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Rio Tinto Investment Appraisal & Governance

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This assignment analyzes Rio Tinto's corporate governance practices and their impact on effective management. It delves into an investment appraisal analysis, recommending a specific project for Rio Tinto based on its financial viability. The report also explores portfolio construction, beta assessment, and required rate of return calculations to guide Rio Tinto's investment decisions.

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Finance Assignment

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Table of Contents
Table of Contents.............................................................................................................................2
INTRODUCTION...........................................................................................................................4
TASK 1............................................................................................................................................4
a. Explaining the corporate governance process followed by Rio Tinto.................................4
b. Describing the benefits which are offered by Rio Tinto to community and environment. .4
c. Stating reasons behind increasing debt level in 2012 as compared to2011.........................5
TASK 2............................................................................................................................................5
a. Calculating cash flows and NPV of the project...................................................................5
b. Assessing the IRR of project...............................................................................................6
c. Suggesting suitable project to Rio-Tinto.............................................................................7
d. Assessing the viability of investment proposal....................................................................7
Computation of NPV and IRR..................................................................................................8
a) Identifying Trump holding period.......................................................................................9
b) Evaluating CAPM model...................................................................................................9
c) Evaluating the impact of policy changes on share price......................................................9
d) Giving suggestion regarding making investment decision................................................10
e) Assessing the share price...................................................................................................10
4. INVESTMENT..........................................................................................................................11
a. Calculating beta for the proposed portfolio.......................................................................11
b. Calculating the required rate of return of the portfolio......................................................11
c. Critically analyzing the extent to which suggestions given by the finance director is
appropriate.............................................................................................................................11
CONCLUSION..............................................................................................................................12
REFERENCES..............................................................................................................................13
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INTRODUCTION
In the business organisation, finance is one of the crucial elements which have a high
level of influence on the growth and success of the firm. Thus, it is the accountability of manager
to ensure proper allocation and usage of the fund by taking into consideration the different tools.
This project report is based on Rio Tinto which is one of the largest British-Australian
multinational operating in the mining sector. In this regard, present report will shed light on the
aspects of corporate governance, environment report presented by Rio Tinto. Besides this, it will
also develop an understanding of several financial techniques such as capital budgeting, CAPM
model and construction of the suitable portfolio.
TASK 1
a. Explaining the corporate governance process followed by Rio Tinto
Rio Tinto has organised corporate governance in a highly structured manner. With the
motive to develop and maintain an effective relationship with the stakeholders, Board made
discussion with senior managers regarding the strategy was undertaken. In such discussion,
presentations were given by senior management about the strategic and policy framework of the
company (Rainey and et.al., 2015). Besides this, directors have made a review of financial
aspects on a regular interval with the aim to assess the present in the existing performance level.
Along with this, in 2015, new members of the board visited the mining operations to get
proper knowledge about the company’s activities and staff. In the accounting year 2015, share
prices were decreased significantly which is not a good indicator. However, business unit has
reduced the level of expenses by $3.5 billion to $4.7billion. Such strategy provided assistance to
the firm in enhancing the profit margin (Annual report of Rio Tinto, 2015). This, in turn, helps in
enhancing profit for distributing among the shareholders. This strategy of Rio Tinto clearly
shows alignment in the interest level of management and shareholders.
b. Describing the benefits which are offered by Rio Tinto to community and environment
Rio Tinto has made the major contribution to the growth and development of the
community as well as environment. Out of 100 business unit has attained the rates of 57 in

