Question: Scott McCarthy wrote this case solely to provide material for class discussion. The author does not intend to illustrate either effective...

Question:Scott McCarthy wrote this case solely to provide material for class discussion. The author does not intend to illustrate either effective

or ineffective handling of a managerial situation. The author may have disguised certain names and other identifying information to

protect confidentiality

This is by no means my question, it was given in class as a case study and i hope course hero can help me solve it.

THE COMPANY

In 2001, a Queensland company, Zeta Mining (Zeta), was formed with the objective of mining the coal

resources of the Bowen Basin in Central Queensland, Australia. Since then, Zeta had become one of the

world's largest producers of metallurgical coal, operating a number of open-cut mines in the Bowen

Basin. The mines were estimated to produce 6,000 million tonnes of coal over the next 120 years. Used in

the manufacture of steel, the coal that was sold offshore was shipped from the company-owned coal

terminal, which loaded about 450 ships per year for 70 customers in more than 20 countries. The major

export destinations were Japan, South Korea, China and India

The company's investment in the area was estimated at about $8 billion and included machinery

accommodation, high voltage infrastructure, ports, water management, roads and tailings management

One of the most important and expensive pieces of machinery used on the mines were the draglines. In

2012, Zeta used the net present value (NPV) methodology to determine whether to "walk" one of its

draglines to another mine

THE SETTING

Draglines are used to remove the mine overburden, that is, the dirt, rock and other geological waste sitting

on top of the coal. The dragline buckets can hold up to 400 tonnes. The draglines are imported from the

United States, shipped by sea to Mackay or Gladstone. The components are then transported by road to a

specially built pad near the mine to operate the dragline, which is then put together on site. The assembly

can take up to eight months and requires a specialist assembly crew of 40 people. From the time Zeta

decides to purchase a new machine, it can be up to two and a half years unti it is ready to be put to use

The draglines weigh about 3,400 tonnes and have a top speed of just 120 metres per hour. A new dragline

can cost approximately $220 million, including fabrication, transport and assembly

Recently, Zeta needed to decide where the dragline originally intended for the southern pit of the New

Find mine could be situated after a change in the mine plan meant that that pit would not be advancing for another 10 years and the dragline was thus no longer required there. Because this change involved

increasing production in the northern pit, earthmoving and mining equipment had to he relocated there.

To "walk" the dragline the six kilometres to the northern pit, it had to cross two public roads and a

railway line owned and operated by Aurizon (formerly Queensland Rail),2 The trains using the tracks

were electric and were powered through lines running above the trains and parallel with the tracks. The

traffic on the roads could be temporarily controlled and diverted at minimal cost, causing only minimal

inconvenience to public traffic. The rail crossing was much more problematic because Aurizon would

only permit the train line, power lines and all supporting materials (sleepers, rock ballast and

network/communication cabling) to be out of service for 48 hours. Potentially, Zeta would be subject to

significant fines if the track was out of commission for any time above the 48 hours, including any

interference caused by inclement weather

THE DETAILS

As Zeta's project evaluation director for the sector that included the New Find mine, Connor Horwill's

role was to financially analyze the project and to recommend whether Zeta should undertake the task of

moving the dragline. Zeta's policy was to use the NPV model on such large-scale projects and have the

project evaluation director present a recommendation to the chief financial officer (CFO) of the entire

Bowen Basin area. The CFO would then consider the NPV result together with any other relevant factors

and make a final decision about the project.

Horwill had total authority in determining the appropriate cash flows for the NPV model. These were

generated by his team in conjunction with various other departments. He calculated the cost of moving

the dragline, building temporary roads and removing and replacing the railway lines and power at S10

million. The discount rate to be used in the analysis was determined at a higher company level using the

weighted average cost of capital (WACC) model. Like many large corporations, Zeta used a whole

company based WACC plus a premium for country risk. In any case, Horwill was simply given the rate

l comparison analysis by balancing the business case optimized with

f alternatives to moving the dragline. Only two alternatives were

by the CFO to use in all analyses; for this project, it was 9 per cent. Further, Horwill was directed to

