Financial Analysis and Management of Rio Tinto (APO004-6 Report)

This report provides a comprehensive financial analysis of Rio Tinto, a prominent company in the mineral and metal mining industry. It begins with an introduction to the company, its core objectives, and the business environment in which it operates. The report then delves into the company's capital structure and dividend policy, analyzing its financial performance over a three-year period, including key metrics such as EBIT, net profit, debt, and dividends paid. The analysis highlights the company's efforts to reduce debt and its consistent dividend payouts. The report further explores various capital investment appraisal techniques, including Net Present Value (NPV), Internal Rate of Return (IRR), Profitability Index (PI), Payback Period, and Accounting Rate of Return (ARR), explaining the implementation of each method and their relevance in investment decisions. The report concludes by summarizing the correlation between the company's objectives and its capital structure, emphasizing the importance of disciplined capital allocation and shareholder value creation.

FINANCIAL ANALYSIS AND MANAGEMENT
RIO TINTO

Contents
Introduction...............................................................................................................................2
Background of the company and the business environment...........................................2
Analysis of the capital structure and dividend policy of the company.............................3
Methods of capital investment appraisal..............................................................................4
Net Present Value (NPV)...................................................................................................4
Internal Rate of Return Method (IRR)..............................................................................5
Profitability Index Method (PI)...........................................................................................6
Pay Back Period..................................................................................................................6
Accounting Rate of Return Method (ARR)......................................................................7
Conclusion................................................................................................................................7
References...............................................................................................................................9

Introduction
Over the years, the globalised business practices have become all the more complex
and demand greater evaluation by the top management of the enterprise. One of the
most significant business decisions amounts to the choice of the capital structure
which refers to the careful balance between equity and debt that is used by the
businesses for the financing of the assets, day-to-day operations, and future growth
(Öztekin, 2015). The following work is aimed at analysing the various aspects of the
financial management in the context of the capital structure, investment appraisal
decisions and the various methods involved therein. The company chosen for the
analysis is Rio Tinto. The first section of the work would shed light on the core
objectives, the business environment, followed by the capital structure of the
company and the dividend policy of the company. The section would also comprise
of the analysis of the financial performance of the company together with the
comparison of the same. The next section of the company would elaborate on the
various techniques of the investment appraisal and the means of the implementation
of the same. Lastly, the work would highlight the correlation between the objectives
of the company and the capital structure.
The company Rio Tinto is known to be one of the most renowned companies that
are engaged in the mineral and metal mining industry. The core mining products of
the company include copper, diamonds, aluminium, uranium, coal and iron ore. The
company has its head offices in the UK as well as at Australia and is also dually
listed on both the London Stock exchange under the name Rio Tinto Plc and the
Australian Stock Exchange under the name Rio Tinto Limited. The company is
additionally forming a part of the FTSE 100 Index in the UK.
Background of the company and the business environment
The key business objective of the company as mentioned in the latest strategic
report of the company can be stated to be the creation of the superior value for
shareholders, meeting the needs of the customers’, maximisation of the cash from
the assets of the enterprise and the efficient allocation of the capital of the enterprise
(Rio Tinto, 2018a). The operations of the company are scattered in the areas of the
US, Canada, Japan, China, other parts of Europe and Asia, apart from the UK and

Australia. Thus, one of the significant factors that guide the business activities of the
enterprise is the regional and international statutes and regulations. Yet another key
factors that impact the operations of the enterprise very deeply are the geopolitical
uncertainties around the world and its economic and social implications.
It has been stated by the management of the company that one of the main strategic
business objectives of the company is the disciplined capital allocation together with
the sanctioning of the expenditure for the new investment projects (Rio Tinto, 2018b,
p. 12). Besides, the management of the company ensures that the expenditure for
the growth is always weighed against the return to the shareholders on the capital
employed.
In the context of the accounting framework, the management of the entity uses the
IFRS measures as well as the non-GAAP measures to assess the performance of
the enterprise as a whole.
Analysis of the capital structure and dividend policy of the
company
One of the key takeaways from the financial statements of the enterprise is that the
net debt of the company was further lowered in the year 2018 by $4.1 billion, as
compared to the year 2017. This not only represents a major change in the capital
structure of the enterprise but also is a positive feature in terms of the strengthening
of the balance sheet.
The following table represents the company’s financial performance over the period
of last three years, together with the dividend policy and the comparison of the same.
The below-mentioned figures are in the US $ million.
(2016)yr1 (2017)yr
2
(2018)yr3
EBIT 7116 14474 18200
Net
Profit
4776 8851 13925
Equity 45730 51115 49823
Debt 17470 15148 12847
Interest
Paid
1111 848 552
Dividend
s Paid
2725 4250 5356

