Cours - 2018

Mining Project Evaluation
Kouayep Lawou Sylvain, EGEM-Université de Ngaoundéré

Special thanks to Cédric Dalmasso, Centre de Gestion Scientifique, Mines ParisTech PSL,
M. Le Breton, L. Noury, M. Duchêne and D. Goetz for their help
Schedule
Novembre Novembre Novembre Novembre Novembre
12 13 14 15 16
Mining Mining
Mining Mining
Property Property
Property Property
Evaluation Evaluation
a.m. Evaluation
Loans,
Evaluation Application
Depreciation, Differential
NPV, IRR, PBP Excel tools
Taxes project, Risk
p.m. Application Application Application Application Evaluation

Mining Property Valuation
What is Valuation ?
When do you consider Valuating ?
What is Valuation?
o You valuate a property when you assess its fair market value in monetary terms
o It provides potential investors with information regarding the desirability of ownership
of the property
When do you consider valuating?

o Acquisition or sale of the property
o Merger
o When a partner leaves and needs monetary compensation
o When assessing property taxation
What are the techniques you can use?
1. The book value approach (BV)

2. The comparable transactions method
3. The market comparison method
4. The Discountable Cash Flow method (DCF)
1. The Book Value Approach
1. The Book Value Approach
The Book Value Approach:

o Book Value = net worth of a firm on the date of assessment
BV = value of the firm ($)

BV = TA -L TA = Total Assets of the firm ($)
L = liabilities of the firm ($)
o The Book Value is assessed by assessing net worth after elimination of any hidden
reserves
o Hidden reserves can be found in undervalued assets (e.g. real estate) or overvalued
liabilities (e.g. provisions for reclamation)
How reliable/applicable is the Book Value approach?

o It is based on historic performance as it is reflected in the balance sheet
o It doesn’t take into account future income potential (although it is the primary interest
of the potential buyer)
It is rather used as a complementary method or in special cases such as the

departure of a business partner
2. The Comparable Transactions method
The Comparable Transactions method:

o Fair market value is derived from a review of the sales price of comparable transactions
made in the recent past
o Given differences in size, location, etc., adjustments have to be made (mark-ups,
discounts)
o Also, data from comparable previous transactions has to be updated using appropriate
industry index that best reflects annual price increases
How reliable/applicable is the Comparable Transactions method?

o In classical cases, it is considered by most appraisers and courts to provide the best
approximation of fair market value because it reflects the actual market (in particular for
real estate or agricultural property)
o However, regarding mines:
• Each mineral deposit is unique (grade, size, shape, rock mechanics, location…)
• There are only a limited number of sales of mining properties so comparative data
is limited
As a result, the Comparable Transactions method is rarely applicable for mining

projects
Examples of transactions vs in situ value per tonne ore

Examples of transactions vs deposit size

3. The Market Comparison Method
3. The Market Comparison Method
The Market Comparison method:

o With this method, property value equals how much investors pay for stocks of similar
firms traded on the stock exchange market
V = value of the firm ($)

V = PE * Profit PE = Average Price Earnings ratio
Profit = profit after tax ($)
SP = Share price quoted ($/share)

PE = (SP * N) / Profit N = Number of shares
How reliable/applicable is this method?:

o PE ratios can vary considerably over time and from industry to industry which limits the
applicably of this method
This method can provide additional information where stocks of comparable

companies are traded on the stock exchange and average PE ratios for the industry
can be derived
4. The Discounted Cash Flow method
The Discounted Cash Flow method (DCF):

o This method stipulates that the fair market value of a property is determined by the
future earnings it will generate
V = value of the firm ($)
NPV = Net Present Value ($)
CF = Cash Flow of year t
= Discount factor of year t
n = number of years
i = interest rate
How reliable/applicable is the method?

o Investors are primarily interested in the future cash flows the property will generate
This is why this method is considered the best method to valuate

