American Barrick Resources Corporation: Managing Gold Price Risk
1. Hedging Motivation In terms of the gold mines owners, they hedge nothing against the price drop risk of gold output. As the profits, cash flows and stock price were tied of gyrations in the price of gold. As to the gold, there was always a ready market for their product, at market prices, once extracted from the earth and refined. Hedging against the risks can protect the downside of gold price, enable the both the shareholders and investors to share the price premium, the high operation leverage and high sunk costs, limit the ability to adjust production and lock-in the low total costs. Historically, American Barrick Resources Corporation’s hedge position had allowed it to profit handsomely and to sell its commodity output at prices well above market rates. Moreover, the firm’s insistence on bearing low financial was attributed to an earlier failed business experience by Mr. Munk and his subsequent distrust of high leverage. Investors also desire some exposure to gold prices, but they want this exposure managed prudently. But by hedging against the gold risk, shareholders may sacrifice the upside of gold price, ahead the unsystematic risk. 2. Vehicles of Hedging Gold Financings: American Barrick used bullion loans and gold-indexed underwritten offerings to raise funds for capital expenditures to develop the mine. American Barrick needed to repay the loan to Toronto Dominion Bank in monthly installments in ounces of gold at an interest rate of about 2% per year. The bullion loan was collateralized by the assets of the mine which is different from gold-indexed Eurobond offerings. In both of these gold financings, the investor benefits not only from increased volumes of gold but also from increased gold price. As for forward sales, from the EXHIBIT 9, a sharp drop in gold prices in 1984 and 1985 led to the first forward sales of gold at American Barrick. But when the gold price rises, the firm lost the opportunity to sell gold at the higher market prices. So option strategies could be used to protect the firm against adverse price movements. By adjusting the exercise prices and ratios of puts and calls, American Barrick could determine the degree to which it chose to participate in gold price rises. Spot deferred contracts are arranged in the same way as a future contract, but it’s possible for a spot deferred contract to be rolled further into the future, providing sufficient notice is given. The spot deferred contracts make more sense in gold market environment in the year 1992. The rollover program will be simpler, smaller, and better positioned to take greater advantage of rising gold prices. At the same time, it will continue to generate significant additional revenues and provide secure and predictable cash flows. Also, because American Barrick is one of the fastest growing and most financially successful gold-mining concerns, so it is able to negotiate subsequent agreements giving the firm 10 years within which to make delivery. 3. NPV analysis and Break-even price The gold price, $386.11 per ounce in 1992 basis, is estimated using the geometric mean of gold spot price from 1987 to 1992. In addition, NPV is counted in 1992 dollars since all the costs are given in 1992 basis.
NPV = total revenue- total expenses =[gold price* gold reserve amount*(1-royalty rate)-operating cost-land reclamation cost]*(1-tax rate)-total capital cost prior to production= $ 702.40 million Break-even price analysis The operating cost of the project = reserved gold amount *operating cost per ounce = 4.5 million ounces * $ 125/ ounce = 562.5 million dollars Based on the projected data in Exhibit 14, the Net Present Value of the total capital cost prior to production is 180 million dollars in 1992 dollar basis. When the sale price is below the break-even price, Meikle Mine Project would work in deficit when the net income of project could...
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