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Agnico Eagle Mines Ltd Case Solution

Solution Id Length Case Author Case Publisher
483 2285 Words (5 Pages) George Athanassakos, Dan Buffery Ivey Publishing : 907N11
This solution includes: A Word File A Word File and An Excel File An Excel File

Acker, the portfolio manager at National Securities is worried about future of its stake in AEM, a gold mining company, so he wants to find intrinsic value of AEM to decide whether he would hold it or sold it out. He has decided to start with DCF method. In the case of AEM, there would be additional elements that should be included in the intrinsic value of the company. The most valuable asset for a gold mining company is the reserve of minerals it has that could be exploited in the future. Another item that is adding value would be the tax benefits available to the company under applicable tax laws. So, first of all, total value of AEM is calculated using basic discounted cash flow method. After it, tax allowances available under different tax regimes are evaluated and value of cash and equivalents and value of debt is adjusted with discounted cash flows to calculate the value of AEM’s equity. In the end, value of mineral reserves available with the AEM is calculated using Black Scholes Model and then value of equity is adjusted again for this value. Finally, value of AEM comes out to be $22, much higher than its current value. So Acker should hold his stake in AEM.

Following questions are answered in this case study solution:

  1. Estimate the value of AEM and its equity from operations using the DCF method.

  2. Discuss the estimation of the value of the tax loss “related items, as well as the impact of the other valuation items shown in case Exhibit 11.

  3. Estimate the value of AEMs real option to mine the un-mined gold by applying the Black and Scholes model to the valuation of a real option.

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Agnico Eagle Mines Ltd Case Analysis

1. Estimate the value of AEM and its equity from operations using the DCF method.

Acker has assigned this task of valuation of AEM to his team of MBA’s, Michel Nickols and Bill Nichols. Acker has provided projected balance sheet, income statement and statement of retained earnings of AEM from year 2002 to 2008. From these statements, Acker has calculated free cash flow for the company. First of all, EBIT is taken as equivalent to operating income from projected financial statements; Taxes on EBIT after it by using effective tax rates given in exhibit 10. After it, changes in deferred taxes are added. It would give net operating profit after tax (NOPAT) for the company. Depreciation is added to this figure and net investment in working capital and capital expenditure is subtracted to calculate operating cash flows. It is then adjusted with non-operating cash flows to calculate free cash flow to the firm.

In order to calculate the terminal value of the firm after projection period, formula given in exhibit 11is used for which growth rate and WACC after 2008 would be required. First few years are expected to be high growth period but from year 2006, growth rate in revenues and EBIT is expected to remain at the level of 4% and it is expected to remain at this 4% till perpetuity after projection period. As given in exhibit 10, there would be some variation in tax rate expected till 2004, after which it is expected to remain constant at 37.8%. WACC also changes till 2004 because of the adjustment in after tax cost of debt but from 2005 onward, WACC is expected to remain at 10.36% till perpetuity. Using these values, terminal value of AEM is calculated using the formula given in exhibit 11 which comes out to be $142,608 in 2008. Present value of cash flows is calculated by discounting at individual WACC calculated for each year. Total value of AEM from discounted cash flows comes out to be $46.67 million. If this figure is adjusted for items given in Exhibit 11, value of equity comes out to be ($114,640) and if it is divided by weighted average number of shares, value of AEM shares comes out to be $-1.87 per share. Although it is negative but there are certain items of significant value to AEM that are ignored in this value and would be considered later on.

2. Discuss the estimation of the value of the tax loss “related items, as well as the impact of the other valuation items shown in case Exhibit 11.

After calculating basic value of AEM, tax loss amounts are adjusted. Details of these tax advantages are given in note 8 in Appendix A.  Effective historical rates for year 1999 to 2001 comes out to be negative because of certain adjustments available which could be carried forward as an adjustment in next year’s. There would be two adjustments against taxable income. One in non-capital income tax losses carried forward of Canadian $64 million and other are Canadian $ 292 million of exploration and development expenses. Since all projected financials of AEM are prepared in US $, so these tax benefits would be first converted from Canadian $ to US $ by using average exchange rate of US $ of 1.5669/C $. Since non-capital tax loss carried forward would be expired after certain period, so first of all these amounts are adjustable as much as possible. These tax losses would be adjusted till year 2007 after which capital expenditure are adjusted. There would be no tax expense for the company till the end of year 2008 because of these adjustments.

Some of tax benefits arising from adjustable exploration and development expenses are availed in year 2007 and 2008. Total tax benefits from adjustable exploration and development expenditure are calculated by multiplying adjustable figure for exploration and development expenditure in US$ by average tax rate of 37.80%. Total tax benefit from these adjustable expenditures would be $172.95 million. Out of this amount, $24.89 million is adjusted till year 2008.Since these expenses could be adjusted without any time restriction, remaining tax benefits of $148 million would be availed after year 2008. So this figure of around $148 million would be added along with the terminal value in 2008. Present Value of cash flows is calculated using WACC calculated for each year. Present value of these free cash flows comes out to be around $197 million.

In order to analyse items given in exhibits, nature of these items has to be considered. Excess Cash and Marketable Securities and Non-Operating Assets would be added to the discounted cash flow value because they would behave as asset to the AEM. This would give the total value of assets of AEM which comes out to be $230.33 million. This value of the company has to be distributed among all investors of the company while equity holder would be getting residual share. Since market value of debt is given, it would be subtracted from the value of the firm. Current liabilities would be adjusted in changes in net working capital. Company has developed a defined benefit plan for its employees and also developed a fund to finance it, but assets of this fund are insufficient to cover all liabilities arising out of defined benefit plan. There would be a deficit of $1.65 million deficit in the fund would be a liability for the AEM. Similarly, company has issued stock options to its executive details of which is given Appendix A. Total value of these stock options comes out be $24.19 million which would be deducted from the total value of AEM. Anything residual would be the share of equity holders and the total value of equity comes out to be $35.69 million. Weighted average numbers of shares of AEM at the end of 2001 are given to be 61.334 million. Value per share for AEM comes out to be $ 0.58 which is much lower than market value of AEM share. But a major source of value creation for AEM shareholders is not appearing in the books which would be the value of un-extracted minerals whose values would be calculated in the next section.

3. Estimate the value of AEMs real option to mine the un-mined gold by applying the Black and Scholes model to the valuation of a real option.

Discounted cash flow approach ignores flexibility available with the company regarding when to extract metals from mine, this methodology have to be expanded to include the value of these un-mined metals. This resource would be a real option from any mining company and it would be valued using Black Scholes model. This model has to be slightly adjusted to use it for real options. Details steps involved in valuing a real option are given in exhibit 4. Explanations of these calculations are given below

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