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comparison to other companies. Moreover, several jobs were offered by Rio Tinto to the people
of the local community. Besides this, the company has made a major contribution to the
development of the community by giving charities for health programs, educational aspects, etc.
Along with this, a company also places emphasis on using natural resources which in turn
reduces the negative impact of business activities on eco or earth system. It focuses on energy
efficient activities and development of renewable sources by taking the assistance of the
alternative as well as high-tech aspects. In addition to this, the business unit also complied with
the environmental rules while performing the business activities and functions (Chikozho and
Jongh, 2014). Thus, all such aspect created an effective image of the company in the mind of
stakeholders and thereby placed a positive impact on share prices of the firm.
c. Stating reasons behind increasing debt level in 2012 as compared to2011
There are several reasons due to which debt level increased in 2012 as compared to 2011
which includes exchange rate fluctuations and price movements. In the year of 2012, net
earnings decreased by the US $ 1289 million (Annual report of Rio Tinto, 2012). Hence, due to
the high reductions in earning level Rio Tinto had taken more debt to carry out the activities
more effectively and efficiently.
TASK 2
a. Calculating cash flows and NPV of the project
Calculation of cash flows
Y
ea
r
Sales
(in $)
Expe
nses
Depre
ciatio
n Total
profi
t tax
Profit
after
tax
Cash
flows Adjustments
Ann
ual
cash
inflo
ws
(in $)
1
2000
0000
0
1000
0000
0
48500
000
1485
0000
0
5150
0000
1545
0000
360500
00
8455
0000
15000000
(Outflow)
6955
0000
2
2500
0000
0
1250
0000
0
48500
000
1735
0000
0
7650
0000
2295
0000
535500
00
1020
5000
0
1020
5000
0
3 3250
0000
1625
0000
48500
000
2110
0000
1140
0000
3420
0000
798000
00
1283
0000
1283
0000
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0 0 0 0 0 0
4
3000
0000
0
1500
0000
0
48500
000
1985
0000
0
1015
0000
0
3045
0000
710500
00
1195
5000
0
1195
5000
0
5
1500
0000
0
7500
0000
48500
000
1235
0000
0
2650
0000
7950
000
185500
00
6705
0000
157500000
(Scrap value
inflow)
2245
5000
0
Calculation of Net present value (NPV)
Year
Annual
cash
inflows
(in $)
PV factor @
10%
Discounted cash inflow (in
$)
1 69550000 0.909 63220950
2
10205000
0 0.826 84293300
3
12830000
0 0.751 96353300
4
11955000
0 0.683 81652650
5
22455000
0 0.621 139445550
Total discounted cash inflows
(TDCF) 464965750
Initial investment (II) 422500000
Net present value (TDCF - II) 42465750
b. Assessing the IRR of Project
Calculation of Internal rate of return (IRR)
Year
Annual
cash inflows
(in $)
-422500000
1 69550000
2 102050000
3 128300000
4 119550000
5 224550000
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IRR 13%
c. Suggesting suitable project to Rio-Tinto
From the above-mentioned calculation, it has been assessed that Rio Tinto will get
$42465750 after the period of five years. Hence, the value of NPV is higher than the initial
investment which is the positive indicator for the firm. Thus, by investing money in such
proposed investment Rio Tinto will get the desired level of outcome or success. Along with this,
IRR of such investment proposal is 13% which is not higher than the average industry level.
However, NPV is one of the most effectual techniques which in turn provide investors with the
highly realistic information for decision making. Moreover, it considers the time value of money
concept and helps the company in making selection of the suitable project. Thus, by considering
the outcome of NPV, it can be said that Rio Tinto should proceed with such project.
Further, the company can also undertake payback for assessing the period within which business
unit will recoup the initial investment. Hence, by taking into account into consideration such
method business unit can assess the period after which it would become able to get profit margin.
In this way, such technique helps in making the effectual plan for the near future. Besides this, it
also helps the business organisation in taking the decision whether it should proceed with such
proposal or not. Moreover, when the business unit takes a long time to recover the initial
investment then it negatively affects the profit margin of the firm. Thus, payback period method
will help the company in evaluating the several alternatives in an appropriate manner.
d. Assessing the viability of investment proposal
Calculation of cash flows
Ye
ar
Sales
(in $)
Expe
nses
Deprec
iation
Total
expense
s Profit tax
Profit
after tax
Cash
flows
Adjust
ments
Annu
al
cash
inflow
s (in
$)
1
20000
0000
14000
0000
606250
00
2006250
00
-
62500
0 -625000
60000
000
150000
00
45000
000
2 25000 12500 606250 1735000 76500 2295 5355000 11417 11417

