SOA_FAP_Mod1Exercise01-01Assignment.pdf

Module 1 Exercise: Can-Do MiningIntroduction Module 1 introduced you to actuarial work and the Control Cycle framework used by actuaries to complete their work. The elements of the Control Cycle include reviewing the relevant External Forces while working through the Define the Problem, Design the Solution and Monitor the Results stages and while applying Professionalism to the work. In Module 1, you reviewed the history of the actuarial profession with special emphasis on how the Control Cycle has formed the foundation for actuarial work for some time. What is actuarial work? How would the famous actuaries of the past answer this question? We think the evidence is that they would have replied: “Actuaries apply actuarial skills to gather and analyze the best information they can possibly find about trends, risks, demographics and cultural practices while adhering to the Control Cycle when approaching a problem so that they can design solutions that minimize risk and monitor the results on behalf of their clients.” What are actuarial skills? Actuarial skills certainly include the application of the Control Cycle, the analysis of risk, the determination of mathematical equivalence, effective general business abilities and enabling skills such as being able to communicate the results of the work. You will be asked to use all of these skills in this Module 1 End-of-Module Exercise. As you work through the tasks described below, ask yourself these questions: • • • • • • Could this be a routine actuarial assignment in the future? Is the 15% contingency sufficient and reliable? What elements of the Control Cycle are covered in this exercise? What are the key or material elements of the problem? Who are the audiences for the written communication? Have I communicated clearly and in a way that my audiences would prefer? Questions similar to these form the foundation of all actuarial work. Your Role It is the end of 2005. You are an employee in the Finance Department of Can-Do Mining Limited (Can-Do), a Canadian-based subsidiary of USA Mines, Inc. Normally you spend your time on more conventional actuarial issues (e.g., employee and retirement benefits), but occasionally you are pulled into other matters. This is one of those times. About Your Company Can-Do is considering the purchase of the South Face Mine, which is owned today by Mountain Mining Canada Limited (MMCL). MMCL is a Canadian-based subsidiary of Mountain Mining Corporation, a U.S.-based holding company with operations located throughout North America. © 2003 - 2013 Society of Actuaries | SOA_FAP_Mod1Exercise01-01Assignment.docx| Page 1 Read the memorandum and complete all the tasks Wilder describes. which is critical to Can-Do’s negotiating strategy. A walk-away point is the amount at which a buyer (seller) in a negotiation would rather walk away from a deal than pay more (accept less). however. Therefore. the Vice President of Mergers and Acquisitions. a property owned by Can-Do. These concepts can be found in the Excel files that you used in the Credit Insurance case study in Section 5 of this module. costs MMCL would clearly like to transfer to Can Do. Moreover. B. MMCL recognizes the strategic advantages of the South Face Mine to Can-Do. and has since followed-up with a detailed memorandum describing exactly what he would like you to do. the walk-away point is the highest amount Can-Do would be willing to pay to acquire the South Face Mine.2013 Society of Actuaries | SOA_FAP_Mod1Exercise01-01Assignment. you should be familiar with these formulae: t (1 + i) —The accumulated value of $1 over a period of t years given an annual rate of interest of i. the projected remaining lifetime of the North Fork Mine. Although the South Face Mine is of little value to any other mining company. return to the Fundamentals of Actuarial Practice course and use the facility to upload your completed exercise files. MMCL has closed the South Face mine and is faced with decades of closure and reclamation costs. In this situation.5 million annually for the next 20 years. is a savvy company. t -t v = (1 + i) —The discounted value today of $1 payable t years from now given an annual rate of interest i. When complete. t ≥ 0. It can be calculated as the difference between the values of the cost savings Can-Do would expect to realize and the additional costs it would expect to incur as a result of the purchase of South Face Mine. He has asked you to include your calculations in this Excel file so that a complete package can be handed over to management. its strategic location would enable Can-Do to cut the costs of operating its North Fork Mine by up to $1. Wilder has begun to try to determine the walkaway point.The Business Problem South Face Mine is located adjacent to the North Fork Mine. you will note that several worksheets use interest discount functions.docx| Page 2 . If Can-Do purchases South Face Mine. As a reminder. t ≥ 