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PRINCIPLES OF

MINE ECONOMICS :

Basic Mine Investment Analysis

Dr. Rudianto Ekawan


Department of Mining Engineering
Institute Technology Bandung - Indonesia

Mine Economics Course


8-9 May 2008
Singapore

Mining Economics Course, 8-9 May 2008, Singapore

The Time Value of Money


A dollar today is worth more than a dollar in the
future.
Time value of money exists for at least three reasons:
1. Inflation
2. Uncertainty
3.Opportunity Cost

Principles of Mine Economics

Mining Economics Course, 8-9 May 2008, Singapore

Time value of money (1)


The value of money (purchasing power) changes over time
Money amount concept
A mathematical concept which result does not depend on time

$ 1.00 (yr 2000) = $ 1.00 (yr 2008)


Value of Money concept
Amount of money at different time will have different value

$ 1.00 (yr 2000) $ 1.00 (yr 2008)

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Mining Economics Course, 8-9 May 2008, Singapore

Time value of money (2)


Value of money depends on :
Discount rate (i)
$ 1.00 (t=0) = $ 1.00 (t=1) + (i x $ 1.00)
Number of year

Principles of Mine Economics

Mining Economics Course, 8-9 May 2008, Singapore

Discount Rate (1)

Discounting :
A large future amount of cash is
reduced to its smaller current equivalent

Discounted Cash Flow Analysis encounters a


problem in determining suitable discount rate value

actual discount rate determination is too complex

There are various type of discount rate

Principles of Mine Economics

Mining Economics Course, 8-9 May 2008, Singapore

Discount Rate (2)


Type of Rate

Description

Opportunity cost of capital Foregone benefits that would have been received from
the next best investment opportunity
Risk-free alternative

Return from a risk-free instrument, such as U.S.


Treasury bill. Note that even these instruments are not
entirely risk-free because of risks related to the
exchange rate and rate of inflation.

Cost of debt

A rate based on the cost of borrowed funds

Weighted average cost of


capital (WACC)

A risk-adjusted rate that weighs a firms cost of


equality and the cost of debt by the debt-to-equality
ratio

Historical rate of return

A rate of return based on constant or current


performance of past investments

Risk-adjusted rate of
return

Any rate based on a constant or current return adjusted


for project risk. The capital asset pricing method
(CAPM) is often used to determine such a rate.

Principles of Mine Economics

Mining Economics Course, 8-9 May 2008, Singapore

Discount Rate (3)


Type of Rate

Description

Hurdle rate

Any specified minimum rate of return, regardless of


how derived

Social rate of return

A rate used to determine the value of social projects.


This rate accounts for issues of equity and morality as
well as financial aspects of an investment

Varying discount rate


over time

A rate that reflects changes in risk overtime. For


example. The risks can change once all capital has
been recovered and minimum rate of return achieved

Varying discount rate by


cash flow line item

A rate that reflects the difference in risk among


various cash flow components. For example, working
capital and inventory charges have lower risks than
capital charges for new tecnologies

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Mining Economics Course, 8-9 May 2008, Singapore

Discount factor (4)


=
=

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+
+

+ e .

Mining Economics Course, 8-9 May 2008, Singapore

Investment Basic Variable


P: Present single sum

F: Future single sum

A: Amount in a uniform series of equal payments

n: Number of interest periods

i: Period interest rate

C: Capital Investment

L: Salvage Value

I: Period Income

TIME DIAGRAM
A

F
0

n-1

n-1

I
L
n

or

C
0
Principles of Mine Economics

Mining Economics Course, 8-9 May 2008, Singapore

Interest Formula
find

given

equation

Formulas name

Functional
symbol

Single cash flow :


F

(1+i)n

1
(1 + i ) n

Single payment compound amound


Single payment
present worth

(F/P

i%,n)

(P/F

i%,n)

Uniform series (annuities) :


F

(1 + i ) n 1
i

(1 + i ) n 1
i (1 + i ) n
i
(1 + i ) n 1
i (1 + i ) n
(1 + i ) n 1

Uniform series compound amount


Uniform series present
worth

(F/A

i%,n)

(P/A

i%,n)

