Mmcl Would Require Us To Bear The Closure And Reclamation Costs Accounting Essay

Executive Summary

The strategically placed South Face Mine, owned by Mountain Mining Canada Ltd (MMCL) is the subject of the interest of Can-Do to present an offer to purchase the mine. If our company is successful in purchasing it the combination of improved surface logistics and the optimal placement of the new mine could result in the opportunity to save as much as $1.5 million over the course of 20 years. Yet, MMCL has closed the mine and has been investing in the closure and reclamation of the site; certainly, MMCL would prefer to transfer these costs to us.

The aim of this memorandum is to establish the walk-away point which is the maximum amount Can-Do will agree to provide in negotiations with MMCL by making use of the management budget supplied by MMCL and using the model of discounted cash flows, as well as tests of sensitivity on different assumptions.

Given the information contained included in the MMCL management budget, which includes the elimination of costs that cannot be transferable to Can-Do, or that can be internalized 1and taking that the interest rate is 6% for discounting and contingency allowance that is used in MMCL is a figure that implies that the rate for inflation is 2.55 percent.

In a study of different assumptions and assumptions, the sensitivity tests show that the short-term duration variance is the primary risk that is at play since a one-year extension of the short-term cost decreases the value of an acquisition by $6.6 million, from $15.5 million down to $8.9 million (58 percent of the original value). The extension for two years further decreases values by 6.4 million, to $2.5 million (16 percent of value). [2]

The suggested walk-away value is $14 million, which is less than the net value of acquisition calculated in the majority of tests of sensitivity, excluding those that deal with short-term duration and estimates of cost savings. This implies that thorough cost control must be implemented to prevent the expansion of short-term costs as well as a failure to achieve the estimated cost savings.

It is also important to remember that there are significant differences in cost items between budgets for 2005 and 2006. A thorough review of financial information is recommended to identify any potential risks or hidden issues.

Introduction

The purchase of South Face Mine, currently controlled by Mountain Mining Canada Limited (MMCL) could result in the possibility of reducing the operating expenses associated with the North Fork Mine, located near South Face Mine, by the estimated amount of $1.5 million annually over in the coming 20 years. because of the best place for new mines and better logistics.

But, it is anticipated that MMCL will require us to cover the closure and reclamation expenses. Thus, the value from the transaction is the sum of cost savings, minus the additional cost.

In analyzing the data and calculating the net value of the acquisition, we come up with the walk-away point that is vital and vital to our negotiation with MMCL. The other parts of this memo explain how to determine what is referred to as the walk-away point. Particularly, the goal for this research is:

Examine the financial information that is included

Conduct sensitivity tests to test hypotheses regarding the cost of reclamation and closure

Create a sensible walk-away point

Consider other risks that could be a risk for the selection for the walking-away location

Data

Data Source

MMCL has released the management budgets to cover the closure and reclamation costs at South Face Mine. The table below provides a summary of the projected costs for the period from 2006 to the present:

Item

Budget 06 ($’000)

Budget 05 ($’000)

Diff. ($’000)

Diff. (in %)

Direct Cost

6.0) 6. Treatment

3,391

1,583

1,807

114.15%

9.0) Tailing Storage Facility Reclamation

575

345

230

66.67%

11.0) Facilities Demolition

2,821

2,303

517

22.47%

12.0) Facilities/Equipment Disposition , and/or Salvage

218

347

(129)

-37.27%

13.0) The Disposition of Inventory

(5,270)

(5,511)

240

-4.36%

14.0) 1.4.0 Post Closure Monitoring Costs

1,319

320

999

312.03%

Total Direct Cost

3,052

(613)

3,664

-598.21%

Indirect Cost

15.0) Social-economic Costs

19,500

15,500

4,000

25.81%

16.0) Consultant Services

388

225

163

72.22%

18.0) Owners Management (post closing)

4,075

1,600

2,475

154.69%

22.0) Bonding Cost

270

90

180

200.00%

23.0) Contracts/Commitments/Royalties

1,250

705

545

77.30%

24.0) Taxes (Land, Buildings etcaEUR|)

2,700

4,800

(2,100)

-43.75%

30.0) Contingency*

1,760

1,021

739

72.40%

Total Indirect Cost

29,943

23,941

6,002

25.07%

Total Cost

32,994

23,329

9,666

41.43%

* Please note that the value of the above items doesn’t reflect any time value. Instead, an indirect expense “Contingency” implicitly bears the cost.

