THE ANTAMINA COPPER-ZINC PROJECT: POLITICAL RISK INSURANCE

Course Name: Corporate Capital Budgeting

Course Code: FIN-5105

Submitted To:

Mokta Rani Sarker

Assistant Professor
Department of Finance
Jagannath University

Submitted By:

Group No-10,7th Batch

MBA 1st Year, 1st Semester
Department of Finance
Jagannath University

Date of Submission: January 31, 2018

THE ANTAMINA COPPER-ZINC PROJECT:
POLITICAL RISK INSURANCE

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 Group Profile

SL. No Name ID

01 Muhammad Shahid Ullah B 120203057

02 Md. Nazmul Hasan B 120203098

03 MD. Jasim Uddin B 120203111

04 Abir Ahmed B 120203113

05 Pronoy Kumar Mondol B 120203115

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 Contents
Introduction .................................................................................................................................................. 4
Case Summary............................................................................................................................................... 4
Project at a glance......................................................................................................................................... 5
Problem Statement ....................................................................................................................................... 5
Economy Analysis ......................................................................................................................................... 5
Changes in the Gross Domestic Product (GDP) ........................................................................................ 6
Interest Rates ............................................................................................................................................ 6
Corporate Profits....................................................................................................................................... 6
Balance of Trade ....................................................................................................................................... 6
Industry Analysis Using Porter’s Five Forces Model ................................................................................... 6
Threat of New Entrants –LOW .................................................................................................................. 6
Bargaining power of suppliers-HIGH......................................................................................................... 7
Bargaining power of customers-MEDIUM ................................................................................................ 7
Threat of substitutes-LOW ........................................................................................................................ 7
Industry Rivalry-MODERATE ..................................................................................................................... 7
SWOT Analysis .............................................................................................................................................. 7
Strength: ................................................................................................................................................... 7
Weakness .................................................................................................................................................. 8
Opportunities ............................................................................................................................................ 9
Threats: ................................................................................................................................................... 10
PEST Analysis .............................................................................................................................................. 10
POLITICAL: ............................................................................................................................................... 11
ECONOMICAL: ......................................................................................................................................... 11
SOCIO-CULTURAL: ................................................................................................................................... 12
TECHNOLOGICAL: .................................................................................................................................... 12
Project analysis and Decision making........................................................................................................ 12
Conclusion .................................................................................................................................................. 18

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Introduction
Compañía Minera Antamina S.A. Thus, following a process of exploration and construction of
the mining complex, it started their trial operations on May 28, 2001. On October 1st, 2002, it
began to commercially produce copper and zinc concentrates and other by-products.

Compania Minera Antamina S.A was eastblished as the commercial entity to undertake the
exploration and development of the Anatmina site in north central Peru. Currently CMA is
ownded by three major Canadian mining companies: Noranda Inc, Rio Algom limited, Teck
Corporation. The ownership structure is respectively 37.5%, 37.55% and 25%. At Antamina
produce different mineral concentrates primarily copper and zinc, in addition to molybdenum,
silver and lead which are obtained as a by-product of the production process.

To Antamina, the most precious resource is the employees, those who make the Antamina one of
the ten largest mining companies in the world family. It develops good labor practices that
provide all employees a privileged environment for optimal performance professional and
personal development.

Case Summary
Antamina Copper-Zinc project case is about to take decision about the capital investment
decision in the project and the decision about the best sources of debt financing. The project
capital expenditure is $2.3 billion and working capital needed is $200 million. Of the capital
requirement, $1 billion will be financed through issuing equity and rest 1.3 million will be
financed through issuing senior debt. For senior debt, about $600 million will be financed
through commercial banks at 8% interest rate that will be secured by political risk insurance and
political risk insurance premium will be 1.5%. And the rest $700 million unsecured senior debt,
there are two alternatives. In the first alternative the debt will be financed through commercial
bank at 9.6% interest rate and for second alternative the debt will be financed though financial
institutions that support the foreign trade investing in developed and developing countries and
their estimated interest rate will be 9.4%. The equity will be financed through the three
sponsoring companies of Canada such as Noranda, Rio Algom, and Tec weighted 37.5%, 37.5%
and 22% respectively.

