The Galore Creek Project

XovaGold Resources is a former gold exploration company that has recently been transforming itself into a gold producer. Its first independent development is the Galore Creek Project. It is also involved as a partner with Placer Dome in another project, and with Rio Tinto in a third. Galore Creek is expected to produce an average of 7650 kilograms of gold, 51 030 kilograms of silver, and 5 670 000 kilograms of copper over its first five years.

In a news release, XovaGold reported that an independent engineering sendees company calculated that the project would pay back the USS500 million mine capital costs in 3.4 years of a 23-year life. They also calculated a pre-tax rate of return of 12.6% and an undiscounted after-tax XPV of USS329 million. All of these calculations were done at long-term average metal prices. At then-current metal prices the pre-tax rate of return almost doubles to 24.3% and the XPV (net present value = present worth) increases to US$1,065 billion.

Source: "Higher Grades and Expanded Tonnage Indicated by Drilling at Galore Creek Gold-Silver-Copper Project," news release, August 18, 2004, XovaGold Resources Inc. site, www.novagold.net, accessed May 11, 2008.

Discussion

Companies have a choice of how to calculate the benefits of a project in order to determine if it is worth doing. They also have a choice of how to report the benefits of a project to others.

XovaGold is a publicly traded company. Because of this, when a large and very important project is being planned, not only does NovaGold want to make good business decisions, but it also must maintain strong investor confidence and interest.

In this news release, payback period, IRR, and NPV were used to communicate the value of the Galore Creek project. However, you need to look carefully at the wording to ensure that you can correcdy interpret the claims about the economic viability of the project.

Questions

1. "[A]n independent engineering sendees company calculated that the project would pav back the USS500 million mine capital costs in 3.4 years of a 23-year life." There are a variety of costs associated with any project. The payback period here is calculated with respect to "mine capital costs." This suggests that there might be "non-mine" capital costs—for example, administrative infrastructure, transportation system, etc. It also means that operating costs are not included in this calculation. What do vou think is the effect of calculating the payback period on "mine capital costs" alone?

2. "They also calculated a pre-tax rate of return of 12.6%. ..." Taxes reduce the profit from an enterprise, and correspondingly reduce the rate of return. As will be seen in Chapter 8, a 50% corporate tax rate is fairly common. Thus if the pre-tax rate is 12.6%, the after-tax rate would be about 6.3%. Does 6.3% seem to you a sufficient return for a capital-intensive, risky project of this nature, given other investment opportunities available?

3. "[A]nd an 'undiscounted' after-tax XPY of USS329 million." The term undiscounted means that the present worth of the project was calculated with an interest rate of 0%. Using a spreadsheet, construct a graph showing the present worth of the project for a range of interest rates from 0% to 20%, assuming the annual returns for the project are evenly distributed over the 2 3-year life of the project. Does the reported value of SUS329 million fairly represent a meaningful XPA for the project?

4. The returns for the Galore Creek Project are much more attractive at then-current metal prices, which were significantly higher than long-term average metal prices. Which metal prices are more sensible to use when evaluating the worth of the project?

5. Did XovaGold report its economic evaluation of the Galore Creek Project in an ethical manner?

Was this article helpful?

0 0
Business Brain

Business Brain

Among the hardest transitions for individuals is to move from the employee to the entrepreneur mentality. The idea of getting on your own, getting your own business is fantastic. It's the desire of a lot of individuals to leave their jobs and get to be successful business owners.

Get My Free Ebook


Post a comment