0. Wilder has asked you to help determine the walk away point. MMCL. he has included an Excel spreadsheet containing several worksheets that have been prepared by other Can-Do personnel. A Note About Formulae Used in This Exercise During this exercise. To complete the assignment. you can expect MMCL to drive a hard bargain. Your Assignment As Can-Do begins to develop its negotiating strategy for the purchase of South Face Mine. -1 v = 1/(1 + i) or (1 + i) © 2003 . you will be required to do the same. During this exercise... A Note About Reporting When reporting the results of their work. © 2003 . The sensitivity test answers the question “how much lower. Thanks Special thanks are offered to the anonymous donor of the data used in this exercise. $2 million) and in percentage terms (e.A Note About Sensitivity Tests You will note that Wilder asks you to complete sensitivity tests for a number of assumptions with respect to the closure and reclamation costs.. the answer) will change under a given scenario. professional actuaries are explicit about the data. the lump sum value of reclamation costs will be lower if the costs last 20 years rather than 25 years. Under a sensitivity test.2013 Society of Actuaries | SOA_FAP_Mod1Exercise01-01Assignment. You should follow the specific outline provided by B.e.” both in absolute (e. methods and assumptions used.docx| Page 3 .g. For example. Wilder in his memorandum. a 5% drop).g. you simply alter your model or an input to your model to determine how much the model output (i. Our engineers and financial analysts have been hard at work estimating the cost savings we could realize if we purchase the South Face Mine. Please prepare three sensitivity tests of the duration of the costs in MMCL’s projections by adding: • One year to the short term costs. MMCL’s projections are reported on both an FAS and on a management basis. Wilder VP. Some are short term. Please identify any other risks we should be concerned about. In addition. it has to report to the parent in accordance with the US Financial Accounting Standards (FAS). Sensitivity test the discount rate assumption of 6% by assuming it changes to both 5% and 7%. Like Can-Do. © 2003 . • Two years to the short term costs. Inflation is not reflected in MMCL’s projections. These savings could be up to $1. Can-Do Re: South Face Mine Date: December 11. this salvage value will accrue to Can-Do. that remains on site. please keep in mind that Can-Do may be able to bear some costs at little or no marginal cost. however. They would remain with MMCL.2013 Society of Actuaries | SOA_FAP_Mod1Exercise01-01Assignment. Re-value MMCL’s projections and the durational sensitivity tests using an inflation assumption of 3% and no contingency allowance. MMCL has recognized the residual (salvage) value of the equipment.g. etc. please ensure that you remove the costs that you would not expect to be transferred to Can-Do and reflect any cost benefit that Can-Do would realize from internalizing some of the costs (for example. MMCL has provided us with its current work papers regarding these costs. mines accessed horizontally from the side of the earth rather than from straight down). The sensitivity tests will enable us to examine the risks associated with the duration of the post closure costs and with inflation and investment income during the post closure period. Can-Do may have inspectors on staff who can conduct required inspections at no marginal cost to Can-Do. Notice that there are five separate worksheets in this file. please determine the inflation rate that is equivalent to the 15% contingency allowance.e. and • Five years to the long term costs. We suspect the management projections are more complete but you should review all to ensure your analysis is complete. Also sensitivity test the inflation rate assuming the rate increases to 4%. Finally note that MMCL has included a 15% contingency allowance in its calculations. Mergers and Acquisitions. Costs have been projected through 2026 by MMCL. most of these will be incurred within five years. When reviewing MMCL’s cost projections. For example. 2. Others are annually recurring costs that will be incurred during the entire reclamation period. severance costs).. Our economists project that inflation during this period will run between 3% and 6% annually. Please note that I’ve included a detailed description of each worksheet in the appendix.-based holding company. Based upon MMCL’s projections and assuming a 6% interest rate for discounting purposes.Memorandum To: FAP Module 1 Candidate From: B. If Can-Do purchases the South Face Mine. Based upon this information. MMCL is a Canadian-based subsidiary of a U.xls.. As you examine MMCL’s work papers. They can be found in the Excel spreadsheet entitled SOA_FAP_Mod1Exercise01-02AssignmentSpreadsheet.docx| Page 4 . inspections). through a combination of improved surface logistics and optimal location of new drift mines (i. please prepare a written memorandum that answers or addresses the following questions or issues: 1. Other costs will not be transferred to Can-Do (e. 4. be aware that there are three different types of costs. When calculating this value. Most of the salvage value would be earned in 2006. 