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Project at a glance

Project’s Name: The Antamina Copper-Zinc

Owner of the Company: Noranda, Rio Algom, Tec
Location: North Central Peru.
Estimated Fixed Cost: US$2.3 Billion
Duration of the Project: Not fixed but assumed it would last at least 20 years.
Cost of Equity: 12.12%
Cost of Debt: 9.40%
Tax Rate: 36%
Weighted Average Cost of Capital: 8.67%

Problem Statement
The main problem of this case was the taking decision of capital expenditure in Antamina
Copper-Zinc project in Peru jointly invested by three Canadian companies and selection of best
alternative sources of debt financing which will provide best return.

Economy Analysis
Peru has dual economy. In general the economic outlook for Peru is positive weakly. Peru is a
highly dollarized economy with two-thirds of its loan and deposits denominated in dollars, the
risks of hyperinflation and devaluation are relatively low. There are some important relatively
modern sector on the coasts and a subsistence sector in the mountains of central Peru.

 Services account for about 45% of GDP

 Industry accounts for about 33%
 Agriculture for about 12%
 GDP is very important in any economy. Given the GDP in 1987 to 1997, so we can find
the percentage changing on GDP.

Year 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
GDP 4350 3970 3505 3377 3475 3414 3633 4108 4410 4514 4827
% 8% -9% -12% -4% 3% -2% 6% 13% 7% 2% 7%
Changes
Averag 2%
e

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Market return has been assumed 10.9% of last 10 year average market returns. Although the 3
years average return is more than 20 percent, we have used 10 years average return from 1988 to
1998.

We will discuss some macroeconomic indicators which show us the real condition of Peru
Economy in 1987 to 1997.

Changes in the Gross Domestic Product (GDP)

GDP is typically considered by economists to be the most important measure of the economy’s
current health. When GDP increases, it’s a sign the economy is strong. In fact, businesses will
adjust their expenditures on inventory, payroll, and other investments based on GDP output. This
company GDP is highly volatile. The average GDP is 2% over the market in 1987 to 1997.

Interest Rates
Interest rates are another important lagging indicator of economic growth. These rates change as
a result of economic and market events. The Canadian required rate of return 12.12% and
including the country risk premium 0.83%.

Corporate Profits
Strong corporate profits are correlated with a rise in GDP because they reflect an increase in
sales and therefore encourage job growth. They also increase stock market performance as
investors look for places to invest income. That said, growth in profits does not always reflect a
healthy economy.

Balance of Trade
The balance of trade is the net difference between the value of exports and imports and shows
whether there is a trade surplus (more money coming into the country) or a trade deficit (more
money going out of the country). The Peru company export is higher than import. The last export
percentage change is 15%. On the other hand import is 8% changes.

Industry Analysis Using Porter’s Five Forces Model

The following section will analyze the Porter’s Five Forces Model of The Compania Minera
Antamina S.A.

Threat of New Entrants –LOW

 High cost of financing a barrier to new entrants.
 The gestation period is also high and hence it will deter new players from entering this
industry.
 Exploration and building of mines requires large amounts of capital.

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  Due to dearth of natural resources there is very limited capacity and supply available in
the market, which restricts any new entrants in the market.

Bargaining power of suppliers-HIGH

 Compañía Minera Antamina S.A. is largely impacted by the bargaining power of
suppliers in labour, materials, energy, shipping, and energy costs.
 As the company ensures reduced capacity through enhanced operations, the overall
costs from suppliers have increased as well.
 In the above-mentioned categories, there are negligible substitutes available, which
enhance the strong bargaining power of suppliers.

