Lecture Objectives and Expected

Outcome
The objectives of this lecture are:
• To discuss the main sources of financing mineral projects.

• To show how to determine the cost of capital in relation to the

sources of funding.

• To outline how to determine the optimum capital structure for a

mineral project.

At the end of this lecture, the student is expected to:

• Know the main sources of financing a mineral project.

• Be able to determine the cost of capital for a project.

• Be able to determine an optimal capital structure for a mineral

project.

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Lecture 5: Financial Analysis Slide 1
 Sources of Funding
The following are the main sources of financing a mineral project:

Equity refers to the money invested in a project by owners of the

project. Equity capital is normally obtainable from the individual
directors of the company or through the issue of common and
preferred stocks. Therefore, equity is often referred to as the
ownership interest of common and preferred stocks.

Loan refers to debt capital reflecting the legal requirements that

almost all borrowings have to be repaid by fixed dates. Loan
capital is obtained from banks, financial institutions or corporate
companies.

The following terminologies are defined for clarification:

Common stock; Preferred stock; Funded debt.
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Lecture 5: Financial Analysis Slide 2
 Cost of Capital
(1) Specific Costs: General Case:
where,
C C2 Cn
I0  1   ...  I0 = net proceeds received at time zero
1  k  1  k 2 1  k n Cj = cash outflow in the ith period
k = cost of this specific source of financing

(2) Cost of Debt:

where
t = marginal tax rate
kd = (1– t)k k = cost of borrowed money
(original interest rate)
(3) Cost of Preferred Stock:
where
D
kp  D = Annual dividend paid
I0 = Net proceeds per share for a
I0 new stock
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Lecture 5: Financial Analysis Slide 3
 Cost of Capital Cont’d
(4) Cost of Equity
• Dividend Valuation Model


D1 D2 Dn D1
1  k e n 
P0    ...  
1  k e  1  k e 2 i 1 1  k e i

where,
P0 = Value of stock at time zero
Di = dividend payment in the ith year
ke = discount rate applicable to companies in this risk class

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Lecture 5: Financial Analysis Slide 4
 Cost of Capital Cont’d
• Dividend Valuation Model (Cont’d)

Obviously, dividend payments in future periods are unknown at

the present time. Investors have subjective estimates of what
these payments will be, and these estimates are based on the
current dividend and also frequently on the historical long run
growth of dividends. An intuitive expression of these
relationships might be:

where,
D0
ke  g P0 = value of stock at time zero
Do = current dividend
P0 g = annual growth rate of dividend

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Lecture 5: Financial Analysis Slide 5
 Cost of Capital Cont’d
• E/P Ratio of Earnings to Price of Common Stock (P)

E
ke  where E = current earnings of common stock
P P = current price of common stock

(5) Cost of Earnings

Retained earnings are really the shareholder’s assets that

are being reinvested in the firm, so the subsequent return
must at least match that from common funds, ie, cost of
common stock.

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Lecture 5: Financial Analysis Slide 6
 Cost of Capital Cont’d
(6) Cost of Convertible Security

Dt
Pc  
t 1 1  k 
c
t

Since Pc is generally 10% to 20% above the current

market price, kc will be less than ke, which is usually
one of the prime objectives in the issuance of
convertibles.

Do
kc  g
Pc
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Lecture 5: Financial Analysis Slide 7
 Cost of Capital Cont’d
(6) Marginal Weighted Average Cost of Capital
The weighted average cost of capital is expressed on
an after-tax basis, which conforms to analyses utilising
after-tax annual cash flow.

(7) Optimal Capital Structure

Each Company should select its long-term financing in a
manner to provide a minimum overall cost of capital.

The optimum structure is generally considered to be fairly

robust so that modest excursion in either direction will not
create large penalties.
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Lecture 5: Financial Analysis Slide 8