Southport Minerals Essay Example

the info provided by the case). The first step Southport took was to form a new subsidiary called Southport Indonesia Inc.

This means that SI is a separate entity than Southport, and they would not be responsible for its debt obligations. SI began to contract the output of the mine to Japanese and German smelters. 2/3’s of the mine output would be contracted to the Japanese smelters, and 1/3 to the German smelter. The Japanese deal would allow a consortium of smelters to invest $20 million in subordinated debt to SI at an interest rate of 7%. The principal would be amortized over 6 years and payable in chunks of 3. 3 million. This debt was “junior debt” meaning they were last in line to receive repayments before senior debt obligations are claimed.

Having several smelters contribute to the loan will lower the risk of the Japanese invested capital. This loan would be guaranteed by the Export-Import Bank of Japan. The German smelter had induced a German bank to lend SI $22 million of senior debt at 7% interest. This loan would be repayable between 1974 and 1982 in escalating installments and was guaranteed by the Federal Republic of Germany. Total foreign investment is $42 million. A group of U. S. banks had agreed to give SI $18 million repayable between 1974 and 1976 with an interest rate a ? % over the prime rate.

This was a senior loan and was guaranteed by the Export-Import bank of the U. S. They made this guarantee because SI agreed to purchase $18 million of U. S. manufactured equipment, a you scratch my back

I’ll scratch yours kind of deal. Offering the biggest investment was a group of U. S. insurance companies which agreed to lend $40 million repayable between 1975 and 1982 at 9. 25% interest. A guarantee was supplied by the Overseas Private Investment Corp. , an agency of the U. S. Government, this guarantee would cost 1. 75% per year, which would raise the interest rate of the loan to 11% all together.

This guarantee was a result yet again of SI agree to purchase $40 million of U. S. manufactured equipment. The remaining $20 million would be provided by Southport minerals in the form of an equity investment. The overseas private Investment Corp. had guaranteed Southport’s investment against loss due to war, expropriation, and currency inconvertibility. To protect Southport if costs exceeded the required $120 million, capital infusions would occur on a pro-rata basis of all investors up to $144 million, a 20% increase from $120 million. . According to the info provided by Exhibits 5 and 7, prepare a consolidated pro forma balance sheet, correspondent debt and equity ratios, and weighted average cost of capital from 1969 to 1985, assume 40% income tax rate. (For the consolidated pro forma balance sheet, the items in Assets could be Net Working Capital and Plant and Equipment; while in Claims are Debt (or different debt items) and Equity. ) 4. Which method of analyzing the value of the Firstburg investment proposal to Southport Minerals is most reasonable? Why?

Why are the other three methods less reasonable? Present your reasoning in detail. Approach 4 seems most reasonable to me as the actual investment of Southport minerals

is only $20 million, not $120 million with NWC. Making the subsidiary will have SI’s debt obligations not liable to Southport Minerals and only to SI, this is yet another reason why the dividend approach is most reasonable. The financing architecture has made contracts with foreign investors who are providing capital to the firm in lieu of loan guarantees that will lower the cost of borrowing for SI.

The entire purpose of this venture is to provide diversification and value to Southport Minerals, not run a separate entity known as Southport Indonesia and retain all the earnings in that country to expand, the entire project needs to benefit solely Southport. The other approaches in discounting the project don’t take this into consideration. Approach 1 ignores the clever financing architecture of SI and the fact that cash flows to Southport can only happen if SI prepays that same amount in debt.

The relevant cash flows in this model are flawed because it takes into account cash flows made at Southport Indonesia and not Southport Minerals, the cash flows remaining in Indonesia create no value for Southport Minerals and really shouldn’t be used in assessing the project. Approach 2 uses the same logic as 1 except hikes the discount rate up to 20% to add some risk to the picture. It may be true that the WACC in most years is 20% due to the capital structure being all equity, however it doesn’t take into consideration the clever debt arrangements and the dividends paid to Southport Minerals.

Approach 3 is better than 1 and 2, as it does take into consideration Southport Indonesia’s clever

financing structure. However, for the majority of the years the project will be 100% equity using the dividend cash flow statement. This will raise the WACC as the later years of the project will use no debt and be all equity, the WACC will be too low if 7. 6% is used to discount all cash flows. 5. How did the specific financing choice available to Southport Minerals alter both the risk and return potential of the Firstburg investment proposal? How effective was it in dealing with the project’s risks?

Having three different countries invest money into the project protected SI against expropriation against the Indonesian government. If they had expropriated them they would have caused several disruptions in their investments and possible legal and economic penalties would have resulted. This clever financing made the riskiness of this venture much lower had Southport only gone with U. S. investments as they successfully diversified its capital investment across three different nations. The loans by foreign governments also carry a lower interest rate than the U. S. oans, so this in itself will make the return on equity invested much higher had Southport gone with all U. S. financing. The $40 million insurance company loan is costing them 11% pre-tax, compared to 7% interest on Japanese debt, and 7% on German debt. 6. What are the key risks associated with this project? What year was Southport most vulnerable? The main key risk to this project is expropriation by the Indonesian government. Southport has had a similar experience in 1960 in Cuba, where a large mine was taken over by the Castro government and Southport had to

write off its $19 million equity investment. 979 poses as a vulnerable year because all debtors have been paid off by SI, the foreign countries no longer have an investment in the firm which would make it easier for Indonesia to take over the mine and continue to sell them ore after expropriating Southport.

7. If you were trying to negotiate an improvement in the terms of the Firstburg financing proposals, in which of the following areas would you concentrate your efforts, and why would you concentrate them there? 1) interest rates; (2) debt maturities; (3) allowable dividends; (4) price terms. The thing I would most likely want to improve upon is the fact that dividends paid to Southport can only be paid if a matching prepayment to debt is made. Obviously Southport is going to want to maximize cash flows of dividends as early as possible since this will yield a higher NPV. However the earlier the principal of the debts are wiped off the books the earlier the investment becomes all equity which heightens the risk of expropriation.

If these terms were more flexible than I think it would be a beneficial thing to Southport. 8. Should Southport Minerals make the investment? Using approach 4 as I recommended the NPV assuming a price of copper of 40 cents a pound and a cost of capital of 20% will be $10 million. Although I would argue that the WACC should be lower around 15% as my analysis gave me an average WACC considering every year of the project at 14. 2%. This further reinstates that the project should be accepted.