The Antamina Copper-Zinc Project Case Solution
Compania Minera Antamina S.A. (CMA) was looking at a prospective cash cow in the form of The Antamina Copper-Zinc Project. The large site with its high-quality reserve was expected to reduce the operational cost of producing to as low as $0.35 per pound, giving the company a significant competitive advantage. Nonetheless, as is with any good project, there was a need to tread carefully when it comes to financing this project as a shortage of funds would transfer the development rights of the site to the Peruvian Government or levy significant sums as a penalty.
Considering the capital-intensive nature of the project, it is imperative to do a thorough background check. The first red flags are the many terrorist threats (MTRA and Shining Path) in the region and negative economic reports. Though a strong opposition is trying to find solutions to these issues, it may mean the end of the long stable Fujimori’s regime. Moving to the economic state of the country, the liberal outlook to foreign capital is likely to stay with either government. The problem though is with the 36% tax rate that the CMA project is likely to incur. Barring this, the level of risk in Peru as faced by investors seems to be on the decline- a healthy sign for the CMA project. As for the market price of copper, analysts predicted a healthy $0.95 per pound over the life of the project which, considering the low operational costs, can result in strongly positive returns. These returns will into the pockets of three experienced Canadian mining companies, namely, Noranda Inc., Rio Algom Limited and Teck corporation with equity hold of 37.5% for the former two and 25% for the latter.
The open-pit mine came with operational risk. The planned single grinding line was one of the largest ever to build and could incur costs. Also, the transporting of the ore concentrate was a problem since the site was near Huascaran National Park and a UNESCO designated World Heritage Site. A possible solution was for CMA to leverage the large tax revenue, solid infrastructure, and jobs that all stakeholders along with the Peruvian local were expected to gain from this large private project.
Peru Commercial banks were smaller players and could come up with only a small sum of the required $1.3 billion after a pro rata portion funding by the three CMA member companies of 1 billion. For the remaining sum, the international financial institutions could be approached who could lend between $400 million to $800 million at a cost of approx. 8.8%. But international lenders were highly sensitive to the country risk this project posed whether it be the risk of a government takeover of the functional mine or risk from civilians who could stop the ore from being shipped out. Thus political risk insurance (PRI) was required for about 50% of the funds lent and EDA was expected to cover it. This EDA insured loan would carry an interest rate of 8% (with an annual premium rate of about 1.5% on the PRI coverage) while the other half would be at 9.6%. Another source of financing was public financial institutions which to contribute bigger sums of $600- $800 million at 9.4%.
Cost of Equity (CAPM model) = Avg Canadian risk free return (10 yr) + beta * market premium
Ke = 8.5 + 1.07*(10.9-8.5) = 11.068%
Cost of debt = (8.8*(0.8/1.3)+(9.4*(0.5/1.3)) = 9.03%
WACC = (11.068*(1/2.3))+(9.03*(1-.36)*(1.3/2.3)) = 7.116%
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