Kettle Mountain Mining Inc. V2 (Adapted with permission of CMA Canada) Andre Rousseau Phd (Environmental Studies), a naturalist and resident of the Northwest Territories discovered multiple mineral deposits beginning in the mid 1990’s. Rousseau incorporated Kettle Mountain Mining Inc (KMM) in 1999 with the intent of developing the mineral deposits and pledged that his company will add to the quality of life within the surrounding community. The company remains private. Rousseau says “Going public would mean bowing to the almighty earnings per share and having to answer to the analysts instead of the citizens.” He did, however, recognize that there may be short run trade offs between economic benefits and social fabric of the community and a zero environmental footprint In 2002, the company discovered a promising seam just outside the town of Carlsbad. Preliminary sampling indicated high concentrations of several valuable minerals including G2, S2 and P1. In 2003, the mine shaft was constructed along with a processing plant and administrative offices. The development of the mine lead to the economic revival of the town of Carlsbad. During 2003, twenty new homes, a sixty-unit trailer park and several new businesses were established. Mining and processing operations began in January 2004 and have continued without interruption since that date. KMM currently operates at 80% capacity due to transportation restrictions (see below). During 2011, the company removed 310,000 tonnes of ore from the mine. The future life of the mine is expected to be twenty-five years. Industry analysts suggest that companies of this nature should earn a 12% real pre-tax profit on sales (after negating the effects of inflation). Rousseau figures the analysts are in a dream world. KMM has never met the 12% pre-tax target. The company consistently earns more than its (real) 5.5% WACC (weighted average cost of capital). The cost of transporting personnel and materials between Carlsbad and the closest railway link during the summer months has become prohibitive. Furthermore, the northern isolation of Carlsbad has resulted in a high turnover of production and administrative personnel. The process of extracting the minerals begins with the removal of ore by drilling and blasting the underground ore body. The raw unrefined ore must then be transported to the surface and crushed so that the particles are no greater than 1/60 of a centimetre in diameter. The crushed ore is then ready to enter the refining process. The total cost of mining and crushing the ore amounts to $30.65 per tonne. In order to extract the usable minerals, the crushed ore passes through three processes: amalgamation, electrolysis and purification. In the first stage, called amalgamation, mercury is added to the unrefined ore. The mercury combines with the valuable minerals forming a compound which is drawn off. This compound is then heated causing the mercury to vaporize leaving a compound residue which will yield 30% G2, 60% S2, and 10% P1 by weight (for example: for every 100 grams of residue that exist after amalgamation, 30 grams of G2, 60 grams of S2 and 10 grams of P1 will exist). 10 grams of residue is obtained per tonne of ore placed in the process. The vaporized mercury is condensed and reused the next day. The total cost of the amalgamation process is $ 0.4503 per gram of residue recovered. Each year the company must invest an additional $280,000 to replace mercury lost in the atmosphere due to evaporation during the recovery process. The second process is called electrolysis. In this process, the residue from the amalgamation process is cast into thick slabs which are hung in large vats of acid. When an electric current is passed through the vat, pure G2 (PG2) is transferred to separate plates. When the G2 plates and acid are removed from the vat, S2 is recovered. There is a 10% loss of acid into the
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environment. Replacement cost of the acid averages $100,000 each year. The total cost of the electrolysis process is $ 0.3200 per gram of residue placed in the vat. At this point, the PG2 plates are 99.9% pure and can be sold on world markets. The current market price for PG2 is $ 13.3333 per gram but mine officials are aware that future prices may rise or fall from this level depending on the state of the world economy. During the past three months, the price has ranged from $ 11.5000 to $ 14.0000 per gram. S2 can be sold after electrolysis for $ 0.1533 per gram or it can be further purified. Purification costs are $ 0.0433 per gram of pure S2 (PS2) produced, which can be sold for $ 0.2000 per gram (both the $ 0.1533 and $ 0.2000 prices have remained relatively stable during the past year and management expects no significant changes during the next year). This purification process reduces the volume of the S2 product by 20%. (1 unit of S2 = 