1. Mining firms
2. Mining properties
3. Mineral deposits
Main steps of the Discounted Cash Flow method (DCF):
Estimate future annual cash flows (including any re-investments necessary

to maintain operations)
Only future cash-flows are relevant here
Determine appropriate discount rate (i.e. a discount rate that reflects

properly the risk associated with an investment in the property)
Calculate the net present value (NPV) of the expected future annual cash-
flows with the appropriate discount rate defined earlier
Why are classical methods non applicable to
Mining Property Valuation?
What are the techniques you can use?
1. The book value approach (BV) In practice, the DCF method is

2. The comparable transactions method considered most reliable to
3. The market comparison method valuate the market value of a
4. The Discountable Cash Flow method (DCF) property
From Cash Flow to Net Present Value
Introduction
Evaluation difficulties
Deciders need a summary of all the flows of revenues and
expenses occuring during the whole life of the project
(several decades):
1) Yearly Cash Flow
Necessitates assessment of yearly

cash-flows ie Revenues less
Expenses for a given period
Investment Operating
expenses Costs
Break down of :
Yearly Taxation
revenues
1) Yearly Cash Flow
60
40
Sales
20
Monetary Flows
0
-15 -10 -5 0 5 10 15 20 25 30
Exploration -20
expenses -40 Operating Expense

Revenue
cost
-60
-80
-100
-120
Construction
cost
-140
Years
1) Yearly Cash Flow
The need for a reference in view of decision

Estimation of a project is estimation of the change
compared to the continuation of the past (no sunk
costs)
All calculations are made in « constant

money », without inflation ; actualisation does
not take inflation into account
1) Yearly Cash Flow
Investment
expenses A surprising investment expense :
http://vimeo.com/97409369
2) From Cash Flow to Present Value
These cash-flows will be actualised ie reduced
to their Present Value
Compounding
2015 Interest rate 2016

= 10%
100 EUR 110 EUR
Compounding

= 10%
100 EUR 161,051 EUR
Compounding

= 10%
100 EUR 100 * (1,1)5 EUR
Present value of CFn = CFn / (1+a)n

= 10%
161,051 /(1,1)5EUR 161,051 EUR
discounting
Values for « a » real actualisation (or discount)

rate in constant money, without risk
- Real rate of interest for cash
- Real cost of access to capital or
opportunity cost
- Practical value without inflation = 5%
(IBOR, Gov Bonds,…)
Compounding
A*(1+a)n = B
2015 Interest rate 20…

A = 10% B
B/(1+a)n = A
discounting
3) From Present Value to Net Present Value
All actualised cash-flows will be summed

to produce the Net Present Value (NPV)
NPV = Σ (CFn / (1+a)n )
Present Value F0/(1+a)0 F1/(1+a)1 F2/(1+a)2 …………. Fn/(1+a)n
Net Present Value = F0/(1+a)0 + F1/(1+a)1 + F2/(1+a)2 + …………. + Fn/(1+a)n

Net Present Value
Present Value
CFn / (1+a)n Σ (CFn / (1+a)n )
Net Present Value

yearly cash-flows
Exercise 0
I = 270 ; Ru = 50 ; N = 18 ; i = 8%
TIME CASH FLOWS
Zero CF0 = -270

1 CF1 = 50
2 CF2 = 50
.
.
n CFn= 50
.
.
18 CF18= 50
Is this a profitable project?

Some other synthetic tools
Some other synthetic tools
Some other synthetic tools will be derived from the

sequence of cash-flows
Internal Rate of Return (IRR)
Payback period (PBP)

The internal rate of return on an investment or project is the

"annualized effective compounded return rate" or rate of
return that makes the Net Present Value (NPV) of all cash
flows (both positive and negative) from a particular
investment equal to zero.
Decision criterion
If the IRR is greater than the cost of capital, accept the project.
If the IRR is less than the cost of capital, reject the project.
PayBack Period (PBP)
Payback period (PBP)
Payback period in capital budgeting refers to the period

of time required to recoup the funds expended in an
investment, or to reach the break-even point.
Tools and mining project
Net Present Value

Internal Rate of Return
Pay Back period
These synthetic tools may be used :

