CONSIDERATION OF UNCERTAINTY

DIAMOND ENERGY RESOURCES

• Look at the following slides 3 to 9 to see that opportunities/decisions like those outlined in the case do exist. Look also at the possible swing in prices, production levels, employee costs and investment costs. There is a lot of uncertainty to consider. See slides 11 to 32.

• Estimate the uncertainty of some of the factors determining project profitability and NPV. Specifically, you are asked to design four year-by-year scenarios for: coal price, mine production levels, expenses and capital investment. A template follows in Slide 47.

• You are also asked to consider risk premiums and make four estimates of what the appropriate discount rate is for the case mine project. See slides 33 to 45.

• You will then be able to make 52 estimates of the project’s NPV and a report. See slides 48 to 50.

• In our class session, we will decide what our decision criteria will be as we investigate NPV. What will we want to know about the NPV? Will distributions of NPV help? Some other measure?

• In class, we will go on try simulations as our major activity.

PLAN FOR INVESTIGATING UNCERTAINTY

9/30/20 2

SOURCE OF DATA ABOUT INDONESIA

http://www.wbiconpro.com/313-Sarah.pdf

9/30/20 3

9/30/20 4

6/16/20 5

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DISCOUNT RATETHERE ARE DEALS LIKE THEONE WE ARE EXAMINING

http://www.asx.com.au/asxpdf/20170720/pdf/43krlhdp8qzth1.pdf

http://www.4-traders.com/ZAMIA-METALS-LIMITED-10354800/news/Zamia- Metals-ZGM-Update-on-Acquisition-of-Coking-Coal-Mine-and-Capital- Raising-24804709/

7

Financial Modeling for Corporate Analysis 8

2/22/20 Financial Modeling for Corporate Analysis 9

WHICH NUMBERS OR ESTIMATES TO USE IN ESTIMATING NPV?

Case estimates?

More robust estimates?

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THERE IS UNCERTAINTY OF DEMAND AND PRICE

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FIRST: PRICE OF COAL

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SECOND: VOLUME PRODUCED

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http://www.wbiconpro.com/313-Sarah.pdf

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THIRD: COSTS

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25

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FOURTH: CAPITAL INVESTMENTS (Positive and Negative)

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http://costs.infomine.com/costdatacenter/miningcostmodel.aspx

CAPITAL COST ESTIMATE: 312 Days X 5,000 Tons per Day

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DISCOUNT RATEFIFTH: DISCOUNT RATE – FIRST LOOK

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1

Optimal Capital Structure of Coal Mining Companies Listed in Indonesian Stock Exchange (Period 2008 – 2011)

Sarah Parsaulian Lumban Gaol* and Ir. Achmad Herlanto Anggono,

Every companies aim to get the biggest return and the highest firm value. A way to achieve those goals is by managing the company’s capital structure which consists of equity and debt. This research focuses on public-listed Indonesian coal companies because coal industry is an important industry for Indonesia as one of the largest exporters of thermal coal in the world. In order to maximize the firm value of coal companies in Indonesia, managing the capital structure, is an essential matter because it is related to the cost of financing. Companies can determine the best proportion of debt and equity for the optimal capital structure based on the lowest cost of capital that is calculated using Weighted Average Cost of Capital (WACC) approach. The optimal capital structure is analyzed from simulation that is done with proportion of debt and equity as the independent variables, while cost of capital and firm value as the dependent variables. From 9 Indonesian coal companies being analyzed during period 2008 – 2011, the optimal capital structures will be generalized to get the best proportion of debt and equity for Indonesian coal industry. By averaging the optimal capital structures of companies being researched during the research period, the optimal capital structure of coal industry would be 13,44% debt and 86,66% equity. In addition, by analyzing the trend of the industry which become more independent year by year, the optimal financing alternative for coal industry would be between 0% – 20% debt and 80% – 100% equity.

