New Earth Mining

In: Business and Management

Submitted By nazy87
Words 1382
Pages 6
702596
Valuation 1
Ever since the seminal contribution of Modigliani and Miller (1958), a key result of corporate finance theory is that a project's cash flows should be discounted at a rate that reflects the project's risk characteristics. Discounting cash flows at the firm's weighted average cost of capital (WACC) is therefore inappropriate if the project differs in terms of its riskiness from the rest of the firm's assets. (Kruger, Landier &Thesmar 2011) According to Modigliani and Miller when discounting a projects cash flows, the projects risks must be adequately reflected, in the case of New Earth Mining, the riskiness of the project is not adequately reflected. New Earth is traditionally a mining company who is traditionally a precious metal mining company; the proposed project is intended to diversify New Earth’s business operations. New Earth Mining’s operations have traditionally been central to the United States of America, and denominated in USD. The new venture is in South Africa, a completely different terrain, a different governing body, a different set of legal restraints, risk of mining a different commodity as well as a different currency namely ZAR.(West 2012) A company using a single firm-wide WACC would tend to overestimate the NPV of a project whenever the project is riskier than the typical project of the company.(Kruger, Landier &Thesmar 2011) As Kruger, Landier and Thesmar have highlighted, the proposed NPV of $83 million could potentially be overestimated.

Valuation 2

The Accounting Officers proposal of taking into consideration the higher risk associated with the project to be undertaken by New Earth Mining is beneficial to the company for a number of reasons, namely precautions can be observed at every stage of operation (reference). This will as well take on board the market and systematic risks prevalent in the country.…...

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