Sinking fund

(A/F

i%,n)

Capital recovery

(A/P

i%,n)

The key to converting project alternatives to an equivalent


basis is use of "time value of money" accounting.
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Single Payment Compound Amount Factor (1)

Company has to pay a reclamation bond to the government


for each hectare of land disturbed. The funds are in trust,
earning interest at 6% compounded annually, until
reclamation is complete, whereupon they are returned. If
you disturb 40 hectares of land this year and the bond is
$50,000 per hectare, how much do you expect to get back
when reclamation is completed in 3 years time?
Answer:
Present value (of money paid out now)
$50,000 x 40 = $2,000,000
Compound factor
(1 + 0.06)3 = 1.191
Future value
$2,382,000

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Mining Economics Course, 8-9 May 2008, Singapore

Single Payment Present Worth Factor (1)

You have received bids from two manufacturers for purchase of a


new dragline. The first bid is very competitive but is from a
company that requires payment in full on placement of an order.
The second bid is for a higher price, but no payment is required
until the machine starts digging 3 years hence. Which is the
preferred option? If the first dragline is purchased, what is the
effective return on investment for the 3 years?
Dragline A bid price (today)
Dragline B bid price (in 3 years time)
Required return on capital (discount rate i)
Taxation
Time (n)

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$30,000,000
$40,000,000
15%
Ignore
3 years

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Mining Economics Course, 8-9 May 2008, Singapore

Single Payment Present Worth Factor (2)

Answer:
Present value of purchasing dragline B 3 years
$40,000,000 X 0.6575 = $26,300,000

Thus, dragline B has a lower cost than dragline A in present value


terms.

Compound factor for investment in dragline A vs dragline B


$40,000,000/$30,000,000 = 1.3333
Effective return on investment over 3 years
(1+i)3 = 1.3333
i = 1.33330.3333-1
= 10.06%

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Mining Economics Course, 8-9 May 2008, Singapore

Sinking Fund Factor (1)

A contractor has purchased a new hydraulic excavator for a 5year-life job. He expects the excavator to last 8 years but knows
that he will also have to perform a major overhaul on it costing
$1,000,000 at the end of the 5-year period. The overhaul cost will
be built into the bid price for the job, with annual payments being
placed in a sinking fund invested at 8% compounded per year. If
the excavator works 3,000 hours per year, how much should be
budgeted (and set aside) per hour to provide for the major
overhaul?
Sinking fund return on funds
8%
Taxation
Ignore for this example
Cost of major overhaul
$1,000,000
Time (n)
5 years

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Mining Economics Course, 8-9 May 2008, Singapore

Sinking Fund Factor (2)

Answer:
Sinking fund factor
= 0.08/(1.085 1)
= 0.08/0.4693
=0.1705
Equivalent annual amount to set aside
= $1,000,000 x 0.1705
=$170,456/year
Hourly cost
= $170,456/3,000
= $56.82/hour

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Mining Economics Course, 8-9 May 2008, Singapore

Capital Recovery Factor (1)

The expected life of a rope shovel is 16 years, after


which time the mine will close and the salvage value
will be effectively zero. What is the annual owning
cost, including allowance for return on your capital
invested in the rope shovel? If the shovel works 6,000
hours per year, what is the hourly cost?
Required return on capital (discount rate i)
15%
Taxation
Ignore for this example
Cost of rope shovel
$7,000,000
Time (n)
16 years

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Mining Economics Course, 8-9 May 2008, Singapore

Capital Recovery Factor (2)

Answer:
Capital recovery factor
= 0.15 / [1 (1 / 1.15)16 ]
= 0.15 / [1 0 . 1069 ]
= 0.1679
Equivalent annual cost of shovel over 16 years
= $ 7,000,000 x 0.1679
= $ 1,175,300/year
Hourly cost $1,175,300/6,000
= $ 195.88/hour

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Investment Evaluation Technique

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Mining Economics Course, 8-9 May 2008, Singapore

Introduction (1)

Investment evaluation techniques is used to convert


information and experience regarding exploration,
exploitation and project interest to get expected value and
risk criteria
Investment evaluation technique may be applied to study
exploitation planning based on cash flow estimation and
time value