consider the project as an incremental comparison analysis by balancing the business case optimized with the investment with the business case optimized without the investment. This approach required Horwill and his team to identify a number of alternatives to moving the dragline. Only two alternatives were considered viable: using the contractor's excavator and truck fleet to strip out the overburden or

purchasing another dragline and assembling it near the northern pit. After further consideration, the new dragline alternative was dismissed because of the significant capital and time required before it

operational. While the contractor model was far more labour intensive, at the appropriate level of staffing it could achieve the same rate of removal of overburden as the dragline. It was estimated for the analysis that all the overburden would be removed after a five-year period. (Coal extraction in the pit could begin about three months after stripping was completed.) The pit would have a useful revenue generating life of approximately 25 years after this five-year period

Contractor stripping was often used when draglines were not feasible because of where the mine was

or specific issues, such as the mine's unstable footings. This approach also had two clear

advantages since Zeta had previously used contractors on other sites: first, their induction costs low: and second, the contractors could be employed without having to go to tender. Horwill's project

evaluation team determined induction expenses Which were tax deductible at the company tax rate of 30

per cent) to be $1 million in Year 1 and a further $250,000 in Years 3 and 5. Using contractors would

allow Zeta to immediately sell the dragline for S19 million with payment received in two instalments of

50 per cent each. The first payment would be received at the end of the first year and the second payment 12 months later. The current book value of the dragline was zero as a result of an attractive depreciation

and investment allowance offered to the mining industry. Any tax payable on disposal of the dragline was to be included in the analysis when the cash was received.

The contractor contract was casual and could be suspended by Zeta at any time. For instance, Zeta might

decide that coal prices or significant exchange rate movements made the mine uneconomical. The cost of employing the contractors comprised three tax deductible parts: an hourly rate per contractor, a flat fee per year and an initial upfront engagement fee. The hourly rate accorded with the contractor's level, whether as labourer or supervisor. (The estimated labour hours required to work at the same rate of

removal as the dragline would cost are shown in Exhibit 1. The rates of pay for labourers are shown in

Exhibit 2, while supervisors cost

total labour cost for the year (excluding the engagement fee) but covered the cost of fuel, maintenance

and other expenses for the contractor. The engagement fee of $750,000, a significant expense for Zeta,

arose because of the casual nature of the contract. The fee was payable immediately, and no part of it was

refundable no matter how long the contract remained in place

an extra S15 per hour.) The flat fee per year was set at 15 per cent of the

The dragline required some modifications owing to the slightly different configuration of the northern pit.

Because this pit shared its eastern border with a major public road. excavation depth on that side was

restricted. This meant that the roads descending into the pit had to be steeper and narrower, requiring

steering and suspension adjustments at an immediate cost of S1.100.000. Ongoing maintenance was

S300,000 per year with an additional major service of $150.000ing required in Year 3. An annual

salary of $260,000 was payable to the dragline operator, while fuel, oil and other running

estimated at $2 million per year. Both these figures were forecast to grow at 10 per cent per year. The

adjustments to the dragline, the ongoing maintenance and major service costs, operator salary, all running

costs and the up-front costs associated with "walking" the dragline were all tax deductible. Horwill

estimated that, during the five-year period to remove the overburden, if the mine was mothballed for any

reason, it could be sold at approximately $4 million less per year off the current sale price. At the end of

the five-year period, the dragline would have just scrap value and hence would not be considered in the

analysis. As a community service, the dragline could be donated to the local council as part of a tourist

attraction to promote the significance of the mines to the local district.

THE DECISION

Horwill was instructed by the CFO to have a recommendation to her within the next month. While she

made it clear that the final decision would take into account various other factors, his recommendation

should be based solely on the NPV analysis.

EXHIBIT 1: CONTRACTOR HOURS PER YEAR

Contractor Year 1 2

Labourer80,000 80,00090,000 90,000 100,000

Supervisor 12,000 12,000 12,000 13,000,15,000

Source: Company estimates

EXHIBIT 2: CONTRACTOR HOURLY RATE

Contractoe

Year 1 - labourer 75

Year 2 labourer 80

Year3- labourer 85

Year4- labourer 90

Year5- labourer 95

Calculate initial cost of investment for both projects