Corporate Finance: FMG Company Analysis and Capital Budgeting

CORPORATE FINANCE
STUDENT ID:
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Question 2
a) FMG is a company which is actively engage in iron ore production and supply to various
global customers especially based in China and Japan. It belongs to the mining industry and
is the 4th largest producer of iron ore globally. Majority of the mines of the company are
located in Western Australia in the vicinity of Pilbara region. The total tenement area in this
region held by FMG is greater than the larger players i.e. BHP Billiton and Rio Tinto.
Considering the large reliance of the company on iron ore, in recent times efforts have been
made on the part of the company to make foray in other minerals mining particularly copper,
gold and lithium. It is noteworthy that the company is not only involved in iron ore
production but also provides the necessary infrastructure which is required to transport this
material first to the port through relevant railway links and later to the end customers through
six iron ore carriers.
A key opportunity that FMG can actively seek is in the form of exploring mining
opportunities in other minerals with a favourable choice being lithium as the underlying
demand of this mineral is ever increasing. A key threat for the company is in the form of high
dependence on iron ore thereby making the company vulnerable when the iron ore demand
falls and both prices and volumes are adversely impacted. Another key threat is concerns
with regards to environment and the potential concern it could have on the operations of the
company.
(b) Cash Conversion Cycle Computations
The above computations are based on the following data that has been extracted from
Morningstar.

The above values of cash conversion cycle indicate the inventory has reduced owing to which
the cash conversion cycle has become shorter which augers well for the company as the
working capital requirements would be reduced. In order to support the reduction in
inventory, relevant shipping data of iron ore to key clients located in Japan and China need to
be obtained for the years under consideration.
c) The financing sources information taken from Note 9 is illustrated as follows.
The equity financing seems to the prominent funding source as the company is lowering debt
but increasing equity as apparent from FY2017 figures when compared with FY2016. The
advantages with regards to equity financing are illustrated below (Parrino and Kidwell,
2014).
 Credit risk does not arise as no need for any repayments in regards to the capital
amount raised by share issue.
 The operational profitability is not hampered on account of higher finance costs which
would have been the case in debt funding.
 There is higher flexibility with regards to use of equity funding owing to absence of
debt covenants.
The disadvantages linked to equity financing are illustrated below (Damodaran, 2015).
 Higher cost of equity in comparison to debt cost thus raising the overall cost of
capital.
 The company cannot realise lower tax outflows facilitated through interest payments.
 Equity dilution takes place where the promoter control and shareholders holdings are
adversely impacted.