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Introduction (2)

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Mining Economics Course, 8-9 May 2008, Singapore

Principle in Selecting
Investment Proposal

Larger profit is better than the smaller one

Faster profit is better than the slower one

Evaluation result must be consistent and realistic

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Mining Economics Course, 8-9 May 2008, Singapore

General Equation in Investment Analysis

Present Worth (PW) equation :


PW Cost = PW Revenue

Annual Worth (AW) equation :


Eq Annual Cost = Eq Annual Revenue

Future Worth (FW) equation :


FW Cost = FW Revenue

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Mining Economics Course, 8-9 May 2008, Singapore

Net Value Analysis (1)

Based on differences between Net Revenue/Positive


Cash Flow (inflow) and Net Cost/Negative Cash
Flow(outflow)
Net Value Analysis is divided into :
Present value
Annual value
Future value

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Mining Economics Course, 8-9 May 2008, Singapore

Net Value Analysis (2)

Present Value

A present amount of money (beginning of a project, t


=0) which has an equivalent value in the future ( along
the life of a project) at a certain rate of return (i)
Estimation of value or assets
S

PWB

Benefit

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PWC

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Net Value Analysis (3)

NPV = A (P/A i,n) + S (P/F i,n) C


or

n CFt
NPV =
I0

t
t =1 (1 + i )

CFt = Cash flow on year t

I0
i
n

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= Early investment
= discount rate
= Total project period
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Mining Economics Course, 8-9 May 2008, Singapore

Internal Rate of Return (1)

Rate of return value to investor that is calculated every year


Measurement of capital use efficiency or the rate of wealth
accumulation
IRR indicates the return per invested money
The larger IRR the more profitable an investment in
restoring the capital

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Mining Economics Course, 8-9 May 2008, Singapore

Internal Rate of Return (2)

Investment rate of return (%) when NPV = 0

n
CF t
NPV = 0 =
t = 1 (1 + IRR
CFt
I0
IRR
n

Principles of Mine Economics

:
:
:
:

)t

I0

Cash flow in year


Intial investment = CF0
Discount rate @ NPV = 0
Total project period

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Internal Rate of Return (3)

Differences between IRR and NPV

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Mining Economics Course, 8-9 May 2008, Singapore

Payback Period (1)

Time (in year) needed for a project revenue to


recover investment or capital amount invested in the
project
Evaluate how fast an investation may return

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Mining Economics Course, 8-9 May 2008, Singapore

Payback Period (2)


Annual Cash Flow
Alternative A

Alternative B

- 50.000.000

- 50.000.000

10.000.000

25.000.000

10.000.000

3.000.000

10.000.000

7.000.000

10.000.000

15.000.000

10.000.000

2.500.000

10.000.000

2.000.000

10.000.000

Payback Period

Basic Investment
Project Period

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Discounted Cash Flow Rate of Return


(DCFROR)

Investment rate of return in % when NPV = 0


Investment rate of return when Positive Present
Worth and Negative Present Worth accumulation
equal zero

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Mining Economics Course, 8-9 May 2008, Singapore

Example
Year

Cash Flow

Calculate DCFROR.

-30

-1

5.5

If minimum ROR =
15% decide
investment
feasibility!

17

20

20

-2

10

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Mining Economics Course, 8-9 May 2008, Singapore

Example#1
An investor has requested that you evaluate the economic potential of purchasing a gold
property now (at year 0) for a $1 million mineral rights acquisition cost. Mining equipment
costs of $3 million will be incurred at year 1. Mineral development costs of $2 million will
be incurred at year 0 and mineral development costs of $1,5 million will be incurred at
year 1. Production is projected to start in year 1 with the mining of 150,000 tons of gold
ore, with uniform production of 250,000 tons of gold ore per year in each of years 2, 3,
and 4. Gold ore reserves are estimated to be depleted at the end of year 4. Reclamation
costs of $0.5 million will be incurred at the end of year 4 when $1.0 million is projected to
be realized from equipment salvage value. All gold ore is estimated to have an average
grade of 0.1 ounces of gold per ton of ore with metallurgical recovery estimated to be
90%.
The price of gold is estimated to be $300 per ounce in year 1 and to escalate 15% in year
2, 20% in year 3 and 10% in year 4. Operating costs are estimated to be $20 per ton of
ore produced in year 1, and escalate 8% per year.
Calculate the project IRR and NPV for a minimum rate of return of 15%.
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Answer#1