*Sarah Parsaulian Lumban Gaol, School of Business and Management, Bandung Institute of Technology, Indonesia. Email: gaol.sarah@gmail.com

Keywords: optimal capital structure, Indonesian coal industry, WACC, firm value

1. Introduction

Every companies aim to reach the biggest return and the highest firm value. A way to reach those goals is by managing the companies’ capital structure that consists of debt and equity. Companies should determine the best proportion of debt and equity to get the highest firm value which required the lowest cost of capital. This research would focus on public-listed Indonesian during the period of 2008 – 2011 because coal industry is a prominent industry for Indonesia as one of the largest exporters of thermal coal. Besides, this industry is growing year by year so it is important to know the optimal capital structures for this industry to reach the highest firm value. The objective of this research is to know the historical capital structure, cost of capital, and firm value of Indonesian coal companies from 2008 – 2011. The second objective is to find out the optimal capital structure, cost of capital and also firm value of each company being researched during the research period. Last, this research is trying to estimate the best capital structure for Indonesian coal industry. There are 9 companies being researched, which are:

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http://wbiconpro.com/313-Sarah.pdf

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https://mercureaace2013.wordpress.com/2013/03/02/w10_ap _marr-for-coal-mining-business-in-indonesia/

Financial Modeling for Corporate Analysis 37

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• Portfolio theory is built around • Expected cash flows • Risk-adjusted discount rates for diversified investors

• The CAPM and Equity Risk Premium approach is logical • From portfolio theory to SML to relative risk and EMRP

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DISCOUNT RATE – SECOND LOOK USING THEORY AND DIVERSIFIED INVESTORS

Return

Risk

.

rf Risk Free

Return =

Efficient Portfolio

Market Return = rm

SETTING RISK-RETURN TRADE-OFF

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Return

.

rf Risk Free

Return =

Efficient Portfolio

Market Return = rm

BETA (β)1.0 Beta is 1.0 by definition

THE PRICE OF RISK DEFINED

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• An increased Equity Risk Premium has some logic • But, could lower rates be set by diversified investors and integrated markets? • ERP estimates could come from default spread as base modified by relative

observed market volatilities (local equity to local debt) • ERP estimates could also come from US EMRP as base modified by relative

observed market volatilities (local equity to US equity)

• The Implied Cost of Equity approach also has logic • The rate can be deduced if we know current price and expected cash receipt pattern

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DISCOUNT RATE – THIRD LOOK WITH NON-DIVERSIFIED INVESTORS OR SEGMENTED MARKETS

• Risk-Free reference instrument • US or local? • Time horizon? • Inflation adjustment?

• Beta • Firm? • Industry? • Local

market/Regional/International? • Present, Past or Future?

• Debt/Equity • Past or planned? • Industry or average or firm?

• Market Risk Premium • US or local? • Which time period? • Is it steady? • Component or total premium?

• Basic Assumptions • Measure of risk is correct? • Investors have same

expectations? • Informed, diversified investors? • Rational markets?

DAMODARAN and CRP

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COMPLICATIONS OF ESTIMATION & MEASUREMENT WITH CAPM

• Risk-Free reference instrument • US • Local • Horizon?

• Beta • Firm • Industry • Local • International

• Debt/Equity • Past • Industry • Planned

• ERP Adjustments • Country • Industry

• Equity Risk Premium Base • Debt spread as base • US ERP as base

• How Rate Adjusted for ERP? • Added • Multiplied • Which volatility as reference? • Adjust Beta also? • Lambda?

DAMODARAN and CRP

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FURTHER COMPLICATIONS OF ESTIMATION & MEASUREMENT INTRODUCING ERP

• Implied Equity Premium • From Gordon Growth Model

• V0 = CF0(1+g)/(k-g)

• k = d1/(MP)0 + g

• Once you have k, you can get Implied ERP. Subtract riskless rate

• Works for a market, an industry or a company

• Questions • What if no dividends are paid?

• Comparable company • What is expected growth rate?

• Current ROE? • Two stages of growth?

• How to specify riskless rate? • Which index if looking at a

market rather than a stock

• There is no explanation of risk or how risk is priced

DAMODARAN and IMPLIED EQUITY PREMIUM (ALTERNATE APPROACH)

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THERE ARE COMPLICATIONS OF ESTIMATION USING IMPLIED COST OF EQUITY APPROACH

DISCOUNT RATESCENARIOS, TEMPLATES, NPV CALCULATIONS, RESULTS, DISTRIBUTIONS

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TEMPLATE FOR PRICE SCENARIOS

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EXPAND USE OF SCENARIOS TO GENERATE 52 SEPARATE NPV ESTIMATES

THIS IS TEMPLATE TO FOLLOW (YOUR RESULTS WITH YOUR ESTIMATES

SHOULD BE REPORTED LIKE THIS)

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You need to use only four estimates for discount rate

Which of these measures are useful to you?

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BETTER: SHOW RESULTS IN A DISTRIBUTION