- Before a project: feasibility studies
- In the course of the project: mining property due diligence
- At the end of project: Cash balance
Application
Exercise 1
Time Expense Revenue
-10 0
-9 -1
-8 -2
-7 -3
-6 -4
Exploration cost -5
-4
-5
-6 Past
-3 -7
-2 -8
-1
0
1
-9
-10
-40 Present
Is this a
Construction
profitable
2 -80
cost
3 -120
4 -30 20
5 -25 50
6
7
8
9
-25
-25
-25
-25
50
50
50
50
project?
10 -25 50
11 -25 50
12 -25 50
Operating cost
13 -25 50
Sales
Estimation
14
15
16
-25
-25
-25
50
50
50
i = 7%
17 -25 50
18 -25 50
19 -25 50
20 -25 50
21 -20 0
22 -15
23 -15
End of mine
24 -10
25 0
Exercise 2
Investment : 270 M EUR

0re deposit in year 0 : 45 M tons
Production : 2,5 M tons / years
Operating Cost : 16 EUR / tons ore
Revenue : 40 EUR / tons ore
i = 8%

Exercise 2 bis

Production : 2 M tons / years
i = 7%

Exercise 3
I need an equipment for 3 years :
Either I buy :
 buying price 300 ; salvage value 30% at year 3
Or i rent :
 renting cost 80 / year
Operating and maintaining cost are the same in both

situations for instance 100 / year
i = 5%
Rent or Buy ?
Exercise 4
Detour by closure :
Mine closed in 1982.

In 1989, a problem emerges: the water of the river is
saturated in Zinc
Solution: build a plant to process the water : 3 M EUR
Operating cost of the plant : 0,3 M EUR per year during
30 years
i = 6%
Question :
Which amount of money the State should get from the company to
allow it to leave definitely (« cash adjustement »)?
Exercise 5
Detour by closure :

saturated in Zinc
Operating cost of the plant : 0,3 M EUR per year
i = 6%
Question :
Exercise 6
Detour by closure :

saturated in Zinc
Operating cost of the plant : 0,3 M EUR per year
Operating Investment every 15 years: 1M EUR
Question :
Morgane Le Breton & Cédric Dalmasso, Centre de Gestion Scientifique, Mines ParisTech PSL
Special thanks to L. Noury, M. Duchêne and D. Goetz for their help
Schedule
Novembre Novembre Novembre Novembre Novembre
12 13 14 15 16
Mining Mining
Mining Mining
Property Property
Property Property
Evaluation Evaluation
a.m. Evaluation
Loans,
Evaluation Application
Depreciation, Differential
NPV, IRR, PBP Excel tools
Taxes project, Risk
p.m. Application Application Application Application Evaluation

Loans, Taxes & Depreciation
Loans (emprunt)
Loans
There are 3methods to

calculate loans:
 The in fine method

 The constant amortization method
 The constant payment method
The in fine method
With this method, the interest is constant and the principal is payed at
the end :
Interest 5% 5 years
principal 20000
Time Principal Interest Amortisation Yearly payment
1 20000 1000 0 1000
2 20000 1000 0 1000
3 20000 1000 0 1000
4 20000 1000 0 1000
5 20000 1000 20000 21000

The constant amortization method
With this method, the amortization of the loan is constant but the
payment is degressive :
Interest 5% 5 years
principal 20000
Time Principal Interest Amortisation Yearly payment
1 20000 1000 4000 5000 5000 = 1000 + 4000

2 16000 800 4000 4800
4000 = 20000/5
3 12000 600 4000 4600
600 = 1200*0,05
4 8000 400 4000 4400
8000 = 12 000 - 4000
5 4000 200 4000 4200
Exercise 7
Principal : 50 000
Interest rate : 10%
Lenght of the loan : 5 years
What is the yearly payment for each period?
Time Principal interest Amortisation Yearly payment
5
The constant payment method
With this method, the payment is constant, which means that the
amortization will not be linear.
First, you need to calculate the payment as follows:
P = annual payment
P = Capital * i/(1-(1+i)^-n) i = interest rate
n: total number of periods for the loan
Interest 5% years 4
Capital 20000
5640,24 = 20 000 *
yearly amount 5640,24 0,05/(1-(1+0,05)^-4)
Time Remaining loan interest Amortisation Yearly payment
1,00 20000,00 1000,00 4640,24 5640,24 1000 = 20 000 * 0,05
2,00 15359,76 767,99 4872,25 5640,24
4872,25 = 5640,24 – 767,99
3,00 10487,51 524,38 5115,86 5640,24
10 487,65 = 15 359,76 – 4 872,25
4,00 5371,65 268,58 5371,65 5640,24
Exercise 8
P = annual payment
Principal : 50 000 n: total number of periods for the loan
Interest rate : 10%
What is the yearly payment for each period? What will the amortization be?
5
Exercise 9