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Mining Economics Course, 8-9 May 2008, Singapore

Example#2
A company is considering the installation of automated equipment in a
processing operation to reduce labor operating costs from $300,000 to
$220,000 in year 1, from $330,000 to $240,000 in year 2, from
$360,000 to $260,000 in year 3, and from $400,000 to $290,000 in year
4. The automated equipment will cost $200,000 now with an expected
salvage value of $50,000 in four years. The minimum rate of return,
i*, is 20%.
Use IRR and NPV analysis to determine if the equipment should be
installed from an economic viewpoint. Then consider an increase in the
minimum ROR to 40% from 20% and re-evaluate the alternatives.

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Answer#2

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Mining Economics Course, 8-9 May 2008, Singapore

Example#3
An existing production facility must be shut down unless an environmental
capital cost of $150 million is incurred now at year 0. This improvement will
enable production to continue and generate estimated profits of $60 million per
year for each of the next 8 years when salvage value of the facility is projected
to be zero. An alternative under consideration would combine process
improvement and expansion with an environmental cost change for a cost of
$200 million now at year 0, plus $150 million cost at year 1 to generate
estimated project profits of $60 million in year 1 and $120 million profit per year
in each of years 2 through 8. The minimum ROR is 12%.
Evaluate which of these alternatives is better using IRR & NPV analysis. Then,
change the minimum ROR to 25% and analyze the alternatives using the same
techniques
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Answer#3

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Basic Cash Flow

Mining Economics Course, 8-9 May 2008, Singapore

Cash Flow (1)

Cash flow is a profitability measurement technique for decision


making
Cash flow = Ann.Cash Inflows Ann.Cash Outflows

Cash flow consists of Cashinflows and Cash-outflows


Cash flow
Net Income After Tax+ Depreciation + Depletion + Amortization +
Deferred Deductions Capital Costs

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Mining Economics Course, 8-9 May 2008, Singapore

Cash Flow (3)

Free cash flow = total cash available for


distribution to owners and creditors after funding
all worthwhile investment activities
Discounted cash flow = a sum money today having
the same value as a future stream of cash receipts
and disbursements
Cash flow from operating activities = Net cash flow
Changes in current assets and liabilities

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Mining Economics Course, 8-9 May 2008, Singapore

Simplified Mining Corporation Cash Flow


REVENUE

* Sale of Metals or Ore or Coal


* Dividends from Subsidiary Companies and Other

Deduct EXPENSES incurred in earning Revenue


* Production, Selling and Administration Costs
* Exploration Expenditure
* Interest on Loans and Royalties

Deduct DEPRECIATION write-off


Equals PROFIT BEFORE INCOME TAX
Deduct INCOME TAX
Equals NET PROFIT
Add DEPRECIATION write-off
Equals CASH FLOW of Company
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Mining Economics Course, 8-9 May 2008, Singapore

Cash Flow (5)


Cash inflows consists of:

Revenue from ore sales or other type of mineral products


Royalty, option or lump-sum payments received for
mineral rights
Salvage value realized from the sale of used equipment
Custom milling income or smelter contract payments
received
Tax credits
Return of working capital at the end of a mines
productive life

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Mining Economics Course, 8-9 May 2008, Singapore

Cash Flow (6)


Cash outflows consists of :

Explorations expenditures
Capital expenditures for new mine development,
expansion, modifications, equipment replacement,
or environment control
Operating costs
Royalty, option or lump-sum payments made to
acquire mineral rights
Income and mining taxation payments
Transportations and further processing charges

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Cash Flow (7)

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Mining Economics Course, 8-9 May 2008, Singapore

Example of Cash Flow


TotalCoalProduction

165,463,454 tonne

SaleableCoal

165,463,454 tonne

CostEscalation

1.5% peryear

RevenueEscalation

1.0% peryear

IRR(InternalRateofReturn)

