Mining & Metallurgical Economics

(MINE 402)

Spring 2022

Prof. Dr. Hussin Ahmed 1

Course description

General introduction: Minerals contributions to economic development-

Economic minerals, resources, reserves, new supplies, research demands,
consumption, recycling and depletion - Ore reserve estimation and grades;
mineral sales prices projection and NSR -Concept of time value of money,
interest rate, inflation, and cost indices - Estimating cost of mine development
and ore production operation, and smelter schedule - Cash flow construction,
time diagram, tax structure, and project viability- Spreadsheet computer
applications- Introduction to sensitivity and statistical analysis and review initial
feasibility reports.

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COURSE CONTENT
1. Course Introduction
2. Introduction to Engineering Economics
3. Common Methods of Project Evaluation
4. Mineral Resource and Ore Reserve
5. Commodity Price Forecasting
6. Capital & Operation Costs
7. Depreciation & Taxation
8. Inflation and exchange rate
 1 Assess purpose of mining economics, Minerals needs, contributions

2 Interpret concept: mineral resources, ore reserves, SA potential deposits

Course Learning Outcomes

3 Appraise ore values, market prices, environment and preservation.

4 Assess ore grade, cut off recovery, metal recovery, concentrate grade
(C.L.O.)

5 Compare interest rate, inflation, mine indices, time value of money

6 Compute, interpret cost estimation, capacity factor, nature of mining

7 List components of mine development, operating, stages of mining project

8 Construct cash flow over project life, tax structure, Decision making tools

9 Analyze valuation, marketing options, constraints, sensitivity analysis

Economic Analysis Methods
• Three commonly used economic analysis methods are
• Present Worth Analysis
• Annual Worth Analysis
• Rate of Return Analysis

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Present Worth Analysis

• Steps to do present worth analysis for a single alternative (investment)

• Select a desired value of the return on investment (i)
• Using the compound interest formulas bring all benefits and costs to present
worth
• Select the alternative if its net present worth (Present worth of benefits – Present
worth of costs) ≥ 0

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Present Worth Analysis

• Steps to do present worth analysis for selecting a single alternative

(investment) from among multiple alternatives
• Step 1: Select a desired value of the return on investment (i)
• Step 2: Using the compound interest formulas bring all benefits and costs to
present worth for each alternative
• Step 3: Select the alternative with the largest net present worth (Present worth of
benefits – Present worth of costs)

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Present Worth Analysis
• A construction enterprise is investigating the purchase of a new dump
truck. Interest rate is 9%. The cash flow for the dump truck are as
follows:
• First cost = $50,000, annual operating cost = $2000, annual income =
$9,000, salvage value is $10,000, life = 10 years. Is this investment worth
undertaking?
• P = $50,000, A = annual net income = $9,000 - $2,000 = $7,000, S =
10,000, n = 10.
• Evaluate net present worth = present worth of benefits – present worth
of costs

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Present Worth Analysis
• Present worth of benefits = $9,000(PA,9%,10) = $9,000(6.418) = $57,762
• Present worth of costs = $50,000 + $2,000(PA,9%,10) -
$10,000(PF,9%,10)= $50,000 + $2,000(6..418) - $10,000(.4224) =
$58,612
• Net present worth = $57,762 - $58,612 < 0  do not invest
• What should be the minimum annual benefit for making it a worthy of
investment at 9% rate of return?

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Present Worth Analysis
• Present worth of benefits = A(PA,9%,10) = A(6.418)
• Present worth of costs = $50,000 + $2,000(PA,9%,10) -
$10,000(PF,9%,10)= $50,000 + $2,000(6..418) - $10,000(.4224) =
$58,612
• A(6.418) = $58,612  A = $58,612/6.418 = $9,312.44

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Cost and Benefit Estimates

• Present and future benefits (income) and costs need to be estimated to

determine the attractiveness (worthiness) of a new product investment
alternative

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Annual costs and Income for a Product
• Annual product total cost is the sum of annual material, labor, and
overhead (salaries, taxes, marketing expenses, office costs, and related
costs), annual operating costs (power, maintenance, repairs, space costs,
and related expenses), and annual first cost minus the annual salvage
value.
• Annual income generated through the sales of a product = number of
units sold annuallyxunit price