@ = 8%
Loans : 150 M ; i = 10% ; 10 years

- In fine
- Constant amortisation
- Constant payment
What is the best loan method ?
Exercise 10
P = annual payment
n: total number of periods for the loan
Interest 12% years 15
Capital 125000
What is the yearly payment for each period? What will the amortization be?
15
Exercise 11
P = annual payment
Yearly interest rate : 5%
Monthly payment
What is the yearly payment for each period? What will the amortization be each year?
…
Exercise 12
P = annual payment
Yearly interest rate : 10%
Monthly payment
What is the yearly payment for each period? What will the amortization be each year?
…
Royalties & Taxes Types
Taxation Unit based (specific royalty)

Value based (ad valorem) royalty
Profit based royalty or tax
Hybrid royalty
Resource rent by tax
Exercise 13

@ = 8%
1) First case : Royalties : 0,5 EUR / ton

2) Profit tax : 33%
Depreciation
Depreciation
There are two methods to

calculate Depreciation:
 The linear method

 The degressive method
The linear method
With this method, the depreciation is constant,.

First, you need to calculate the payment as follows:
Time Ivt Depreciation %

3500
1 700 20%
2 700 20%
3 700 20%
4 700 20%
5 700 20%
3500 100%
The Degressive method
With this method, the depreciation is degressive.

First, you need to determinate the coef. as follows
(and the degressive %)
Year Coef.
2-4 1,25
degresive linear Degressive linear Book
5-6 1,75 Years Base rate rate amount amount Amount value
+6 2,25 1 3500 35% 20% 1225,00 700,00 1225,00 2275,00
2 2275,00 35% 25% 796,25 568,75 796,25 1478,75
3 1478,75 35% 33% 517,56 492,92 517,56 961,19
4 961,19 35% 50% 336,42 480,59 480,59 480,59
Year linear Degressive 5 480,59 35% 100% 168,21 480,59 480,59 0,00
5 20% 35%
1/5 = 20% 20% * 1,75 = 35%

The Degressive method
Another example
Buy at the begining of June

Year Coef.
2-4 1,25
degresive linear Degressive linear Book
5-6 1,75 Years Base rate rate amount amount Amount value
+6 2,25 1 3500 35% 20% 714,58 408,33 714,58 2785,42
2 2785,42 35% 25% 974,90 696,35 974,90 1810,52
3 1810,52 35% 33% 633,68 603,51 633,68 1176,84
4 1176,84 35% 50% 411,89 588,42 588,42 588,42
Year linear Degressive 5 588,42 35% 100% 205,95 588,42 588,42 0,00
5 20% 35%
Exercise 14
reserves 600 Mt Rate 0,05

Mt/
Capacity 38 y
N y
Investment 7000 M$
Operating cost 50 $/t
Revenues 100 $/t
Royalties 5,00 $/t
Income tax 30%
Depreciation
(regressive) 10 years
Exercise 15
reserves 600 Mt Rate 0,05

Capacity 38 Mt/y
N ? y
Investment 7000 M$
Operating cost 50 $/t
Revenues 100 $/t
Loan 7 years 3000 M$
interest rate 12%
constant payment
Royalties 5,00 $/t
Income tax 30%
Depreciation
(regressive) 10 years
Comparaison of 2 different financial structures
• We chose a project thanks to the NPV.

• Then, we can calculate a financial NPV (F NPV)
in order to compare between 2 financial
structures for the project
Financial NPV : exercise 15 bis
• I = 8,5 M euros
• Time : 5 years
• Linear depreciation
• Revenues – operating costs :
Year 1 Year 2 Year 3 Year 4 Year 5
1,5 M 3M 5M 6M 6M
• Situation 1 : self financing

• Situation 2 : 60% self-financing, 40% loan
• (interest rate 8%, in fine payment)
Questions about the NPV criterium :
a special case (16)
• How can we chose between the 2 projects ?

