Calculate NPV: Evaluate the two options using NPV analysis and clearly identify which of the two alternatives results in a higher valuation for Rio Tinto. Include a brief commentary of your analysis.

Option 1: Building a Crusher and 13-kilometre Conveyor The construction and installation of a new Crusher and 13-kilometre conveyor will cost $24 million. In addition, an ANFO facility will also need to be constructed at a cost $8.2 million. This facility will need to be supplied with slurry pumps, mixed flotation systems and other equipment at a total cost of $7 million. Rio Tintos reserve fleet of autonomous Caterpillar Haulage trucks will meet the needs for this project, however until recently, the fleet has been earning a rental income of $1,030,000 per 2 year. The additional iron ore mined is expected to generate a revenue of $18 million per year, which is forecasted to increase by 2.5% per annum due to higher demand from China. As a result of the additional complexities involved with the construction and management of this project, 7 new engineers (yearly salary per engineer $145,000) will replace 11 existing engineers (yearly salary per engineer $105,000). The 1000 additional construction labour required for this project is expected to cost $6.2 million per annum for the duration of the project. For tax reasons you will expense the cost of the ANFO facility immediately. The cost for the construction of the new Crusher, 13-kilometre conveyor and associated slurry pumps, mixed floatation systems and other equipment will be depreciated over three years using the straight-line method. Due to the nature of the mining project, the crusher and associated systems and equipment will likely have a salvage value of $12 million at the end of three years. Finally, the required net working capital is $6.3 million which will be returned at the end of the projects lifetime.

Option 2: Outsourcing the supply of ore Alternatively, to achieve the same iron ore mined from Option 1, Rio Tinto can contract BHP to supply the required iron ore. Based on the amount of iron ore required, BHP has quoted a total cost of $25 million. BHP has however offered this rate on the condition that Rio Tinto pays 24% of the total cost in advance in the beginning of the year (i.e. Y0), with the remaining paid in equal instalments thereafter. Rio Tinto will process the iron ore using existing facilities at an expected cost of $6.2 million per year. Interest expenses related to this project is expected to $3.8 million per year.

[For simplicity we will assume a project life time of 3 years that is Year 0, Year 1, Year 2 and Year 3]

Interest on all debt securities is paid twice-yearly and the corporate tax-rate is 30 percent.

WACC = 4.25%