20.17%

DiscountRate

10% peryear

NPV(NetPresentValue)

54,680,226

PBP(PayBackPeriod)(Years)

6.36

BlockACoalPrice

28.00 US$/Ton

BlockCCoalProce

25.00 US$/Ton

CoalSellingPriceChange

0.0%

OperatingCostsChange

0.0%

ExchangeRate

9000 RP/US$
14.80%

19.45%

18.38%

17.67%

17.09%

16.36%

16.52%

CostEscalationFactor

1.0000

1.0150

1.0302

1.0457

1.0614

1.0773

1.0934

1.1098

1.1265

1.1434

1.1605

RevenueEscalationFactor

1.0000

1.0102

1.0103

1.0105

1.0106

1.0108

1.0109

1.0111

1.0113

1.0114

1.0116

Year
CoalProduction

tonne

SaleableCoal

tonne

TotalGrossRevenue
Royalty

13.5%

1,058,278

2,068,310

3,037,195

4,559,662

6,049,707

6,083,368

6,057,062

6,072,034

10

6,080,761

6,108,103

1,014,381

2,021,656

3,019,811

4,536,327

6,027,127

6,082,491

6,057,678

6,071,497

6,080,741

6,107,539

26,781,032

53,527,547

78,590,526

116,515,438

153,779,312

155,165,114

154,532,890

154,894,656

155,119,727

155,797,446

3,615,439

7,226,219

10,609,721

15,729,584

20,760,207

20,947,290

20,861,940

20,910,779

20,941,163

21,032,655

+Salvagevalue

1,745,120

115,000

257,500

310,000

45,000

1,797,620

+Bookvalue

23,165,593

46,301,328

67,980,805

100,785,854

134,764,225

134,332,823

133,928,450

134,293,877

134,223,564

136,562,411

29,171,576

41,623,535

53,662,416

71,907,449

88,423,127

90,655,999

91,944,056

93,494,325

94,994,056

96,812,504

2,778,408

NETREVENUE
OperatingCost
PreDevelopment

5,655,556

DebtInterest

3,375,767

2,700,614

2,025,460

1,350,307

675,153

Depreciation

2,530,908

2,737,908

2,737,908

2,737,908

2,737,908

2,737,908

2,778,408

2,778,408

2,778,408

Amortization

36,172

70,695

103,812

155,850

206,780

207,930

207,031

207,543

207,841

208,775

9,451,209

24,634,341

42,721,257

40,730,986

38,998,955

37,813,602

36,243,259

36,762,724

NETINCOMEBEFORETAX
Tax

30%
NETINCOMEAFTERTAX

(5,655,556)
0
(5,655,556)

(11,948,830)
0
(11,948,830)

(831,423)
0
(831,423)

2,835,363

7,390,302

12,816,377

12,219,296

11,699,687

11,344,081

10,872,978

11,028,817

6,615,846

17,244,038

29,904,880

28,511,691

27,299,269

26,469,522

25,370,281

25,733,907

+Depreciation

2,530,908

2,737,908

2,737,908

2,737,908

2,737,908

2,737,908

2,778,408

2,778,408

2,778,408

2,778,408

+Amortization

36,172

70,695

103,812

155,850

206,780

207,930

207,031

207,543

207,841

208,775

8,439,418

8,439,418

8,439,418

8,439,418

8,439,418

1,150,000

3,275,000

4,150,000

750,000

20,636,200

1,375,000

3,275,000

4,150,000

750,000

21,011,200

PrincipalPayment
WorkingCapital

5,814,799

+WorkingCapitalReturn
CapitalCost

54,466,756

+Borrowed

42,197,088
CASHFLOW

(23,740,022)

(18,971,168)

(9,737,238)

(3,131,852)

10,948,378

3,773,950

30,082,529

27,009,707

25,305,472

27,606,530

7,709,890

CUMMULATIVENETCASHFLOW

(23,740,022)

(42,711,190)

(52,448,427)

(55,580,279)

(44,631,901)

(40,857,951)

(10,775,423)

16,234,285

41,539,757

69,146,287

76,856,177

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Cash Flow (9)


w a k t u ( ta h u n )

