to hedge the exchange rate. They wonder whether they should hedge using a forward contract or an option contract. a. At what forward price can they hedge the investment? b. What would be the cost of an at-the-money option? c. Which hedge strategy do you recommend? 3. They also wonder whether they should hedge the ZAR/USD-risk in the cash flows from the venture. If they decide to hedge, should they hedge the entire cash flow or only part of it? And if only partly, which part of the cash flow should they hedge? 4. For the years 2024-2029, what is your estimate of the volatility of the cash flow (in percentage)? (If you cannot answer this, use 35% as an estimate in the next question.) 5. The senior subordinated debt needs to be repaid in 2024 ($ 30 million plus compounded interest). Using the option approach to value debt and equity, what is the value of the subordinated debt at the beginning of 2013 and what is the implied cost of this debt? Hint: note that when repaying the debt in 2024, the venture will last for five more years. It is the present value of these last five cash flows that is the underlying value of the option. You are asked to write a short management report addressing the questions above. Please that the report is clear in itself, but you can add a spreadsheet with more detailed calculations. Note that the spreadsheet contains the option functions =bscall(), =bsput(), = fxcall(), and fxput().