Extract Inc. is a global metals company1 . Its chief businesses are the exploration, mining and refining of copper, zinc and lead, and other metals. Extract Inc. is a US firm, and further, as a miner and refiner of internationally traded commodities, views the US dollar as its currency of operation.

It is March 2015 and Extract Inc. is considering investment in an Antamina copper mine in Peru. Antamina is located in the Ancash region, 300 miles (480 km) north of Lima, the capital. Antamina is being sold by the Peruvian state mining company as part of Peru's privatization program. Extract Inc. may acquire 100% of the mine for a total investment of US$ 29 billion, payable December 31, 2015, to form its Antamina subsidiary. Specifically, the deal structure provides for an initial equity investment by Extract, Inc. of US$ 25 billion. The remaining investment funds would come from a 10-year, local currencydenominated, amortizing loan described below.

The Antamina has proven and probable ore reserves of 128.6 million metric tons at an average grade of 2% copper equivalent. (All Antamina ore yields 2% pure copper by weight.) Extract Inc. expects extraction, refining, and metal production and sales to begin in 2016. It estimates that 7.1 million tons of these reserves could be extracted in 2016 and 13.5 million tons each year for years 2017-2025.

At current (2015) prices, a cost of US$ 200 million will be incurred in 2016 in site exploration and development expenses. Total operating costs of the mine are not certain but a reasonable estimate in Peruvian Nuevo Sol (PEN) is 295 million in annual fixed costs plus variable costs of PEN 82 per ton of copper ore, both estimates are in current (2015) prices and predicted to rise annually at Peruvian inflation of 3.07%. Operating costs would be incurred starting with the extraction of ore in 2016. The current (2015) rate of exchange is 3.00 PEN per $US.

Extract Inc. has negotiated a government-guarantee on a 10-year PEN 12 billion loan (US$ 4 billion at the current (2015) exchange rate) to the Antamina subsidiary, and a group of banks, led by Banco Santander, have agreed to lend on a fully amortizing basis at 5.44% (the yield on Peruvian government bonds). The rate of 5.44% reflects a substantial subsidy as even with a guarantee by its parent, the subsidiary would have to pay 7.50%. Assuming the analysis supports the acquisition, the loan would be taken down on December 31, 2015.

The major risk facing the project, management acknowledged, is fluctuations in the price of copper. Extract Inc. estimates that the mine would be unprofitable at a copper price of US$3,300 per metric ton or lower. However, the firm's best estimate is that copper prices will increase at the US inflation rate of 2% per year from their current (2015) level of US$5,707 per metric ton.

Other cash flow consequences of this acquisition are licensing fees of 10% of revenues paid by the Antamina subsidiary to Extract Inc. for the use of its refining technology. Dividends will be paid out in an amount equal to 100% of (unlevered) free cash flow and repatriated to the US immediately. A tax treaty exists between the US and Peru such that the US will credit Extract Inc. for its share of taxes paid by Antamina. The US federal corporate tax rate is 35%, whereas the Peruvian corporate tax rate is 25%. Consequently, it is expected that additional US tax will be due. In addition, there is a 15% withholding tax on dividends paid to nonresidents and a 20% withholding tax on licensing fees paid to nonresidents.

Extract Inc. is a publicly held corporation and has reviewed its investors' stock holdings. The firm has determined that its investors are primarily US investors with some home bias in their investment portfolio, placing 70% of their risk-bearing investments in the US market portfolio and 30% in diversified global equities. Extract approximates its investors' holdings with an 70-30 weighting of two exchangetraded funds that trade on NYSE Arca: iShares Core S&P Total US Stock Market ETF and iShares MSCI ACWI ex US ETF, respectively.

Under the pre-2018 US tax code, income taxes paid by a subsidiary to a foreign government are credited to the parent for repatriated profits based on the share of equity owned by the parent and the proportion of net income paid out:

(%Equity Owned by Parent) X (%Net Income Paid Out as Dividends) X (Subsidiary Income Tax Paid); however

In this case, this value is equal to the total income tax paid by the subsidiary. Extract, Inc. owns 100% of the subsidiary and dividends, which equal free cash flow, exceed net income.

These additional US taxes appear in the Parent Perspective analysis. You do not need to calculate additional US taxes as they are given.

To complete the analysis, the following information is available:

Appendix I, II, and III below,

Historical monthly copper prices and "returns" (in Excel document "Returns.xlsx"),

Historical monthly returns on iShares Core S&P Total US Stock Market ETF (ticker ITOT) in Excel Document "Returns.xlsx",

Fact Sheet on iShares Core S&P Total US Stock Market ETF (ITOT.pdf),

Historical monthly returns on iShares MSCI ACWI ex US ETF (ticker ACWX) in Excel Document "Returns.xlsx",

Fact Sheet on iShares MSCI ACWI ex US ETF (ACWX), and

Answer template in Excel ("My Answer - Cost of Capital Given.xlsx").

Plan of Attack

After studying the case, Extract Inc. in Per, solve the case in the following steps completing the corresponding section of the answer template "My Answer.xlsx". The answer template provides structure for the output and some pre-calculated answers. Assume all transactions take place on December 31 of each year (the standard, end-of-period payment assumption). Assume a valuation date of December 31, 2015, and use a 10-year projection period:

Estimate the unlevered beta for the copper mining industry. i. For the 61-month period February 2010 to February 2015, estimate Extract Inc.s investors world market portfolio returns by weighting the US market portfolio proxy returns (ITOT EFT returns) 70% and non-US market portfolio proxy returns (ACWX ETF returns) by 30%.