Bargaining power of customers-MEDIUM

 Being a commodity, the bargaining power of customers does exist, as prices are
determined by demand and supply
 Also, given the number of players in the industry and also the fact that there is little
product differentiation among companies, buyers enjoy bargaining power as they will
prefer the company which offers the best rate

Threat of substitutes-LOW

 All of these metals have unique physical properties which suit certain application more
than other substitutes.
 Although research to develop alternatives which are cheaper has been underway for some
time, till now there is no major threat to the usage of these metals.
 However, substituting one metal with another is quiet common. For example, a lot of
industries today have started using aluminums instead of steel as it is cheaper and lighter

Industry Rivalry-MODERATE
 The competition is primarily on price and quality as differentiation is difficult, being a
commodity

 The more reserves the company has the more power they hold

SWOT Analysis
SWOT Analysis of The Antamina copper zinc Project

Strength:
1) Lowest production cost: The operating cost per pound of copper was projected to be about
US$0.35. It was the lowest cost among copper and zinc producers in the world.

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2) Relatively low inflation: Since Peru is a highly dollarized economy with two thirds of its and
deposits in dollar and the risks of hyperinflation and devaluation is relatively low.

3) Able to reduce project development risk: If the company unable to manage adequate fund
for developing the site they can return the rights to the site to the Peruvian government.

4) Net international reserves at the central bank: Since Peru was the leading economy that
period and it has adequate net international reserve at central bank to meet up the any hamper
from the running project.

5) No International trade barriers for international trade: A currency board has been formed
to stabilize the exchange rate or value of the currency.

6) High credit rating (BBB by S&P): All the sponsoring companies are rating “BBB” by S&P
is a good sign for the betterment of the project.

7) Intelligence in corporate social responsibility: To minimize different risks of the project it

was promising to make significant investments in the country like providing jib, contribute to
solid infrastructure and regular tax revenue.

8) Loan providers can adopt PRI to recover default loan if occurred: The total risk derived
from long term financing by commercial banks can partially remove by adopting PRI.PRI would
protect the banks in case of default loan by CMA.

Weakness
1) Unable to fully finance without the support of sponsors ownership: If sponsoring director
didn’t guarantee the specific portion of the financed amount it would require loan at higher rate
of interest.

2) Poor public policy: Sometimes poor public policy creates conflict among external and
internal drivers.

3) Face currency crisis for weak institutional framework: sometimes weak institutional
frameworks and regulations causes financial crisis.

4) Agency problems: sometimes conflict has arisen because the companies pay more the
financial analyst than general employee.

5) Commercial risks can’t be insured: commercial risks can’t be insured by PRI policy.

6) Declining demand from some countries: Due to slumping auto sales and declining
construction as well as oversupply in Japan and Asian countries demand for copper and zinc is
declined for some years and it was causes to revise their copper price.

7) After the completion of the project it is very costly to re-explore the site: If the company
wants to reuse the site after first session it is very costly to develop the site for another use.

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8) Higher capital cost because of having beside a natural heritage site: For the betterment of
a world heritage site situated near the project to use a pipe line around the environmentally
sensitive area causes extra cost.

9) International agency demand higher interest rate for taking extra risk: In case of
international financing it is required more interest than commercial banks loan.

Opportunities
1) Available alternatives for financing: There are two alternatives way to finance for the
project one is sponsoring director and senior debt which is secured by projected cash flow and
companies assets at existing market determined rate.

2) Political risk can remove by purchasing PRI: Political riots create diversified problems
which are removed by PRI policy.

3) Effective interaction among external and internal drivers: The company has a good
relationship with local government, host country government and legislative authority to run the
project.

4) Influential marketing channel: now we live in the era of globalization. All types of sales
promoting activities are performed by internet based advertisement.

5) Proper balance between export and import: It provides half of the country’s export
earnings. Recent foreign trade policy is the positive instigator for increasing export earnings.

6) Contribute greatly to GDP: It contributed 33% of the country’s total GDP.

7) Sponsoring partners are experienced in mining business: All of the three companies
Noranda Inc , Rio Algom and Tech corporation have extensive experience and interest in
developing major international projects and expertise in the Zink and copper markets.

8) Government takes the responsibility to develop the site after completion of the project
for re-use

9) Favorable working environment for employees: All sorts of modern facilities are available
for the employee who was working this project.