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Rate of Return Analysis
• Single alternative case
• In this method all revenues and costs of the alternative are reduced to a
single percentage number
• This percentage number can be compared to other investment returns
and interest rates inside and outside the organization

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Rate of Return Analysis
• Steps to determine rate of return for a single stand-alone investment
• Step 1: Take the dollar amounts to the same point in time using the compound
interest formulas
• Step 2: Equate the sum of the revenues to the sum of the costs at that point in
time and solve for i

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Rate of Return Analysis
• An initial investment of $500 is being considered. The revenues from this
investment are $300 at the end of the first year, $300 at the end of the
second, and $200 at the end of the third. If the desired return on
investment is 15%, is the project acceptable?
• In this example we will take benefits and costs to the present time and
their present values are then equated

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Rate of Return Analysis
• $500 = $300(PF, i, n=1) + 300(PF, i, n=2) + $200(PF, i, n=3)
• Now solve for i using trial and error method
• Try 10%: $500 = ? $272 + $247 + $156 = $669 (not equal)
• Try 20%: $500 = ? $250 + $208 + $116 = $574 (not equal)
• Try 30%: $500 = ? $231 + $178 + $91 = $500 (equal)  i = 30%
• The desired return on investment is 15%, the project returns 30%, so it
should be implemented

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What’s the PV of $100 due in 3 Years if r = 10%?

Finding P is discounting, and it’s the

reverse of compounding.

0 1 2 3
10%

PV = ? 100

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 Economic equivalence
• Any cash flow can be converted to an equivalent cash flow at
any point in time

P1 + P 2 + P 3
V3

V1

0 T
V2 F1 + F2 + F3

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Economic equivalence
V1=$110

V2=$150 Time
V1=$110 V3=$120 0 1 2 3

=
V2=$150
0 1 2 3
Time
0 1 2 3
P=P1+P2+P3
V3=$120

Time
0 1 2 3

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Example : uneven-payment series
Consider given cash flow series, compute the equivalent lump-sum
amount at n=3 at 10% annual discount rate
$200
$150
$120
$100 $100
$80

0 1 2 3 4 5 6
Base
period

P=P0+P1+P2+P3+P4+P5
Answwer :
V (t  3)  100(1  0.10)3  80(1  0.10)2  120(1  0.10)1  150  200(1  0.10)1  100(1  0.10)2
 $776.36
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Common methods of project valuation
 IRR (internal rate of return)
Compare project with one different sized

 NPV (net present value)

Explicit measure of value

 Payback period
Easy to calculate, BUT ignores time value of money in case of simple PBP

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 Cash flow typical input
$3,200
Cash flow calculated from basic cash flow input
$2,700
+ Gross Revenue
$2,200
-Treatment, Refining, and Freight charges $1,700

-Royalties $1,200
$700
-Operating costs
$200
= Net Operating Income -$300
0 10 20 30
-Capital Expenditure -$800
-$1,300
-Working Capital
-$1,800
-Mining and income taxes (cash taxes) -$2,300
= Cash flow Capital Expenditure Net Revenue

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 Somewhere in the world

start-up
operation

construction
600
ramp-down
400

200
Cash flow ($M/year)

0
5 10 15 20
-200
Year
-400

-600

-800

-1000

• $2 Billion Preproduction Cost

• Total Reserves of 23.2M oz gold on a 100% basis
• An Average Annual Production is expected to be 750,000-825,000 oz gold and 190M-200 M lb copper
• up to about 90,000t in the first full five years of operation at total cash costs of US$200-US$250/oz.

