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New Earth
The New Earth Mining, Inc. was a large player in the world precious-metal industry, whose main business activities were operating gold mines in North America and making investment projects in gold exploration in other areas such as Australia and Chile. The recent gold price boom allowed the company to accumulate a large amount of access cash, but it also raised the management’s concerns that the gold prices might not be sustainable in the future. In response to this threat, the company decided to implement an operating strategy to diversify its main business through a new investment in iron ore exploration in South Africa. We assess this strategy by conducting a SWOT analysis.
Internal Strengths – The firm’s balance sheet indicated that its cash and marketable securities had been increased from 142 million to 1,732 million during the past 10 years. These cumulative access cash was able to provide support and enough liquidity for the new investment in South Africa.
Internal Weaknesses – South Africa was an untapped marketplace for the New Earth Mining’s management team and broad team. Moreover, the lack of iron ore exploration expertise and the limited resources within the company might become a constraint.
External Opportunities – Since steel was the most widely used metal in the world, its inelastic demand shows that the price of iron was less volatile than the price of gold, which was expected to stay around $80 per metric ton in the near future. The production cost tended to be low due to the high quality of iron ore and the easy access to the ports from the mine location, which reduced the need for infrastructure investment. In addition, South Africa possessed abundant of iron ore reserves and was one of the largest producers of iron ore in the world. Both the global seaborne iron ore trade and steel production were expected to grow quickly in the next decade, especially in the area of China, South Korea, and Japan. Based on its feasibility and profitability, this 15-year new investment project seemed to be attractive, and it was supposed to provide a relatively stable stream of cash flows for the company.
External Threats/Risks – The project also carried a number of risk factors that needed to be considered. First, the political system in South Africa was unstable and corruption was a major concern that would affect mining operations, resulting in unexpected costs. Second, high risk of civil war in surrounding countries was a constant threat. Also, there would be risk of nationalization of natural resource operations in South Africa. In response to these threats, the company has taken appropriate actions against the significant political risk by acquiring insurance of long-term raw materials supply from customers and setting up credit guarantee programs backed by the U.S. government against potential losses.
The revenue components of the project’s cash flow were dependent on both the volumes and market prices of iron ore. The company approached its potential customers by securing large steel producers in China, Japan, and South Korea through contractually obligation to purchase the iron ore, which was an effective way to lock in volumes. Based on the assumption of the U.S. Geological Survey that the iron ore price was expected to maintain at least $80 per metric ton, the current strategy allowed the company to maximize its revenue components of its cash flows. However, if this assumption did not hold and the market price of iron ore fell unexpectedly, the contract would force the company to sell the iron ore to customers even though the market price was below the cost of the iron ore. In this case, the maximization of its revenue components of cash flows cannot be guaranteed.
The company negotiated a financing package with its potential buyers in U.S., Japan, Korea, and China by raising $160 million funds as senior secured debt (10%), senior unsecured debt (7%), and senior subordinated debt (9%), respectively. The company’s customers became its stakeholders and helped to share the operating risk associated with the new business. By securing potential customers, the company was able to lock in their sales volumes of iron ore and thus lower operating costs. In addition, China, Japan, and South Korea governments all agreed to assure long-term supply of raw materials to their domestic steel producers, and they also provided credit guarantee programs that allowed the company to protect itself against the huge political risk associated with the South Africa project. Furthermore, an insurance company backed by the U.S. government guaranteed this new project against potential losses due to civil war and government nationalizing natural resource assets. Therefore, the financing strategy allowed New Earth to reduce its operating risks.
The levered NESA’s cost of capital tended
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By: bpte122
Submitted: June 15, 2016
Essay Length: 1,809 Words / 8 Pages
Paper type: Research Paper Views: 613
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