11) All technologies are proven: All technologies are used for mining is proven in such a way
that there is no problem will be arise during operation.

12) One of the largest mines in the world: It was the seven largest copper mine and second
zinc mine in the world.

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13) Lower tax rate: Peru has only 36% corporate tax. It is obviously a great opportunity for the
project.

14) Helped government: CMA helped government by providing foreign currency and
technological facility and tax regime.

15) Adequate cash flow to repayment senior debt: The projected revenue would be enough to
cover the senior debt by CMA.

Threats:
1) Highly volatile copper and zinc market: As a newly developed economy Peru has more
experienced about political turmoil and as a result the market frequently volatile and faced
business risks. This risk has direct impact on the value of the sponsors stake and interest rate on
the required loan.

2) Environmental risk: The original plan required transporting the concentrate the through a
UNESCO designated natural world heritage site and environmental organization had expressed
concern about this project. It caused to use a pipeline and increased capital costs.

3) Emerging economy: As Peru is an emerging economy and there is a question of

governmental agreements and the stability of its regulations. Also World Bank environmental
standards.

4) Long life projection is impossible: The main threat for the project that forecasting
commodity price at a certain level is always challenging.

PEST Analysis

PEST Analysis of The Antamina Copper-Zinc Project: Political Risk Insurance

PEST analysis is a widely used tool to analyze the Political, Economic, Socio-cultural &
Technological which can provide great and new opportunities to the finance committee of
Compania Minera Antamina as well as these factors can also threat for Compania Minera
Antamina, to be dangerous in future.
PEST analysis is very important and informative. It is used for the purpose of identifying
business opportunities and advance threat warning. Moreover, it also helps to the extent to which
change is useful for Compania Minera Antamina and also guides the direction for the change. In
addition, it also helps to avoid activities and actions that will be harmful for Compania Minera
Antamina in future, including projects and strategies.

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PEST FACTORS:

POLITICAL:

 Maoist and Marxist terrorist groups were rampant, killing thousands of people and
disrupting the bombing infrastructure
 During military dictatorship nationalized many foreign-owned mining and energy
companies
 Economic mismanagement led to hyperinflation and widespread strikes
 People are concerned about the loss of jobs and national control of natural resources
resulting for privatization

ECONOMICAL:

 Dual economy
 With cost advantage, Site development, construction, infrastructure, transport & shipping
cost are lowest
 Project financing loan is more restrictive and higher interest rate
 Mining is especially important for the balance of payments because it provides almost
half of the country’s export earnings
 Increasing foreign trade especially exports
 Restriction on capital flows have been removed
 A currency board has been imposed to stabilize the value of the currency and agreement
were signed with IMF
 Risk of hyperinflation and devaluation are relatively low
 One of the most liberal foreign investment regimes in Latin America
 Slightly lower corporate income taxes
 Credit rating and weak projected future economic performance are still troublesome
 Costs and benefits to the sponsoring companies were very different for each alternative

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SOCIO-CULTURAL:

 CMA was promising to make significant investment in the country and it would provide
jobs, a solid infrastructure and considerable tax revenue
 CMA engaged local community and NGO to understand and address shareholders
concerns

TECHNOLOGICAL:

 Technology to be used in the mine was proven, conventional mining and processing
technologies
 The original plan required transporting the concentrate through UNESCO
 The use of pipeline going around this environmentally sensitive site
 The volatility and uncertainty of future copper and zinc prices
 The reliability of agreements with the government and the stability of its regulations
 The ability to comply with Peruvian and World Bank environmental standards

Project analysis and Decision making

This part will be conducted for taking decision whether the project will be profitable or not and
also decide the sources of financing. Different capital budgeting techniques like Net Present
Value (NPV), Internal Rate of Return (IRR) and Payback Period will be used to take the project
investment decision.

For applying the techniques mentioned above, some assumptions need to be specified and
defined which are discussed below:

Assumptions
Depreciation

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Depreciation has been calculated by using straight line method on 2.1 billion over the 20 year
period. Each year depreciation has been calculated 105 million.