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Year Cash Flow ($M) Cumulative CF Phase
Commutive Cash flow
1 -622.86 -622.86

2 -632.91 -1255.77 construction

3 -802.27 -2058.05

4 298.59 -1759.46 Cumulative cash flow is the

5 541.56 -1217.90 aggregated cash flow in any given
6 374.06 -843.84 time.
7 355.29 -488.55

8 518.41 29.86 Cum.CFn  Cum.CFn1  CFn

9 207.03 236.89

10 251.14 488.03
Example:
11 406.02 894.06
How to calculate the
12 321.90 1215.96 operation
cumulative Cash flow of year 7?
13 256.60 1472.56

14 324.80 1797.36

15 17.32 1814.68 Cum.CF7  843.84  355.29

16 124.08 1938.75
 488.55
17 433.54 2372.29

18 459.91 2832.20

19 368.76 3200.96

20 160.25 3361.21

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Cash flow vs Commutive Cash flow
4000

3000

2000

1000

0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
-1000

-2000

-3000
Cash flow Cumulative cash flow

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Payback period
The length of time required to recover the cost of
investment

Payback period

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Payback period
One simple measure of project appraisal
Larger payback period is not desirable

• Two measures:
1. Simple payback period
2. Discounted payback period
(later in the course when we talk about time value of money)

Decision rule:
Accept the project only of its payback period is less than target payback
period

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Simple payback period
For Even cash flow:
Simple payback period (SP)=
Initial investment (IC)/cash flow per period (f)
f f f f

Time
0

1 2 3 n

IC
IC SP 
f
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Example
• Company ABC is planning to undertake a project requiring initial
investment of $105M. The project is expected to generate $25M per
year for 7 years.

• 1. Draw a cash flow and cumulative cash flow diagram?

• 2. Calculate the simple payback period of the project?
• 3. Use MS Excel, plot the cash flow and cumulative cash flow in one
figure ?

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 $25M

0 Time

1 2 3 4 5 6 7

Payback period =4.2 years

$105M
105
SP   4.2years
25

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Simple payback period
For Uneven cash flow:
1- Calculate the cumulative net cash flow for each time
2- Simple payback period can be calculated as SP= A + (B/C)
where
A: is the last period with a negative cumulative cash flow
B: is the absolute value of cumulative cash flow at the end of period A (or at time A)
C: is the total cash flow during the period after A
f2 f3 fn
1 Time
0

2 3 n
B
f1
SP  A 
C
f0
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Example
• Company ABC is planning to undertake another project Y requiring
initial investment of $50M (Capital cost less than project X). The
project is expected to general $10M (year 1), $13M (year 2), $16M
(year 3), $19M (year 4), and $22M (year 5).

• 1. Draw a cash flow and cumulative cash flow diagram

• 2. Calculate the simple payback period of the project and check your
answer from the diagram

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 $13M $16M $19M $22M
$10M
0 Time

1 2 3 4 5 6

Payback period =3.58 years

$50M
Year Cash Flow Cumulative
$M Cash Flow $M
0 -50 -50 11
1 10 -40 SP  3   3  0.58
2 13 -27 19
3
4
16
19
-11
8
 3.58years
5 22 30

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 Decision regarding Project X
payback period
If you are the decision-maker in company
ABC and have to choose between project X
and Project Y, and you consider only one
piece of information or variable (the
payback period) and ignore other
variables, which project would you choose
and why? Project Y

$50M
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 Net Present Value (NPV)
The net present value is
the sum of the present
values of each of the
estimated cash flows of
the project. In the
discrete case
N
fRj  fCj N
NPVd   1  r     f
i j
j
j 1
Rj  fCj   P F , j , r 

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Quick review of cash flow analysis -
NPV … from any engineering economics textbook
Compound interest factors for single disbursements or receipts

Compound interest factors for Annuities

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 Comparing projects using IRR
One way to compare investments is to compare different rate of
returns for investments per each dollar invested.

The project rate of return is known as the internal rate of return

(IRR), i.e. the interest rate r* as such that when all cash flows
associated with one particular project are discounted at i* then the
PV of the inflows should be equal to the PV of the outflows.
In other words, the r* that makes NPV = zero

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 IRR for our example:
In principal , we will invest in any project that has an IRR equal or exceeding
MARR (minimum attractive rate of return) … 17.7% > 8%
(good investment)
$4,000

$3,500
NPV at 8% discount rate
$3,000
NPV in $2,500
$million
IRR = 17.7%
$2,000

$1,500

$1,000

$500

$0
0 3 6 9 12 15 18 21 24 27 30 33 36 39 42 45 48
-$500 Discount rate %/year
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