There is a gap between


deposit discovery and its
initial

to k 0 1

p e r io d e
in v e s t a s i

c a s h
f lo w
( ju t a $ )

p e r io d e
p ro d u k s i

r e k u lt iv a s i

to k 0 1

6 0
4 0
2 0

A u s t r a lia

0
- 2 0
p e n g e lu a r a n e k s p lo r a s i
b ia y a d e v e lo p m e n t
re v e n u e o n g k o s p ro d u k s i

- 4 0
4 0

K a n a d a

2 0
0
- 2 0

2 0

3 0

4 0

5 0

6 0

7 0
w a k tu

8 0

9 0

(ta h u n )

- 4 0

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Component

Cash Flow
Structure (10)

Principles of Mine Economics

Production

Selling Price

Gross Revenue

Royalty

Net Revenue

Operating Expenses

Operating Earning

Depreciation

Amortization

10

Interest

11

12
13
13

=
=

W/H tax on Interest, Royalty


Component
Other Deduction

14

Taxable
Taxable Income
Income Before
Before Loss
Loss Forward
Forward
Loss Forward Deduction

15

Taxable Income

16

Income Tax

17

Net Income

18

Depreciation

19

Amortization

20

Loss Forward Deduction

21

Capital Expenditure

22

Borrowed Money

23

Principal Payment

24

W/H Tax on Divident

25

CASH FLOW

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Mining Economics Course, 8-9 May 2008, Singapore

Example#4
An investment project required the year 0 investment of $20,000 for depreciable
assets and $5,000 working capital. The assets will be depreciated straight line
for a 4 year life with no salvage value. Annual project income is expected to be
$25,000 with annual operating costs of $11,000. The effective tax rate is 30%
with no investment tax credit and depletion.
a) Calculate project DCFROR under equity investment
b) Calculate project DCFROR with equity of 30% and a loan with an interest
rate of 10% per year for the rest of the investment. Assuming the loan will be
paid off with uniform and equal mortgage payments in 4 years.

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Example#5
A company is trying to evaluate the economic merits of purchasing or leasing a
plant. It can be purchased installed on company land for $1,000,000 cash or
leased for $200,000 per year. Annual income is expected to be $800,000 with
$200,000 annual operating costs. The life of the plant is estimated to be 10
years with zero salvage value for depreciation calculation purposes. Actually the
net salvage value of the plant is estimated to be $400,000 at the end of the 10year life. The effective tax rate is 30%. Depreciation is straight line. Consider
ordinary income tax on salvage value gain over book value.
Determine the DCFROR that the company would receive on the $1,000,000
extra investment that must be made to purchase rather than lease. If 10% is
the minimum DCFROR, should the company lease or purchase? Verify the result
with NPV analysis. Assume end of year lease payments and the investment tax
credit is not applicable .
Principles of Mine Economics

51

EXERCISE #2

Mining Economics Course, 8-9 May 2008, Singapore


PURCHASE
- CAPITAL COST
= REVENUE
+ SALVAGE VALUE AT YEAR 10
- OPERATING COST
- DEPRECIATION
- LEASE FEE
= PROFIT BEFORE TAX
- TAX, 30%
= NET PROFIT
+ ADD BACK DEPRECIATION
= ANNUAL CASH FLOW
NPV @10%
DCFROR
LEASE
- CAPITAL COST
= REVENUE
+ SALVAGE VALUE AT YEAR 10
- OPERATING COST
- DEPRECIATION
- LEASE FEE
= PROFIT BEFORE TAX
- TAX, 30%
= NET PROFIT
+ ADD BACK DEPRECIATION
= ANNUAL CASH FLOW
NPV @10%
DCFROR

0
($2,000)