Table 1: Budget for Management for the Closure/Reclamation Costs from 2006 to the present

There are various kinds of costs, which include those that are short-term and will be incurred in five years, and long-term expenses that will be incurred throughout the entire period of reclamation. Additionally, there are salvage values of any equipment remaining at the site (i.e. Inventory Disposition) which are credited to Can-Do. Additionally, MMCL has included a 15% contingency allowance into its calculation.

In the above table, the table above clearly shows that there are significant discrepancies for many cost items that were included in the budgets in 2006 and 2005 and that is a sign of a lack of contingency allowance for 2005 to compensate for the negative growth of the cost estimates between 2005 and 2006. This raises concerns concerning the accuracy and credibility of the estimates. It is recommended that a comprehensive analysis of financial information and other data regarding the state of the mine uncover any possible issues that could expose our company to risk.

Adjustment of Data

The information provided will be subject to changes to determine the most reasonable walk-away points. These include:

Costs that are not moved to MMCL into Can-Do (e.g. segregation costs)

Eliminating costs that could be incurred by internalizing them into Can-Do (e.g. cost of inspection)

The specifics of adjustments to data are provided in the Appendix Table 2. illustrates the revised budget of South Face Mine starting in to the year 2006:

Item

Modified Budget 06 ($’000)

Direct Cost

6.0) 6. Treatment

3,391

9.0) Tailing Storage Facility Reclamation

508

11.0) Facilities Demolition

2,821

12.0) Disposition of Equipment/Facilities and/or Salvage

218

13.0) Disposition of Inventory

(5,270)

14.0) 14.0) Post Closure Monitoring Costs

1,319

Total Direct Cost

2,985

Indirect Cost

15.0) Social-Economic and Economic Costs

16.0) Consultant Services

388

18.0) Owners Management (post closing)

2,375

22.0) Bonding Cost

270

23.0) Contracts/Commitments/Royalties

24.0) Taxes (Land, Buildings etcaEUR|)

2,700

30.0) Contingency*

1,307

Total Indirect Cost

7,040

Total Cost

10,024

Table 2: Original and Modified Budgets from 2006 and to the present

Analysis: Methods and Assumptions

Contingency Allowance and Inflation Rate

MMCL has included the contingency allowance of 15% in its budget, but it has not taken into account the value of time for cost items. If the allowance is purely to cover the inflation rate, the implied inflation rate which is equal to the contingency allowance of 15% is determined to be 2.55 percent (using Excel’s Excel feature “goal find”) after the adjustment of data mentioned.

Testing for Sensitivity, Risks, and Walk-away Point

To understand the risks that underlie these assumptions, sensitivity tests have been conducted to determine the risks that are inherent in the assumptions used to create the cash flow forecasts (all with no reserve for contingencies). This table summarizes these results

Assumption

Annual Cost Saving

Value ($’000)

Scenario

Short-Term Duration

Long-Term Duration

Inflation Rate*

Discount Rate

Amount ($’000)

percent of Base

Cost Saving

Add’l Cost

NPV

Base

Base^

Base^

2.55%

6%

1,500

100%

21,934

7,102

14,832

1

Base + 1 year

Base

2.55%

6%

1,500

100%

21,934

13,614

8,320

2

Base + 2yr

Base

2.55%

6%

1,500

100%

21,934

19,914

2,020

3

Base

Base + 5 years

2.55%

6%

1,500

100%

21,934

7,512

14,422

4

Base

Base

3.00%

6%

1,500

100%

22,823

7,289

15,534

5

Base + 1 year

Base

3.00%

6%

1,500

100%

22,823

13,882

8,941

6

Base + 2 years

Base

3.00%

6%

1,500

100%

22,823

20,288

2,535

7

Base

Base + 5yr

3.00%

6%

1,500

100%

22,823

7,743

15,080

8

Base

Base

4.00%

6%

1,500

100%

24,947

7,724

17,223

9

Base

Base

3.00%

5%

1,500

100%

24,904

7,715

17,189

10

Base

Base

3.00%

7%

1,500

100%

20,994

6,902

14,091

11

Base

Base

3.00%

6%

1,350

90%

20,541

7,289

13,252

12

Base

Base

3.00%

6%

1,200

80%

18,258

7,289

10,970

The durations in Scenario Base represent the initial assumptions outlined in MMCL budget.