3. 5. there could be savings over the next 20 years. Their analysis shows that. Offsetting these savings.5 million the first year and will increase with inflation in subsequent years. There are clearly risks that the durations of MMCL’s short and long term cost projections will be exceeded.S. The projections were produced for separate purposes at MMCL. 2005 Thank you for agreeing to support our analysis of the potential purchase of the South Face Mine from Mountain Mining Canada Limited (MMCL). are closure and reclamation costs that we would assume as part of the purchase. you should familiarize yourself with each. As such. 2013 Society of Actuaries | SOA_FAP_Mod1Exercise01-01Assignment. I look forward to receiving your results! © 2003 . • Modified Budget Valuation Detail—Similar to 2006 Budget Valuation Detail but should be tied to the Modified Budget worksheet. which you should create in Microsoft Word (or compatible word processing program).xls should be used to complete your analysis. the value of the cost savings should be incorporated. • Introduction—This section of the memorandum expands upon the background offered in the executive summary. conclusions and recommendations. Important information about the data such as a summary. 7. If you have any ideas for managing the risks identified. It should clearly state your major conclusions. what are the key risk factors (i. These are described below. • Analysis: Methods & Assumptions—This section of the memorandum describes the methods and assumptions used to generate your results and to develop your observations. at what amount do you recommend we set our walk-away point? Based upon all of your work. Your report must summarize the data. extracted from the existing 2005-2006 Mgmt Budget Summary worksheet. • Sensitivity Tests—Summarizes sensitivity tests. Your Deliverables You should prepare two deliverables: a written memorandum and an enhanced spreadsheet. Good executive summaries state recommended actions to address any outstanding issues and state any outstanding concerns in a compelling way.. • Data—This section of the memorandum summarizes data for the readers of actuarial reports. • Modified Budget—Modifies the existing 2006 Budget worksheet to eliminate and/or adjust MMCL’s expenses to the level that Can-Do would expect to incur. 8. methods and assumptions that you use in your analysis. in which the amounts reported in the worksheet Net Value of Acquisition are collected. The Enhanced Spreadsheet The Excel spreadsheet SOA_FAP_Mod1Exercise01-02AssignmentSpreadsheet.6. the summary often identifies the data. • Conclusions and Recommendations—This section of the memorandum succinctly reiterates the findings of the memorandum. • Net Value of Acquisition—Similar to Present Value of Add’l Costs but should be tied to Modified Budget Valuation Detail. As a result. could be organized as follows: • Executive Summary—This section of the memorandum summarizes in a single page the issues that we should be most concerned about and provides background to the reader in a few sentences. The Memorandum After you’ve completed your analysis to arrive at your answers or to address the issues presented above. to be included in the Analysis section of your memorandum. its source and its strengths and weaknesses. Consider adding the following worksheets to this file before submitting: • Data Summary—Summarizes key data. Again. Detail such as data adjustments can be placed in an Appendix. thank you for agreeing to support our analysis of the potential purchase of the South Face Mine. Based upon all of your work. the most important assumptions) in your assessment? Management will use your report. please include them in your report. it should well-organized and understandable. (The appendix on the following page describes each worksheet in this spreadsheet. In addition. For actuarial reports. its source and how it was modeled. • Value of Contingency—Shows how the inflation rate that is equivalent to the 15% contingency allowance was determined. commentary and weaknesses of the data should normally be part of the body of the report. • Modified Budget Summary—Extracts the Modified Budget worksheet to summarize modifications made to 2006 Budget.docx| Page 5 . to be included in your memorandum. Your memorandum.) As part of your assignment. Really good observations set the stage for the following sections. This section also provides observations about the data that help the reader understand the data.e. you should modify this worksheet to complete your analysis and to generate tables to integrate into the Data and Analysis sections of your memorandum. please write a memorandum reporting your results. Worksheet 