10

$800

$800

$800

$800

$800

$800

$800

$800

$800

($200)
($100)
$0
$500
($150)
$350
$100
($2,000) $450

($200)
($100)
$0
$500
($150)
$350
$100
$450

($200)
($100)
$0
$500
($150)
$350
$100
$450

($200)
($100)
$0
$500
($150)
$350
$100
$450

($200)
($100)
$0
$500
($150)
$350
$100
$450

($200)
($100)
$0
$500
($150)
$350
$100
$450

($200)
($100)
$0
$500
($150)
$350
$100
$450

($200)
($100)
$0
$500
($150)
$350
$100
$450

($200)
($100)
$0
$500
($150)
$350
$100
$450

$800
200
($200)
($100)
$0
$500
($150)
$350
$100
$650

10

$800

$800

$800

$800

$800

$800

$800

$800

$800

($200)
$0
($200)
$400
($120)
$280
$0
($1,000) $280

($200)
$0
($200)
$400
($120)
$280
$0
$280

($200)
$0
($200)
$400
($120)
$280
$0
$280

($200)
$0
($200)
$400
($120)
$280
$0
$280

($200)
$0
($200)
$400
($120)
$280
$0
$280

($200)
$0
($200)
$400
($120)
$280
$0
$280

($200)
$0
($200)
$400
($120)
$280
$0
$280

($200)
$0
($200)
$400
($120)
$280
$0
$280

($200)
$0
($200)
$400
($120)
$280
$0
$280

$800
0
($200)
$0
($200)
$400
($120)
$280
$0
$280

2
$170

3
$170

4
$170

5
$170

6
$170

7
$170

8
$170

9
$170

10
$370

$842
19%
0
($1,000)

$1,720
25%

PURCHASE - LEASE
ANNUAL CASH FLOW

0
1
($1,000) $170

NPV @10%
DCFROR

$122
13%
SELECT PURCHASE

Principles of Mine Economics

52

Mining Economics Course, 8-9 May 2008, Singapore

Example#6
A mine is considering two economic alternatives of whether to lease or purchase a fleet of
10 trucks. The total purchase cost of new trucks is $60,000. They are depreciable by SL
depreciation over 3 years. Investment tax credit is applicable. Salvage value is expected to
be $20,000 three years from now when the trucks will be traded or sold. Insurance and
maintenance costs for all 10 trucks are expected to be $10,000 the first year, $12,000 the
second year and $14,000 the third year. The ten trucks can be leased for $22,000 per
year including maintenance costs. Total insurance costs on the leased trucks will be
$4,000 per year. Operating costs other than maintenance and insurance for the trucks will
be the same as whether they are purchased or leased. The effective tax rate is 30%.
If the mines minimum rate of return is 15%, do the economics dictate leasing or
purchasing? The mine has sufficient income to enable it to use all allowable tax deductions
in the year in which they are incurred.

Principles of Mine Economics

53

EXERCISE #3

Mining Economics Course, 8-9 May($,000)


2008, Singapore
PURCHASE
- CAPITAL COST
= REVENUE
+ SALVAGE VALUE AT YEAR 3
- OPERATING COST
- DEPRECIATION
- LEASE FEE
= PROFIT BEFORE TAX
- TAX, 30%
= NET PROFIT
+ ADD BACK DEPRECIATION
= ANNUAL CASH FLOW
NPV @10%

0
($60)

0.3

NPV @10%

Principles of Mine Economics

$0

$0

($10)
($13)
$0
($23)
($7)
($16)
$13
($3)

($12)
($13)
$0
($25)
($8)
($18)
$13
($4)

$0
$20
($14)
($13)
$0
($7)
($2)
($5)
$13
$8

$0

0.3

$0

$0

($4)
$0
($22)
($26)
($8)
($18)
$0
($18)

($4)
$0
($22)
($26)
($8)
($18)
$0
($18)

$0
$0
($4)
$0
($22)
($26)
($8)
($18)
$0
($18)

($45)

PURCHASE - LEASE

ANNUAL CASH FLOW

($60)

NPV @10%
IRR

($60)

LEASE
- CAPITAL COST
= REVENUE
+ SALVAGE VALUE AT YEAR 3
- OPERATING COST
- DEPRECIATION
- LEASE FEE
= PROFIT BEFORE TAX
- TAX, 30%
= NET PROFIT
+ ADD BACK DEPRECIATION
= ANNUAL CASH FLOW

