While evaluating the investment's attractiveness, it is critical to include the after-tax cost of the long-term loan that Alamo Gold intends to employ as leverage against the new acquisition. With the present decrease in gold prices, the cost of equity and the weighted cost of capital (WACC) should also be examined. This is based on the background on the influence on the firm's revenues in terms of the tonnage of gold ore that the company will be able to recognize. According to the case study, this is based on the idea that greater output will allow for the recovery of infrastructure costs. The current production capacity of the company stands at 2 tones and by considering the extra annual tone that the new mine will offer, indicates that the investment may be viable. However, as indicated above, the return on investment needs to be considered given that the new mine has a verified tonnage of 12 tones and at the rate of 1 tonnage per year, the mine is only going to remain operational for a maximum of 12 years. As such, by considering the after-tax cost of the debt of 10.5%, which is obtained by 14% *(1-25%), the company evidently benefits in the savings that repayments on the loan generate annually.
In addition, the cost of equity obtained from 7.50% + (1.4*8.80%), stands at 19.82% This represents an expected minimal return on the $30million that is raised towards the acquisition as well as effective operations towards increased productivity by a guaranteed one tonne.despite the 5% annual increase in operating expenses, the company indicates that growth in revenues and thus earnings per share will increase at a higher rate. This is evidenced by the reported after-tax profits fro the year 2019.
Given that Alamo Gold had total debts amounting to $78,455,000, return on invested capital at 10%, net debt to capital ratio of 24%, 6% return on equity, and 15% operating margin for the year 2016, it is expected that the realization of the impact of acquisition of the Yukon Mine will negatively influence the operations of the business. As indicated by the cash flow, the first two years that require a capital injection of $30million will be greatly affected as this costs will all be capitalized. However, the resultant increased revenues and output indicate that this will be effectively recovered after the third year against expected price shifts in the gold market.
Further, the WACC calculated as ($12,000,000/$30,000,000) * 10.50% + ($18,000,000/$30,000,000) * 19.82% indicates that the company must be able to pay back its investors $0.1609 for each extra dollar that the company receives from them. This investment payback should be attained after the $30 million capital outlay from which the annual investment from 2018 to 2028 is $2,500 annually. This is attainable given the projected after-tax profits indicated in the projected cash flow.
In considering the above from the company's forecasted cash flow, The increase in tonnage of gold that the company will produce not only increases their revenues but also increases the different expense allocated to operations and royalties. This is also evident from the discounted cash flow which both indicates that operations and capital injection will be vital for the first two years after acquisition since the discounted cash flows indicate a $5,024.73 after discounting at 0.724. Thereafter, the decreased discounting factors still yield positive returns for both the company and investors.
In considering the bank and investors allocating the required funds, it is important to consider the net present value(NPV), the internal rate of return(IRR) and the present value of cash flows/initial outlay (PI). The NPV for the discounted cash flow stands at$1,775.96 which is obtained at an IRR of 16.09% and further extrapolates to 17.62%. In addition, the PI yields a 1.12 return that is favorable to the bank as well as the investors. In addition, the current capital base that the company has combined with the future cash inflows from the extra tone expected fro the Yukon acquisition provides revenues that are capable of not only ensuring the operations of the company continue but also offer an avenue where the capability of Alamo Gold to settle its debts when they arise is evident. As such, the acquisition is a viable and profitable venture that the organization needs to undertake since it offers the company funds that are able to cover infrastructural costs that translate into increased output. In addition, the market capitalization and total debt to equity of the selected competitor indicate that the company will still be better placed given that the industry's earnings before interest and taxes as well as the operating margin are influenced by a company's level to increase its capitalization. As such, the company will be able to remain a going concern and increase revenues in direct relationship to its capitalization ability.