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0000 0000 00 00 000 0000 0 5000 5000
3
32500
0000
16250
0000
606250
00
2110000
00
11400
0000
3420
0000
7980000
0
14042
5000
14042
5000
4
30000
0000
15000
0000
606250
00
1985000
00
10150
0000
3045
0000
7105000
0
13167
5000
157500
000
28917
5000
5
15000
0000
75000
000
1235000
00
26500
000
7950
000
1855000
0
18550
000
18550
000
Computation of NPV and IRR
year
Annual cash inflows
(in $)
PV factor
@ 12%
Discounted
cash flows
(in $)
1 45000000 0.893 40178571.43
2 114175000 0.797 91019610.97
3 140425000 0.712 99951741.3
4 289175000 0.636 183775940.3
5 18550000 0.567 10525768.17
Total
discounted
cash inflows 425451632.2
Initial
investment 422500000
NPV 2951632.19
Computation of IRR
Year Annual cash inflows (in $)
Initial investment -422500000
1 45000000
2 114175000
3 140425000
4 289175000
5 18550000
IRR 12%
The above-mentioned table presents that NPV and IRR of the investment proposal are
$2951632.19 & 12%. Hence, it has been identified that return of the firm is affected by the
decreasing pattern when the cost of capital increases. Besides this, the amount of return of such
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proposal also decreased due to the rise in the level of expenses. Hence, the company should
invest money in the above-mentioned proposal which will prove to be more beneficial for it in
financial terms.
TASK 3
a) Identifying Trump holding period
On 31 July 2012, the price of share was 41.52
On 30th November 2016 the share price was 57.75
Thus Trump's holding period return can be calculated as
= ((41.52 - 57.75)/ 41.52) * 100
= -39%
b) Evaluating CAPM model
Beta 1.3
RFR 2.50%
R(M) 10.00%
Required rate of return 12.25%
c) Evaluating the impact of policy changes on share price
Dividend policy of the firm sets certain guidelines which are required to be complied with when
deciding the amount of dividend that has to be paid to the shareholders. There is the presence of
various reasons for the change in Rio Tinto's dividend policy. This has been enumerated in the
manner stated as under:ï‚· Type of industry: The nature of the industry to which the company belongs to has a
greater impact on the dividend policy. Industries wherein the earnings have stability may
make adoption of the consistent dividend policy as it is being opposed to the industries
wherein the earning are uncertain as well as uneven (Kotha and Sahu, 2016). They have
better off in having the conservative approach to dividend payout.ï‚· Ownership structure: The ownership structure of the business also affects the policy to a
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greater extent. A firm that has higher promoter holding would prefer a lower dividend
payout as paying the dividend can result in causing the decline in the stock value.
However, a higher institutional ownership would favour a high dividend payout as this
assist in increasing the control on the management.ï‚· The extent of the share distribution: The companies that are newly developed would have
to retain the major part of their earnings for future growth as well as expansion. Therefore
they have to comply with the conservative policy, unlike the established firms that make
payment of higher dividends from their reserves.
ï‚· Different shareholder's expectations: Another major factor that affects the policy is
related to diversity in the kind of shareholders that is being possessed by the organisation
(Gharaibeh, 2016). A different shareholders group would have varied expectations. It is
important for the business to gain insight into the expectations and make the development
of successful dividend policy.
d) Giving suggestion regarding making investment decision
Table 1 Calculation of share price
D1 1.4729
K 20%
G 3%
Share price 8.66411765
Interpretation
It is advised to Trump that he must not make an investment in the Rio Tinto shares. This is
because currently shares are traded at 59.55 in the stock market. Based on valuation results of the
model intrinsic value of shares is 8.66. Hence, it can be said that firm share is available at the
very high price than real value. It can be said that shares are available at the high price than real
value. Hence, Trump must not make the investment in shares.
e) Assessing the share price
Table 2 Share price after three years
D 1.4729
G 0.03
R 0.21
Share price 7.19