$15

($15)
-4%
SELECT LEASE

$14

54

$26

Mining Economics Course, 8-9 May 2008, Singapore

Example#7
Determine the Discounted Cash flow Rate of Return and Net Present Value at10% discount Rate, which
can be expected to be achieved from the mining of a copper-molybdenum ore body. The deposit is to be
mined by an integrated open-pit and flotation operation. The period of interest for the valuation exercise
is Jan 1, 2008 to Dec 31, 2013 and the following conditions of operation have been identified.
a. Unclaimed Exploration and Property Acquisition Cost, $10 m
b. Allowable capital write offs at January 1, 2008
On site plant, installed cost
$40 m 5 years S.L
Open pit haulage trucks
$ 5 m 5 years S.L
Product transportation facilities
$ 5 m 5 years S.L.
Town site assets
$70 m 5 years S.L.
c. Tax rate is 30%
Royalty for Cu 4% while for Mo 4.5%.
d. Annual mil throughout 12,000,000 tonnes
e. Open Pit Stripping Ratio 2:1 = Waste : Ore (tonnage basis)
f. Operating Costs
Mining 2008 $0.60/t increasing at an annual compound rate of 10%
Milling 2008 $1.50/t increasing at an annual compound rate of 5%
g. Mill Head Grade 0.8% Cu, 0.1% Mo
h. Anticipated Metal Prices received by mine for concentrate shipped.
Contained Cu $750 per tonne in 2008 increasing at 5% per annum.
Contained Mo $5,000 per tonne in 2008 increasing at 3% per annum.
i. As at January 1, 2008 the operation carries a debt of $30 m at 10% compound interest charge. Loan
Principal
replacement
is $7.5 m per annum.
Principles
of Mine
Economics
55

EXERCISE #4

Mining Economics Course,


May 2008, Singapore
( in $8-9
)
Capital Expenditure
Exploration Expenditure
Tax Rate
Annual Throughout
Strip Ratio
O perating Cost
- M ining
- Increasing Annual at
- M illing
- Incresing Annual at
M ill Head G rade Cu
M ill Head G rade M o
Sales Prices
Contained Cu
Contained M o
Debt at Jan 1996
Loan Replacem ent

120,000,000
10,000,000
0.30
12,000,000 tonnes
2.00 waste : ore
0.60 $/t
10%
1.50 $/t
5%
0.80% M o
0.10%

750 $/t increasing annual


5,000 $/t increasing annual
30,000,000 Interest
7,500,000
0
2008

(
-

$' 000)
Capital Cost
Unclaim ed Exploration Expenditure
O perating Cost
- M ining
- M illing
Subtotal
= Revenue
Cu
Mo
Subtotal

Principles of Mine Economics

DCFRO R
Net Present Value @ i=10%

1
2009

5%
3%
10%

2
2010

3
2011

4
2012

5
2013

(100,000)
(10,000)

(23,198) (25,518) (28,070) (30,877) (33,964)


(18,000) (18,900) (19,845) (20,837) (21,879)
(41,198) (44,418) (47,915) (51,714) (55,844)
72,000
60,000
132,000

- 4% royalty for Cu
- 4.5% royalty for M o
- Interest Paid
- Depreciation
- Am ortization
= Profit Before Tax Incom e
- Tax, 30%
= G ross Profit After Tax
+ Add Depreciation & Am ortization
- Loan Repaym ent
Annual Net Cash Flow

0.001

75,600
61,800
137,400

79,380
63,654
143,034

83,349
65,564
148,913

87,516
67,531
155,047

(2,400)
(2,472)
(2,546)
(2,623)
(2,701)
(2,700)
(2,781)
(2,864)
(2,950)
(3,039)
(3,000)
(2,250)
(1,500)
(750)
0
(24,000) (24,000) (24,000) (24,000) (24,000)
(2,000)
(2,000)
(2,000)
(2,000)
(2,000)
46,702
59,479
62,209
64,876
67,463
(14,011) (17,844) (18,663) (19,463) (20,239)
60,712
77,323
80,871
84,338
87,702
26,000
26,000
26,000
26,000
26,000
(7,500)
(7,500)
(7,500)
(7,500)
(7,500)
(100,000)
20%
6,190

33,500

33,500

33,500

33,500

56

33,500