Update on Merger with Polymetals - Notice of Meeting

APPENDIX 3 – DISCOUNT RATES
SXG
We have derived a discount rate for SXG to apply to the future cash flows of the Marda Project prior to
the Transaction on a stand alone basis as set out below.
Determining the correct discount rate, or cost of capital, for a business requires the identification and
consideration of a number of factors that affect the returns and risks of a business, as well as the
application of widely accepted methodologies for determining the returns of a business.
The discount rate applied to the forecast cash flows from a business represents the financial return that
an investor would require if they were to acquire (or invest in) the business.
The capital asset pricing model (“CAPM”) is commonly used in determining the market rates of return for
equity type investments and project evaluations. In determining a business’ weighted average cost of
capital (“WACC”) the CAPM results are combined with the cost of debt funding. WACC represents the
return required on the business, whilst CAPM provides the required return on an equity investment.
Cost of Equity and Capital Asset Pricing Model
CAPM is based on the theory that a rational investor would price an investment so that the expected
return is equal to the risk free rate of return plus an appropriate premium for risk. CAPM assumes that
there is a positive relationship between risk and return, that is, investors are risk averse and demand a
higher return for accepting a higher level of risk.
CAPM calculates the cost of equity and is calculated as follows:
CAPM
K e = R f + β x (R m – R f )
Where:
K e
R f
R m
R m – R f
β
= expected equity investment return or cost of equity in nominal terms
= risk free rate of return
= expected market return
= market risk premium
= equity beta
The individual components of CAPM are discussed below.
Risk Free Rate (R f )
The risk free rate is normally approximated by reference to a long term government bond with a maturity
equivalent to the timeframe over which the returns from the assets are expected to be received. Having
regard to the period of the operations we have used the current yield to maturity on the 10 year
Commonwealth Government Bond which was 3.27% per annum as at 27 May 2013.
Market Risk Premium (R m – R f )
The market risk premium represents the additional return that investors expect from an investment in a
well-diversified portfolio of assets. It is common to use a historical risk premium, as expectations are not
observable in practice.
We have noted that the current market risk premium is 6%. This has been sourced from Bloomberg. The
market risk premium is derived on the basis of capital weighted average return of all members of the S&P
200 Index minus the risk free rate is dependent on the ten year government bond rates. For the purpose
of our report we have adopted a market risk premium of 6%.
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