The above EBIT has been calculated by the subtraction of the cost of goods sold
and the operating expenses from total revenue of the enterprise Rio Tinto.
As depicted from the table above, the enterprise is consistently lowering the debt
components in the capital structure and thereby reducing the interest payments as
well. The move is in line with the company's objectives of expanding yet being self-
sufficient. The significant reduction in the debt levels can also be attributed to the
overall reduction in the debt level in the mining sector as a whole (Rio Tinto, 2018b).
Further, it is vital to note that the company Rio Tinto has been consistently on the
positive trends in the context of the earning of the profits and the same are
generously shared with the shareholders of the enterprise in the form of the
dividends. Thus, as the profits are on the rising trends, so are the dividends paid by
the entity, which describes that a healthy balance has been created between the
growth objectives of the company and the distribution of what is earned.
It must be also noted that the overall return on capital employed (ROCE) for the
shareholders thus accounts to be to 19 per cent for the year 2018. The reduction in
the debt of the company from the capital structure would further lead to the
stabilisation of the share prices of the company, to gain a strategic advantage over
the competitors of the enterprise.
Methods of capital investment appraisal
The five primary techniques that can be used by the management for the evaluation
of the investment appraisal projects are the Internal rate of return method (IRR), Net
Present Value (NPV) method, Profitability Index (PI) method, Accounting Rate of
Return (ARR) method and lastly the payback period method. The management of
the enterprise can use one or more of the above-mentioned techniques depending
on the project and the options available. The implementation of each of the project is
explained as follows.
Net Present Value (NPV)
The technique is the most popular one and employs the time value of money to
arrive the decision of the selection of the project or the projects. Initially, the cost of
the capital is computed to be used as the discounting rate for the technique. The

administration of the technique involves the discounting of the estimated cash flows
arising out of the operations in the upcoming years from the project in question
(Brigham and Houston, 2012). The aggregate of the said present values is then
compared to the initial investment amount to arrive at the net present value. It must
be noted that the selection is based on whether the NPV is positive or negative. In
the case of the single project, the same must be selected if the NPV is positive and
vice versa. In case of the mutually exclusive projects, the project possessing the
higher NPV must be preferred by the management of an entity (Gallo, 2014).
The same can be described in the form of the formula as listed below.
NPV=∑
i=1
n CFi
(1+ d)i
= CF0 + CF 1
(1+k )1 + CF 2
(1+k )2 + …. + CF3
(1+k )3
Here:
k = discount rate,
CFi = net cash flow from year i,
CF0 = initial investment amount, and
n = number of years.
Internal Rate of Return Method (IRR)
The technique is next most popular after NPV and is also considerate of the time
value of money. The internal rate of return of the IRR is the representation of the
interest earned by a company on the capital investment employed (Arjunan, 2017).
The said rate is representation at different points of time in the context of the
investment proposal concerned. The determination of the IRR can be done by the
management by using the following formula as stated below.
IRR= 𝑑l + NPV at Dl
NPV at Dl -NPV at Dh❑
× d ifference in discount rates,
Here,

dh = higher discount rate.
dl = lower discount rate.
The IRR technique can be utilised to make the selection decision between two or
more independent projects. The general rule to be followed by the management to
make a selection based on the IRR is, the higher the IRR, the better it is. Thus, the
management must select the proposal with the highest IRR while using the said
technique.
Profitability Index Method (PI)
The technique denotes the ratio of the cash flows occurring from a project over the
years and the amount of the initial investment of the project concerned. Thus, the
investment appraisal technique is an attempt to draw the relationship between the
costs and benefits of a proposed project (Rὂhrich, 2014). The management of an
enterprise can employ the following formula for PI to make the evaluation of the
investment-
Profitability Index = Present value of future net cash flows
initial Investment
An increment in the value of the profitability index represents the financial
attractiveness of the proposed project. This is because in the said case, the ratio
indicates that present value (PV) of the project is more than the initial investment.
Thus, the management must note the fact that the profitability index of 1.0 or lower
than that are logically the lowest acceptable measures on the index, and the
proposals must be rejected in this case.
Pay Back Period Method
The technique leads to the calculation of the ratio which represents the time the
initial capital investment of the project recovered by the earning of the cash inflows of
any proposal concerned. Thus the formula that can be used by the management for
the computation of the payback period is-
Payback period = Cost of the proposal/ Annual cash inflows from the proposal

