Investment Project Analysis of PT. Berau Coal Block 5-6 Binungan Using Discounted Cash Flow Method
Ridho Ilham Mury Nanda1*, Taufik Faturohman2
1 Safety Operation Superintendent Binungan Mine Operation, PT Berau Coal, Indonesia
2 Supervisor, Master of Business Administration Lecturer, Banudung Institute of Technology, Indonesia
*Corresponding Author: [email protected]
Accepted: 15 February 2023 | Published: 1 March 2023
DOI:https://doi.org/10.55057/ijbtm.2023.5.1.6
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Abstract: The evaluation of business projects that have high complexity and uncertainty will require a thorough study since the coal mining industry is a business that has extremely high costs as well as a high risk where there are many uncertainty elements that impact this sector.
Blocks 5 and 6 are locations that have previously been mined by PT. Berau Coal in an effort to boost output. PT. Berau Coal now wants to reopen the block 5-6 region to optimize the area that was previously deemed unproductive for mining in an effort to boost coal output there. To assess if the block 5–6 region can be mined once more in an endeavor to increase PT. Berau Coal's production reserves, an analysis is thus required. PT. Berau Coal currently uses the Discounted Cash Flow (DCF) approach to determine the viability of an investment. The mathematical results of the DCF technique will be taken into account by management when making mining decisions. Further research is required to be able to maximize shareholder value because this technique has a restriction in that it does not offer flexible project for management. We obtain an NPV of $14,44 million, an IRR of 67,98%, and a Payback Period of 3.4 years based on the results of the DCF calculations performed on the Block 5-6 project from the mine plan for PT. Berau Coal. There are a number of preparations that must be made for the mining plan for this project, including the building of farm roads to replace existing roads that are part of the mining plan and pumping operations to lower the water level in the mining plan area. There is no new investment required because the infrastructure for mining equipment is already a part of the contractor selection component and the infrastructure for processing coal already uses it.
Key words: discounted cash flow, uncertainty, infrastructure, decision-making
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1. Introduction
This study aims to provide the most exhaustive feasibility analysis possible for the proposed mining project, taking into account the numerous possibilities that may arise throughout the project's implementation. Each component that contributes to the uncertainty is subjected to a sensitivity analysis to determine which aspects of the project are the most crucial. In addition, it is vital to analyze the impacting factors and study the outcomes of the worst, average, and best conceivable outcomes. Currently, the DCF technique is applied for valuation purposes. In this method, the pricing assumption, along with the operational cost, capital expense, and tax,
2. Literature Review
2.1 Coal Price Assumption
In Indonesia, buyers and sellers of coal as well as the government use the reference coal price for spot trading, tax calculations, financial and investment analysis, strategic reporting, and production planning due to the wide range of quality of coal. The Indonesian coal index is also used to determine the domestic coal price in Indonesia (ICI). The price of coal is primarily determined by its caloric value (CV), total moisture (TM), ash, and total sulfur, which are the four primary attributes of coal (TS). ICI is split into five categories based on these characteristics: ICI 1, ICI 2, ICI 3, ICI 4, and ICI 5.
In the study of mathematics and statistics, the word "mean" is utilized. The average function is crucial because it gives a reflection of the values contained in the data collection. The average is a value that is used to represent a collection of data. Most of the time, adding up all of the numerical data first, then dividing that total by the total amount of data, is how we determine the average value. The arithmetic average and the geometric mean, on the other hand, were found to be two ways to calculate the value that serves as the average (geo-mean).
1) Arithmetic mean is the average that may be derived by first adding up all of the numerical data that is available and then dividing that sum by the total number of observations. The average school grade, average student height, and many other instances are just a few examples of how averages are used in mathematics.
2) The geometric mean is the average obtained by averaging all the data in a sample group data, and then ranking the outcomes in accordance with the total number of data in the sample.
When calculating the average for the same period of numerous data without growth, arithmetic averages are more precise, whereas the geometric mean accounts for cumulative growth over time. The geometric mean method is more precise in situations involving growth, such as the price of coal. Since rank roots are employed, geometric averages cannot be calculated with negative data.
2.2 Capital Expenditures
Investments made by a business in infrastructure (factories, buildings, technology, or equipment), exploratory operations, land acquisition, and so forth are referred to as capital expenditures.When beginning new initiatives on fixed or brand-new assets to establish, sustain, or build a corporation, capital expenditure is necessary.
2.3 Operational Expenses
An expense incurred by a business as a result of ongoing operations is known as an operating expense. Operating costs, also referred to as OPEX, include expenses like as rent, equipment, supplies, marketing, salaries, insurance, step charges, and money allocated for R&D. For most businesses, operating expenses are both necessary and unavoidable. Some businesses are successful at reducing operational costs to acquire a competitive advantage and get more profitability. However, lowering operating costs could result in a decline in the dependability and perfection of operations. Finding the ideal balance may be challenging, but the results can be profound.
2.4 Taxes
An area, regional, or federal government must collect taxes from citizens or businesses in order to operate. These operations include the Social Security and Medicare systems in addition to public works and services like roads and schools. Theoretically, taxes are paid by whoever carries the tax burden, whether that be the taxable entity, such as a corporation, or the consumers who ultimately buy the goods made by the business. From an accounting perspective, payroll taxes, federal and state income taxes, and sales taxes should all be taken into consideration.