1: “2006 Budget” Includes all of the data provided by MMCL. the “2005 Budget for 2006+ Costs” column shows estimates of the costs beginning 1/1/06 as estimated for the 2005 Budget. Identifies the year in which the expense begins Identifies the number of years for which MMCL budgeted an expense item Identifies the number of years during which an expense item is incurred in a specific sensitivity test. Wilder. NA has been entered into the Severance item only.2013 Society of Actuaries | SOA_FAP_Mod1Exercise01-01Assignment.xls. Again. The “Total 2006 Budget” column shows estimates of the costs beginning 1/1/06 as estimated for the 2006 Budget. Years J Annual Amount Description Identifies whether an expense is direct or indirect Identifies the Major Category to which each expense item is assigned Identifies the Minor Category to which each expense item is assigned Describes each expense item (Yes/No) Identifies expense items that must be reported to the US parent according to the FASB (Short/Long/NA/Salvage) Identifies whether an expense item will be incurred before the end of the projection period (Short). The column headings are defined below. consists of five worksheets. SOA_FAP_Mod1Exercise01-02AssignmentSpreadsheet. or is a recoverable asset (Salvage). Based upon the guidance provided by B.docx| Page 6 . The column labeled “2005 Budget for 2006+ Costs” shows comparable information as estimated one year prior.Appendix: MMCL Closure and Reclamation Costs Workpapers The Excel spreadsheet. The value of Test No. through the entire projection period (Long). which are described below. Amount of expense item during each year it is incurred © 2003 . Years Test No. That is. Worksheet 4: “2006 Budget Valuation Detail” Restructures the data shown in 2006 Budget in order to facilitate the valuation and sensitivity testing of the additional costs Can-Do will incur if it acquires South Face Mine. Inflation is not reflected Sum of columns F-Z Worksheet 2: “2005-2006 Mgmt Budget Summary” Summarizes the data in 2006 Budget in a pivot table. Worksheet 3: “2005-2006 FAS Budget Summary” Summarizes only the data in 2006 Budget that relates to information as it is required to be reported by the FASB for purposes of US Generally Accepted Accounting Principles (US GAAP). candidates should consider whether other expense items should also be identified as NA or if other expense amounts should be adjusted. does not apply to Can-Do (NA). Years (column H) plus a value that is entered on the worksheet Present Value of Add’l Costs. The column headings are defined below: Column A B C D E Column Heading Direct/Indirect Major Category Minor Category Description FAS? F Short/Long/Salvage/ NA G H I Begin Year No. Years equals No. the column labeled “2005 Budget for 2006+ Costs” shows comparable information as estimated for the 2005 Budget. Column A B C D E F-Z AA Column Heading Direct/Indirect Major Category Minor Category Description FAS? 2006-2026 2006 Budget Description Identifies whether an expense is direct or indirect Identifies the Major Category to which each expense item is assigned Identifies the Minor Category to which each expense item is assigned Describes each expense item (Yes/No) Identifies expense items that must be reported to the US parent according to the Financial Accounting Standard Board (FASB) Estimated cash flow by expense item by year. Column K L Column Heading Value @ 1/1/Begin Value @ 1/1/06 Description Present value as of Begin Year (column G) of an immediate annuity certain of Annual Amount (column J) at the Effective Discount Rate. The calculation assumes that all expenses are paid at mid-year. (See worksheet Present Value of Add’l Costs. and note the total value with the 15% contingency allowance. To refresh a pivot table. (Hint: To determine the inflation rate equivalent to the 15% contingency allowance.) © 2003 . These differences are due to rounding and may be ignored.) Present Value as of 1/1/2006. when discounting at 0% interest with 0% inflation and a 15% contingency allowance. modify and/or eliminate cash flows according to Wilder’s guidance on 2006 Budget Valuation Detail. you must refresh the pivot table. there are minor differences between the values shown on this worksheet and the values shown on 2005-2006 Mgmt Budget Summary and 2005 – 2006 FAS Budget Summary. The Effective Discount Rate is the discount rate adjusted for inflation. Worksheet 5: “Present Value of Add’l Costs” Calculates the present value of the additional costs that Can-Do will incur if it acquires the South Face Mine. Sensitivity tests may be performed by entering values into the cells highlighted in yellow.” Note that. Then eliminate the 15% contingency and solve for the inflation rate that reproduces the same value. Each time any of the values in the yellow cells is changed.docx| Page 7 . right-click on any cell in the pivot table and left-click on “Refresh Data.2013 Society of Actuaries | SOA_FAP_Mod1Exercise01-01Assignment.