Marginal Tax Rate

As the Antamina Copper-Zinc Project will be operated in Peru, the marginal tax rate of Peru will
be used and it’s also assumed that the tax rate will be 36% for the whole project time.

Risk Free Rate

Current Canadian Risk Free Return (10 Yr.) of 5.30% has been used as risk free rate for
calculating the required return. As the sponsors are of Canada, the Canadian risk free rate has
been used.

Market Return
Market return has been assumed 10.9% of last 10 year average market return. Although the 3
years average return is more than 20 percent, we have used 10 years average return from 1988 to
1998

Weighted Average Beta

As the three Canadian company listed following is investing in Peru. The weighted average beta
has been calculated using beta vs Peruvian market and weights of investment by the companies
which has been used to calculate the required rate of return on equity.

Weighted Average Beta Calculation

Investing Companies of Canada Beta Weight
Noranda Incorp. 0.93 0.375
Rio Algom 1.13 0.375
Teck Corp 1.19 0.25
Weighted Average Beta 1.07

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Cost of Equity

Cost of equity or required rate of return for the project has been calculated by using Capital
Asset Pricing Model (CAPM). For calculating it, country risk premium of 0.83% has been used
to adjust the country risk premium for investing in Peru. The country risk premium has been
calculated by the formula sovereign spread of 10 years average risk free rate multiplied by the
ratio of average beta vs Peruvian market and Canadian market index. The beta has been used as a
proxy of standard deviation of market return.

Cost of Equity Calculation

Canadian Risk Free Return (10 Yr.) 5.30%
Average Canadian Market Return 10.90%
Weighted Average Beta 1.07
Required Return 11.29%
Country Risk Premium 0.83%
Total Required Return 12.12%

Cost of Debt

The finance committee estimated that the debt financing can be obtained from two sources.

For debt financing from commercial bank, the cost has been estimated 9.6% for unsecured
portion and for debt financing secured by Political Risk Insurance the cost of debt will be 8%
and the political insurance premium will be 1.5%.

Weighted Average Cost of Capital (WACC)

Weighted average cost capital is the discount rate used to discount the operating cash flows of
the project to take the decision which is a very crucial factor in capital budgeting technique.

Weighted Average Cost of Capital

Weight of Equity 0.43
Weight of Debt 0.57
Cost of Equity 12.12%
Cost of Debt 9.40%
Tax Rate 36%
WACC 8.67%

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Project Investment Decision

The project investment been taken based on the results obtained from the capital budgeting
techniques which are being discussed below:

Net Present Value (NPV) and Internal Rate of Return (IRR)

It’s a wide spread and most sophisticated method in capital budgeting project analysis. For
calculating the NPV, firstly the operating cash flows has been calculated based on the
information provided in the project paper. Then by discounting the 20 years cash flows, we
calculated the net present value using the WACC. As the project has two alternative sources of
debt financing, we have sown the NPV of the two alternatives.

NPV and IRR for the First Alternative

From the above assumptions, we have calculated the following cash flows where the debt
financing from financial institutions the support the international trade at 9.4% has been
collected. Under this alternative sources, the project has generated positive NPV and IRR is also
higher than the WACC. This indicates the project is profitable.

Year 2001(Jan) 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
OCF -83 266 329 425 459 439 413 361 334 293 201 193 197 196 165 178 176 183 214 58 57
Working Capital -200 200
Capital Investment -2,300
Total Cashflows -2,500 -83 266 329 425 459 439 413 361 334 293 201 193 197 196 165 178 176 183 214 58 257
Discount Period 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21
Discount Factor 1.00 0.92 0.85 0.78 0.72 0.66 0.61 0.56 0.51 0.47 0.44 0.40 0.37 0.34 0.31 0.29 0.26 0.24 0.22 0.21 0.19 0.17
PV of OCF -2,500 -77 225 257 305 303 267 231 186 158 128 81 71 67 61 47 47 43 41 44 11 45
Net Present Value 40
Internal Rate of Return
8.89%

NPV and IRR for Second Alternative

In the second alternative where debt financing has been collected from commercial bank at 9.6%
interest rate. The weighted average cost of capital for this alternative has been 8.74% which was
used to discount the cash flows of the project. By calculating the NPV and IRR, it is observed
that the project generates positive NPV and the IRR is higher than the WACC which also shows

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the project is profitable but first alternative is the best because that provides the higher NPV and
IRR.