2.5 Projected Cash Flow
Projected cash flow is the distribution of money that is continuously flowing into and going out of a company. Cash flow projection is the process of estimating how much money will be available at the end of a specific time period using calculations of expenses and revenues.
2.6 Cost of Equity
The lowest practical rate of return that a company may potentially offer its shareholders is the cost of equity, also referred to as the rate of return. Investors that invest in a company are given cost equity as compensation for the risk they are willing to assume. Investors frequently anticipate a return in the form of dividends or an increase in the value of a particular investment.
The financial risk connected to the capital invested in the business's operations determines the predicted return, or cost of equity.
Returns have traditionally changed with the growth of the stock market. In countries like Indonesia, China, or India that have had rapid economic expansion, the market risk premium is higher than 5%. Market risk premiums range from 1 to 3% in wealthy countries like the United States, Japan, and the United Kingdom.
Each company's market risk sensitivity ( ) is distinct and is influenced by each element of the capital structure and corporate governance. This amount cannot be calculated until the firm or project is up and running, but it can be hypothesized based on past performance (if the business has already been operating) and familiarity with businesses operating in the same sector or undertaking similar projects.
2.7 Weighted Average Cost of Capital
Based on the company's debt and equity, the weighted average cost of capital (WACC) is a method of calculating the cost of capital (equity). This method is frequently used to evaluate the viability of investing in businesses with a variety of capital arrangements, which typically include debt and equity (equity). In businesses that only use equity financing, the cost of capital is equal to the cost of equity. In businesses that only use debt financing, the cost of capital is equal to the cost of debt.
2.8 Description of Risk-Free Rate or Time Risk Adjusted
The theoretical return rate of an investment with no risk is known as the risk-free return rate.
A potential investor's potential interest earnings from a risk-free investment over a specific time period are estimated by the risk-free rate. Since they won't take on further risk until the prospective rate of return is higher, an investor should theoretically anticipate that the risk-free rate will be the lowest possible return on any investment. The investor's home market must be
2.9 Net Present Value
Since it is obtained by deducting the original investment value from the project's total cash flow, the net present value (NPV) is a capital budgeting strategy that is closely related to cash flow analysis. The project is considered advantageous or will maximize the wealth of the owners if the NPV value is more than zero; otherwise, the project is not recommended.
2.10 Internal Rate of Return
The internal rate of return (IRR), a variable in financial analysis, is used to determine the profitability of future investments. The net present value (NPV) of all cash flows is set to zero by the IRR discount rate in a discounted cash flow analysis.
The NPV and IRR computations both use the same formula. Keep in mind that the IRR does not accurately reflect the project's true financial value. The annual return is what zeroes out the NPV.
2.11 Payback Period
The amount of time needed to recover an investment's cost is known as the payback period. It is the length of time it takes an investment to start paying off. The payback period is important because people and businesses invest money primarily to get money back. An investment is more alluring the faster it pays off. The payback period, which is determined by dividing the initial investment by the typical cash flows, can be useful knowledge for anyone.
3. Methodology
Examining the capital budgeting model's primary valuation elements and their interconnections is necessary to comprehend the four cash flows required to solve the case study. Cash flows consist of revenue, operations costs, capital expenditures, and taxes. The methodology of this study involves collection of market data, cash flow analysis, and NPV calculation. This research begins with a business issue analysis and an analysis of the planned design for a coal project investment project. To plan till the mine's life expires, it is necessary to maximize each coal resource utilizing primary data. Next comes the cashflow linkage for the mining scenario, followed by the DCF method valuation. The final step is to estimate the optimal valuation value for the mining scenario by considering its optimal NPV, IRR, and PBP.
4. Findings
The anticipated mining activities in the block 5-6 region have an NPV of USD 14.44 million, an IRR of 67.98%, and a payback period of 3.4 years, according to calculations performed using the discounted cash flow approach for planned mining scenarios. Then, a sensitivity analysis was conducted to determine the most relevant parameters affecting the functioning of block 5-6 mining activities. From the four selected parameters—coal prices, contractor payment prices, fuel prices, and infrastructure development costs—it was determined that coal price changes had the greatest impact on the development of this project. In addition, a scenario analysis was conducted based on historical data patterns in the sensitivity analysis parameters, and it was determined that in the worst conditions, the NPV of this project is -$97.77 million and under the best conditions, it is $247.50 million.
Table 1: DCF calculation Block 5-6
5. Conclusions
This scenario has an NPV of USD 14.44 million, an IRR of 67.98%, and a payback period of 3.4 years, according to calculations performed on mine planning scenarios for the mining operations plan for the Block 5-6 region. In terms of economic feasibility, this project can be executed based on the findings of the calculations and the chosen method. This sensitivity analysis is introduced to discover the most influential parameters in this mining operation.
According to the results of the sensitivity study, the coal price is the most sensitive parameter for mining activities in the 5-6 block area. In addition, scenario analysis is conducted to determine the project's status under the worst and best possible conditions. In the worst-case scenario, the project has a negative net present value (NPV) of -97.77 million US dollars, while in the best-case scenario, it has a positive NPV of 249.75 million US dollars.
References
Damodaran, A., 2010.The Dark Side of Valuation Second Edition. New Jersey: Pearson Education.
Gitman, L. J., & Zutter, C. J., 2015. Principles of Managerial Finance. Kendallville: Pearson Education.
Haq, N. (2018). Modeling Valuation Risk Decision in Mining Projects. FIRA Publishing.