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Interpretation
At the end of three-year, share price will be 7.19. Hence, it can be said that after three years the
fair value of Rio Tinto shares will be 7.19.
4. INVESTMENT
a. Calculating beta for the proposed portfolio
In the present time, performance level and financial condition of different types of
companies vary to the significant level. Both these are the main factors due to which volatility
level of the securities of one company to another differs. In the stock market, investors consider
beta to measure the risk level or volatility (Chaudhary, 2016). By making the evaluation of the
stock prices of Evolution Mining Ltd, Abacus property group, Mayne Pharma Group and ASX
300 it has been assessed that beta value is 1%. Thus, risk level which is associated with the
portfolio is 1% which is not higher. Thus, it is advised to the Board of Directors of Rio Tinto to
invest money in the proposed portfolio of such Australian Listed companies which will offer the
high level of financial benefit to it.
b. Calculating the required rate of return of the portfolio
Computation of required rate of return
R(m) 0.11
RFR 0.02
Beta 0.010
Required rate of return 0.02
The above-mentioned table shows that Rio Tinto requires 2% return for the risk will be
undertaken by it. Hence, such amount is lower which can be easily earned by the firm by
investing money in the shares of mining, infrastructure and biotech companies (Yadav, 2016).
c. Critically analysing the extent to which suggestions given by the finance director is
appropriate
Being an advisor, it has been identified that suggestions provided by the finance director to
Board are highly appropriate. Moreover, finance director suggested the board regarding the
adoption of the acquisition strategy, use of derivatives, etc. (Baillie and Cho, 2016). Thus, by
investing money in the profitable instruments, Rio Tinto can improve its financial position and
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performance.
CONCLUSION
From the above report, it has been concluded that process of corporate governance assists
Rio Tinto in ensuring effective management within the firm. Besides this, it can be revealed from
investment appraisal analysis that Rio Tinto should go with the proposed project. It can be seen
in the report by building the suitable portfolio Rio Tinto can assess beta and required rate of
return. Thus, by taking into account such information Rio Tinto can take suitable and profitable
investment decision.
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REFERENCES
Baillie, R. T. and Cho, D., 2016. Assessing Euro crises from a time varying international CAPM
approach. Journal of Empirical Finance. pp.39-45.
Chaudhary, P., 2016. Test of CAPM: A Study of India and US. International Journal of
Financial Management. 6(2).
Chikozho, C. and Jongh, D. D., 2014. Restoring degraded landscapes: Assessing the utility of
biodiversity offsets for the business sector in Africa. International Journal of African
Renaissance Studies-Multi-, Inter-and Transdisciplinarity. 9(2). pp. 61-76.
Gharaibeh, O.K., 2016. The Inter-Firm Value Effect in the Qatar Stock Market: 2005-2014.
International Journal of Business and Management. 11(1).
Kotha, K. K. and Sahu, B., 2016. Macroeconomic Factors and the Indian Stock Market:
Exploring Long and Short Run Relationships. International Journal of Economics and
Financial Issues. 6(3).
Rainey, H. J., and et.al., 2015. A review of corporate goals of No Net Loss and Net Positive
Impact on biodiversity. Oryx. 49(02). pp. 232-238.
Yadav, S., 2016. Role of CAPM to Analyse Risk & Return Relationship: Evidence of Indian
Stock Market. Asian Journal of Research in Banking and Finance. 6(3). pp.69-76.
Online
Annual report of Rio Tinto. 2012. [Online]. Available through:
<http://www.riotinto.com/documents/rio_tinto_2012_annual_report.pdf>. [Accessed on
28th December 2016].
Annual report of Rio Tinto. 2015. [pdf]. Available through:
<http://www.riotinto.com/documents/RT_Annual_Report_2015.pdf>. [Accessed on 28th
December 2016].

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