This inflation figure of 2.55 percent that is that is used in the scenario Base and #1-3 is derived from the calculation that was discussed in the previous section.

Table 3: Tests of Sensitivity

The table shows the net value of an acquisition under various combinations of short-term duration, longer-term length, the rate of inflation, and discount rates (Scenario Basis and #10-10). The table is evident that for the majority of scenarios the cost of acquisition is between $14-15 million. So, it’s prudent and prudent to choose the figure at $14 million as the minimum amount to walk away from.

Additionally, an additional test of sensitivity on estimates of savings in cost is conducted (Scenario 11-12). If compared with Scenario 4, it is evident that a decrease of 10% in cost savings results in a cost of acquisition to be below $14 million. This implies that a strict control is required to ensure whether the cost savings realized is in line with the anticipated one.

In the table The short-term duration is likely to be the most significant danger factor because any increase in this causes a dramatic reduction in value (by comparison of Scenario Base to Scenario #1-2 or Scenario #4 to Scenario #5-6). Can-Do must therefore pay close attention to the duration of cost projections for the short-term.

Conclusions and Recommendations

Based on using the revised cost budget and using a discount rate of 6 that a contingency of 15% allowance would result in the inflation rate being 2.55 percent. Additionally, following a review of different assumptions using a test of sensitivity the walk-away point of $14 million is enough to purchase South Face Mine. But, there are a few points that must be considered:

The wide variances in the budgets for 2006 and 2005 have raised questions about the accuracy and reliability of the estimated value included in the budget.

The implied rate of inflation of 2.55 percent is less than the lower limit of inflation rates predicted by economists.

The amount of the acquisition is highly dependent on the length of the short-term cost, based on the results of tests of sensitivity.

The calculation of the walk-away point is dependent on the assumption $1.5 million could be saved each year over 20 years. A slight reduction could be enough to result in an overall loss on the purchase if the price at which South Face Mine is purchased South Face Mine is close to the walk-away level.

For some costs including water treatment operation/maintenance costs and salaries of accountant/environmental person, they may be internalized to a certain extent; yet they are not removed for the determination of walk-away point due to their specialty. This is also a prudent walk-away point.

It is suggested that an in-depth investigation be conducted to confirm the cost estimates in the budget and to find any other potential issues. It is also suggested that a cost-control system is needed to ensure that the costs remain in line with the forecast in the event that Can-Do is successful in purchasing South Face Mine from MMCL.

Appendix to the Data Adjustment

Some reclamation and closure costs are taken out of The MMCL budgets of South Face Mine from 2006 to date since they are either eliminated (not transferable into Can-Do) or internalized. The table below provides a summary of the adjustments made to the data:

Direct/Indirect

Major Category

Description

Data Adjustment

Direct

9.0) Tailing Storage Facility Reclamation

Engineering and inspections

Internalized

Indirect

15.0) Social-Economic and Economic Costs

Severance

It is not transferrable to Can-Do

Indirect

18.0) Owners Management (post closing)

Tech Contract: $55k/yr for 20 years.

Internalized

Indirect

18.0) Owners Management (post-closing)

One manager for 4 yr at $150k /yr

Internalized

Indirect

23.0) Contracts/Commitments/Royalties

Employee Housing Buy-back

It is not transferrable to Can-Do

Please be aware that:

For some costs including water treatment operation/maintenance costs and salaries of accountant/environmental person, they can be internalized to a certain extent; yet they are not removed due to their specialty.

For salvage value, the salvage value will accrue until Can-Do in 2006 rather than 2026.

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