Year 2001(Jan) 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
OCF -83 265 329 424 458 438 412 360 333 292 201 192 196 195 164 178 176 182 213 58 56
Working Capital -200 200
Capital Investment -2,300
Total Cashflows -2,500 -83 265 329 424 458 438 412 360 333 292 201 192 196 195 164 178 176 182 213 58 256
Discount Period 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21
Discount Factor 1 0.92 0.85 0.78 0.72 0.66 0.60 0.56 0.51 0.47 0.43 0.40 0.37 0.34 0.31 0.28 0.26 0.24 0.22 0.20 0.19 0.17
PV of OCF -2,500.00 -77 224 256 303 302 265 229 184 157 126 80 70 66 60 47 46 42 40 43 11 44
Net Present Value 19.89
Internal Rate of Return8.85%

Discounted Payback Period

Payback period is the time required to recover the original investment. It measures the liquidity
of project. The lesser time required to recover the investment, the more liquid the investment is
and less risky.

Payback Period for the First Alternative

Under the first alternative discussed above where debt financing will be collected from financial
institutions that support foreign trade and development between developed and emerging
countries at 9.4% interest rate. Under this alternative the required years to recover initial
investment is almost 20 years that means the initial investment will be recovered at the last year
of the project. It indicates that the investment is less liquid and more risky but profitable.

Discount Total Cash Flows PV of Cash Flows Investment

Period Recovered
0 -2,500 -2,500 -2,500
1 -83 -77 -2,577
2 266 225 -2,351
3 329 257 -2,094
4 425 305 -1,790
5 459 303 -1,487
6 439 267 -1,220
7 413 231 -989
8 361 186 -804
9 334 158 -646
10 293 128 -518

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 11 201 81 -437
12 193 71 -366
13 197 67 -299
14 196 61 -238
15 165 47 -191
16 178 47 -144
17 176 43 -101
18 183 41 -60
19 214 44 -16
20 58 11 -5
21 257 45 40

Payback Period for the Second Alternative

Under the second alternative discussed above where debt financing will be collected from
commercial banks at 9.6% interest rate. Under this alternative the required years to recover initial
investment is also almost 20 years that means the initial investment will be recovered at the last
year of the project. It indicates indicates that the investment is less liquid and more risky but
profitable.

Investment
Years Total Cash flows PV of Cash flows
Recovered
0 -2,500 -2,500.00 -2,500
1 -83 -77 -2,577
2 265 224 -2,353
3 329 256 -2,096
4 424 303 -1,793
5 458 302 -1,492
6 438 265 -1,227
7 412 229 -997
8 360 184 -813
9 333 157 -656
10 292 126 -530
11 201 80 -450
12 192 70 -380
13 196 66 -314
14 195 60 -254
15 164 47 -207
16 178 46 -161
17 176 42 -118
18 182 40 -78

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 19 213 43 -35
20 58 11 -24
21 256 44 20

Decision:

The project under both alternative sources of raising capital provides the positive NPV and IRR
higher than the WACC. First alternative is more profitable where the debt has been assumed to
be financed from the financial institutions which support the foreign trade.

Conclusion
We have discovered a new horizon of knowledge by solving the case where we have applied the
tools and techniques and our gathered knowledge in the practical area. We used capital
budgeting techniques like NPV, IRR, and Payback Period for project investment decision
making. We also calculated the cost of equity and weighted average cost of capital which are a
crucial factor in project analysis. The project report has been completed using our diverse
knowledge and teamwork which has facilitated us to share our ideas and thoughts.

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