• I = 90 000, Y = 5 years, i = 10%
Project 80 000 50 000 20 000 5 000 5 000

1 (CF)
Project 2 5 000 5 000 40 000 80 000 100 000

(CF)
The limits of the NPV criterium (17)
• Problem 1 : 2 projects with 2 different

durations ?
– Example : which is the best project between
– Project 1 : 6 years, I = 450, CF = 190 CF, i = 3%
– Project 2 : 12 years, I = 4000, CF = 530, i = 3%
??!
• Problem 2 : The NPV value is VERY sensistive
to the hypothesis chosen…
Becarefull : not relevant for mining project evaluation
Problem 1 : different durations
• First solution : we consider that we can do

again the same 2 projects endlessly…
• … we find the smallest common multiplier !
Problem 1 : different durations (17)
• Example
• Exercise :
• Second solution : Equivalent report yearly

payment
• It’s the NPV « constant report yearly
payment » (CRYP) when you discount NPV on
the total duration of the project.
CRYP = NPV * i/(1-(1+i)^-n)

Problem 1 : different durations
• It’s like the constant loan yearly payment !

• Remember :
P = Capital * i/(1-(1+i)^-n)
• Here, the CRYP : CRYP = NPV * i/(1-(1+i)^-n)
• You will chose the project with the biger CRYP

• Example :
• Exercise :
Problem 2 : many hypothesis
• For only one mining project, there are an

infinite number of possible NPV…
• It depends on the hypothesis chosen by the
companies
• Be carefull : the NPV varies a lot (high
sensibility) with the hypothesis chosen.
• Let’s be convinced…
• Remember :
• NPV decision choice results from 2
comparaisons :
– First : between the discounted revenues and costs
(if IRR > 0) => THE CALCULATION OF CASH FLOWS
IS VERY IMPORTANT
– Second : between project rate of return and firm
request of rate of return (if IRR > requested rate of
return = discount rate ; if NPV > 0) => THE CHOICE
OF DICOUNT RATE IS VERY IMPORTANT
Problem 2 : many hypothesis (20)
• Simulation exercise…
• I = 8,5 M ; 5 years ; i = 6% ; D = 3 M
• CF : Year 1 Year 2 Year 3 Year 4 Year 5
1,5 M 3M 5M 6M 6M
• NPV = -I + Σ CF/(1+i)^t + D/(1+i)^N

• With D = salvage value – reconditionning cost
Not relevant for mining project

• First of all…
• …The choice (or the right calculation of) the
residual value D is decisive !!! (D like Decisive)
• And often hard to determine : zinc traitment
cost, sell to another mining firm, etc.
Hypothesis about the discount rate
• How is the discount rate (i) chosen ?

• Theoretical definition : it is the minimal rate of
return requested by the investor (m) + a risk
premium (r)
• i=m+r
• How is dtermined the minimal rate of return

required (m) ?
• The firm determines its weighted average cost of
capital (wacc) (cmpc in french) :
• WACC = (D*kD + E*kE)/(D+E)
• How is determined the equity cost ?

• With the CAPM : kE = kNR + B(kR – kNR)
• How is determined the risk premium (r) ?

Hypothesis about the discount rate (21)
• Exercise :
• I = 8,5 M ; 5 years ; D = 800 M (kD = 4,5%) ;
E = 1500 M (kE = 7%) ; CF = 3 M (for the first
3 years) and 5 M (for the last 2 years) ; r =
2%
• Am I going to invest in this project ?

• PROBLEM : it assumes that you reinvest the cash-flows

at the same interest rate than the minimal required
rate of return… but actually it differs a lot !!
• What does NPV tell us ?

• It answers the question : is it better to invest I today in
order to have CF later or is it better to keep I and put it
in the bank to get interest ?
• Let’s look at the board explanation !

• Solution : integrated NPV : how does it work ?