0.80 unit of PS2) The P1 can be sold after electrolysis for $ 14.3333 per gram or further purified and sold as PP1 for $ 18.3333 per gram. Purification results in a 10% reduction in the volume (1 unit of P1 = 0.90 units of PP1). The total cost of purification is $ 1.6200 per gram of PP1. During the winter, food and supplies are brought to the mine and the town of Carlsbad from Whitehorse on a winter road built over the frozen tundra and lakes. Whitehorse is KMM's closest link to a railway line. Once the supply trucks are emptied, processed minerals are loaded for shipment to outside markets. The total cost of winter road transportation was 2 million dollars 2011. This cost was split equally between KMM and the residents of Carlsbad. During the spring, summer and fall periods, all shipments between Whitehorse and the mine site have to be made by float plane and helicopter. KMM spent a total of 3.5 million dollars on these flights during 2011. No figures were available on summer transportation expenditures for local businesses and residents. The high cost of transporting supplies and personnel to the mine site and getting processed minerals to the outside market is of great concern to the management of KMM. They are now considering the option of building a railroad from Carlsbad to Whitehorse. Preliminary studies have indicated that construction of the railroad would cost 80 million dollars and that a train (engine, box cars, caboose, and a passenger car) would cost an additional 25 million dollars. With the railroad, KMM would be able to charge the residents of Carlsbad for freight and passenger fares for trips to and from Whitehorse. It is estimated that the revenue collected from freight and passenger fares would amount to $ 570,000 per year. The operating and maintenance costs (not including interest and depreciation) for the railroad would be $ 240,000 and $ 140,000 per year respectively. The company will have to support the operations with $1,000,000 of additional working capital. KMM expects the railroad and train to last for 25 years with no salvage value at the end of that time. The capital cost allowance for the railroad and train are set up at 4% and 10% respectively and KMM would depreciate the fixed assets for financial reporting purposes using the straight-line method. Management believes that the railroad would eliminate the need for summer air freight and winter roads between Carlsbad and Whitehorse. Also, administrative costs ($1,250,000 in 2009) would be reduced by 25% because KMM would no longer have to pay large isolation bonuses to key personnel. Transportation costs from Whitehorse to outside markets would remain at approximately $ 3,300,000 next year. The effective corporate tax rate is 40%. If construction were to begin in the summer of 2012, the railway would be ready for use by January 2013. The railway will allow KMM to produce at 100% capacity. Before such a railroad could be built, KMM would have to obtain permission from the Territorial government and the town councils of Carlsbad and Whitehorse. It appears that there is some opposition to this
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proposal from certain members of the councils and various levels of government. Everyone is concerned about the impact of the railroad on the environment including the disruption of the caribou calving grounds just outside of Carlsbad. On the other hand, it appears that building the railroad would create new employment opportunities in both towns and stimulate growth throughout the region. KMM has petitioned the federal government for a 50% subsidy to offset the costs of building the railroad and buying the train. The federal government has indicated that this request will be approved provided support is obtained from all stakeholders. Should the subsidy be granted, KMM would receive all revenue and incur all operating and maintenance costs of the railroad. The subsidy will be shown as an offset to the capital cost for financial accounting (depreciation) and income taxation (capital cost allowance) purposes. The company’s bank has agreed to finance the railway. The pre tax charge on the bank debt will be 11%. Due to the size of the investment, entering into the a debt agreement with the bank will increase KMM’s WACC to 5.8% (real). Dr. Rousseau is unsure whether to proceed with the rail road or not. He realizes that the issues facing KMM are complex and require a level of expertise beyond his own knowledge of business management which has come from experience. He has contracted John Kenneth George CMA to provide a report containing appropriate issue identification, analysis (financial and non-financial), and recommendations including an assessment of the risk that the major variables present. Required As JK George CMA, prepare the report as requested by Dr. Rousseau.

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