Audrey ANG BMF5331 Applied Corporate Finance

Case Assignment 8: Diamond Energy Resources

What is the central problem here?

The central question in this case is if PT Diamond Energy Resources Indonesia should
or should not invest into the expansion of coal mining. This question will be discussed
from the point of view of Mr. Agus Halim, the Chief Executive Officer PT Diamond Energy
Resources Indonesia. Pertinent questions include:

1. What is the resulting Net Present Value, or rather the final Enterprise Value of this
project? (Technical Analysis)

2. Considering decreasing coal prices, should Diamond move forward with this project?

3. And ultimately, will the banker grant the required $12 Million debt financing?

Whilst other periphery questions should also play into Mr. Agus’s corporate decision making
as CEO. Such as is this the right time in industry for expansion and for Diamond to raise
capital? What are the current market and industry risks? How will Diamond’s parent company
take to this project proposal?

Analysis of Valuation methodology:

CAPM – Capital Asset Pricing Model
re = 7.5% + 1.4(8.8%) = 19.82%

Base on the given case date, we can find that the

cost of equity to be 19.82%.

WACC – Weighted Average Cost of Capital

WACC = (56%)(19.82%)+(44%)(14%)(1-25%)

WACC = 0.1110+0.0462 = 15.7%

Taking debt-to-capital ratio to be 44%, Using

2014’s debt-to-capital ratio from Exhibit 2.
Diamond has a healthy debt-to-capital lower than its industry average of 59%. With a
Weighted Average Cost of Capital of 15.7%.

Via a Discount Cash Flow Analysis, then applying Net Present Value analysis; we can
find that the Enterprise Value to be 128 Million with approximately a healthy 40% debt-
to-capital ratio. Indonesian banks have been cutting rates to further stimulate its growing
economy, this makes it an optimal timing to raise debt to take advantage of the low interest
rates. While this puts forth an interesting proposal for the banks, and Diamond does seem to
have a healthy cash flow to service the loan… It begs the question if the Cash Flow
assumptions will be backed by healthy industry growth?

Macroanalysis of Coal industry

Looking at the case’s exhibit 1, coal prices have been dropping. The Indonesian Government
has put in place sanctions in effort to protect coal prices, but this policy has proven to be a
major backlash for smaller mining firms and further squeezing profit margins.

Should the trend of decreasing coal prices persist, Diamond’s Cash Flow will be adversely
affected. It will then prove difficult to service their loans and recoup their capital investments.
As such, we will advice Mr. Augus not move forward with this project.

2
Technical Analysis via Excel
Assumptions Terminal Value Market Value
Tax Rate 25% Perpetural Growth 72,841,908 Market Cap 101,462,000
Discount Rate 16% Plus: Debt 52,766,000
EV/EBITDA 100,163,000
Perpetural Growth Rate 3% Less: Cash 25,690,000
Average 86,502,454
EV/EBITDA Mulltiple 7.0x Enterprise Value 128,538,000

Transaction Date 31/12/2013

Equity Value/Share 101,462.00
Fiscal Year End 30/06/2014
Current Price 101,462.00
Shares Outstanding 1,000
Debt 52,766,000
Cash 25,690,000
Capex + Working Capital Investment 15,000,000

Graph of Cash Flow

Discounted Cash Flow Entry 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 Exit
Date 31/12/2013 30/06/2013 30/06/2014 30/06/2015 30/06/2016 30/06/2017 30/06/2018 30/06/2019 30/06/2020 30/06/2021 30/06/2022 30/06/2023 30/06/2024 30/06/2025 30/06/2025
Time Periods -1 0 1 2 3 4 5 6 7 8 9 10 11
Year Fraction 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00
EBIT 6,272,000 51,095 6,272,000 8,363,000 11,309,000 9,862,000 8,343,000 6,748,000 13,722,000 11,964,000 10,117,000 8,178,000 8,178,000
Less: Cash Taxes 1,568,000 12,774 1,568,000 2,090,750 2,827,250 2,465,500 2,085,750 1,687,000 3,430,500 2,991,000 2,529,250 2,044,500 2,044,500
Plus: D&A 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000
Less: Capex & Working Capital Investment 15,000,000 17,500,000 2,500,000 2,500,000 2,500,000 2,500,000 2,500,000 2,500,000 2,500,000 2,500,000 2,500,000 2,500,000 -
Less: Changes in NWC 375 611 398 511 272 272 272 272 272 272 272 272 272
Unlevered FCF (7,296,375) (14,462,290) 5,203,602 6,771,739 8,981,478 7,896,228 6,756,978 5,560,728 10,791,228 9,472,728 8,087,478 6,633,228 9,133,228
(Entry)/Exit (128,538,000) 86,502,454
Transaction CF 25,690 (7,296,375) (14,462,290) 5,203,602 6,771,739 8,981,478 7,896,228 6,756,978 5,560,728 10,791,228 9,472,728 8,087,478 6,633,228 9,133,228 86,502,454
Transaction CF (128,538,000) (7,296,375) (14,462,290) 5,203,602 6,771,739 8,981,478 7,896,228 6,756,978 5,560,728 10,791,228 9,472,728 8,087,478 6,633,228 9,133,228 86,502,454