The Payback Period is a basic project selection method and in the case of the two or
more mutually exclusive projects, the project with the lowest payback period must be
preferred by the management. With this technique of the investment appraisal, the
management gets an edge in terms of the simplicity to operate and understand the
results and is best suited for small organisations whose operations are not that
complicated.
Accounting Rate of Return Method (ARR)
The technique is also referred to as the Average rate of return. The return refers to
the expected percentage rate of return on an investment or asset as against the
initial investment cost of the proposal. The management of an enterprise can
compute the ARR in two steps listed as follows. Firstly, the expected net operating
profits are divided by the initial investment, and the results are expressed. In the
second step, the result expressed as above is compared with a pre-decided rate of
return, initially regarded as the benchmark by the top management of the enterprise.
Thus, the ARR is used mainly as a general comparison between multiple projects
and aids the management in the determination of the expected rate of return from
each project (Corporate Finance Institute, 2018). Accordingly, the proposal with the
highest ARR must be accepted by the management and the rest must be rejected.
The formula for the ARR calculation can be prescribed as follows.
Accounting rate of return = Net operating profits
Initial Investments
The method is simple to be performed by the management for investment appraisal
and accounting profits of the enterprise play the chief role in the computation unlike
in the other methods, where the cash flows are utilised (Scott, 2012). The technique,
however, does not consider the time value of money and the results can be
misinterpreted, as the same is described in the form of the ratio and not the actual
profits.
Conclusion
The analysis conducted in the previous sections of the work, lead to the
establishment of the following conclusions on the capital structure of the enterprise
Rio Tinto. It can be concluded that the various sources of finance and the nature of

borrowings are significant elements of the balance sheet and are rightly termed as
the strategic business decisions because of the amount involved and the impact on
the business. The decision concerning the capital structure must be efficient enough
to be in line with the overall corporate objectives of an enterprise. As seen from the
case study of the company Rio Tinto, which is a well-known name in the field of the
metal and mining industry, it can be stated that sound capital allocation policies lead
to the stabilised business operations and facilitate the company to gain a competitive
advantage as well. The company Rio Tinto has been consistently investing in major
capital assets and projects and the success can be rightly attributed to the sound
capital structure. Currently, the company is engaged in the reduction of the debt
component. Thus, The capital structure of the company has improved as that from
the last year. The company has been additionally considering major capital
investments to attain the overall development objectives and growth of the entity.
In addition to the above, the work also highlighted the various methods of capital
appraisal which can be used by the management of the entities to assess the
viability of the capital expenditures. The administration of each investment appraisal
technique is different and has individual pros and cons.

References
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Schedule and an Insight into Why NPV Is Not the Appropriate Criterion for Capital
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Available from:
https://corporatefinanceinstitute.com/resources/knowledge/accounting/arr-
accounting-rate-of-return/ [Accessed on: 21/07/2019].
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21/07/2019].
Öztekin, Ö. (2015) Capital structure decisions around the world: which factors are
reliably important?. Journal of Financial and Quantitative Analysis, 50(3), pp. 301-
323.
Rio Tinto (2018a) 2018 Strategic report [online] Available from:
https://www.riotinto.com/documents/RT_2018_strategic_report.pdf [Accessed on:
21/07/2019].
Rio Tinto (2018b) 2018 Annual Report [online] Available from:
http://www.riotinto.com/documents/RT_2018_annual_report.pdf [Accessed on:
21/07/2019].
Rὂhrich, M. (2014) Fundamentals of Investment Appraisal: An Illustration based on a
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Scott, P. (2012) Accounting for Business: An Integrated Print and Online Solution.
Oxford: Oxford University Press. p. 342.