– We compound cash-flows at the market rate
– And we discount the value at discount rate
Hypothesis about the cash-flows
• Cash-flows includes some « difficult to check »

parameters such as : depreciation, revenues
(because of the volatily price of ore), etc.
Hypothesis about the cash-flows
• Gold price variation in 2012…

Hypothesis about the duration
• How long am I going to operate a mine ?

• It depends on the deposit, etc.
Actually…
• Actually the firm calculates for itself NPV

including risk scenarios, like : in situation 1, I
will get NPV 1, in situation 2 (if ore price is
higher), I will get NPV2 … etc.
• …And the firm can show to other people (the

state ; or the bank) another NPV (very low to
pay very low tax ; very high to get very big
loan with very little interest rate) …
Beyond the DCF : real options method
• It’s based on the pricing options methods

• The will to buy a mine (the choice to invest or
not) is considered as an option (the right) to
have or not future revenues from the mining
project
• You calculate this value of the right
(mathematical game…) to decide if you want
to invest or not or when.
The real options method
• Better than the NPV because no need for

discount rate and choice under uncertainty !
• But hard to determine : high complexity.
22)
23
Synthesis
Evaluation
@ 0,07
Invt 1000
Reserves 400
Capacity 38 Royalties : 0,5 $/T
N Tax = 0,3 (30%)
Op. cost 55
Revenue 65
Depreciation 7 years degressive
500, constant payment i = 10% N = 7

Or
Loans (3 types) 400, in fine i = 10%, N=7
or
500, constant amortisation, N=7
What is the NPV without loan (with tax) ?

What is the best loan ?
What is the NPV for the shareholder ?

Cours - 2018

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Cours - 2018

Uploaded by

Copyright:

Available Formats

Mining Project Evaluation

Kouayep Lawou Sylvain, EGEM-Université de Ngaoundéré

p.m. Application Application Application Application Evaluation

When do you consider valuating?

What are the techniques you can use?

1. The book value approach (BV)

The Book Value Approach:

BV = value of the firm ($)

How reliable/applicable is the Book Value approach?

It is rather used as a complementary method or in special cases such as the

The Comparable Transactions method:

How reliable/applicable is the Comparable Transactions method?

As a result, the Comparable Transactions method is rarely applicable for mining

Examples of transactions vs in situ value per tonne ore

Examples of transactions vs deposit size

The Market Comparison method:

V = value of the firm ($)

SP = Share price quoted ($/share)

How reliable/applicable is this method?:

This method can provide additional information where stocks of comparable

The Discounted Cash Flow method (DCF):

How reliable/applicable is the method?

This is why this method is considered the best method to valuate

Main steps of the Discounted Cash Flow method (DCF):

Estimate future annual cash flows (including any re-investments necessary

Determine appropriate discount rate (i.e. a discount rate that reflects

What are the techniques you can use?

1. The book value approach (BV) In practice, the DCF method is

Necessitates assessment of yearly

expenses -40 Operating Expense

The need for a reference in view of decision

All calculations are made in « constant

2015 Interest rate 2016

2015 Interest rate 2020

2015 Interest rate 2020

2015 Interest rate 2020

Values for « a » real actualisation (or discount)

2015 Interest rate 20…

All actualised cash-flows will be summed

NPV = Σ (CFn / (1+a)n )

Present Value F0/(1+a)0 F1/(1+a)1 F2/(1+a)2 …………. Fn/(1+a)n

Net Present Value = F0/(1+a)0 + F1/(1+a)1 + F2/(1+a)2 + …………. + Fn/(1+a)n

CFn / (1+a)n Σ (CFn / (1+a)n )

Net Present Value

Zero CF0 = -270

Is this a profitable project?

Some other synthetic tools will be derived from the

Internal Rate of Return (IRR)

Payback period (PBP)

Internal Rate of Return (IRR)

The internal rate of return on an investment or project is the

Payback period (PBP)

Payback period in capital budgeting refers to the period

Net Present Value

These synthetic tools may be used :

Investment : 270 M EUR

Is this a profitable project?

Investment : 200 M EUR

Is this a profitable project?

I need an equipment for 3 years :

Operating and maintaining cost are the same in both

Mine closed in 1982.