MIN E 408: Mining Enterprise Economics

Costs
Types of Costs
Types of Cost Estimates
Methods to estimate capital costs

Types of Costs
Operating Costs all expenses at the plant site
General Expenses off-site management or corporate level
expenditure
Direct vs. Indirect Costs
Direct (or variable) costs apply to those items that are consumed in
production process and are roughly proportional to level of production
E.g. labour, material and supplies
Indirect (or fixed) costs are expenditures that are independent of
level of production.
There are exceptions:
If project is liquidated, then fixed costs are eliminated
If production level drops or increases drastically, then fixed costs
may also change, e.g. insurance.

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Cost-Revenue Relationships

$
Fixed Cost

Fixed Cost
Break-even

Production Level

Break-even

Capacity

Capacity
Production Level

a) Firm with Low Fixed Cost

b) Firm with High Fixed Cost

Types of Costs

Capital Costs (or first cost or capital investment):

Expenditures made to acquire or develop capital assets
Three main classes of capital costs:
1. Depreciable Investment:

Investment allocated over the useful life of the asset according to

some formula acceptable to tax authorities.
E.g. mine machinery and equipment

2. Expensible or Amortizable Investment:

Investment that can be deducted over a fixed period of time

E.g. mine development can be deducted at the same rate as ore
production.

3. Nondeductible Investment:

Expenditures that cannot be deducted for tax purposes.

E.g. successful exploration and property acquisition.

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Types of Costs

Sunk Cost:

Portion of fixed cost that cannot be recovered

E.g. exploration cost

Consider the following:

Youve spent $15M to evaluate a mining property over a long period
of time, and the project looks (almost) viable. Your accounting policy
requires you to allocate the $15M across the proven reserves, and
when this cost is included the project fails to meet your required
investment return. Should exploration costs be included or excluded?

Types of Costs
Opportunity Cost:

Cost of forsaking an alternative option, or lost revenue due to foregoing other

opportunities.
Think of as the case of with vs. without, not before and after

Consider the following:

You have some old equipment that cannot be used for overburden
removal, and you propose to use it for reclamation. If you do not use
it for reclamation, you could sell it for $1M. Should the $1M be
included in cash flow analysis and in the decision to use the
equipment for reclamation?

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Types of Costs
Marginal Cost:

Change in total cost

Any production process involves fixed and variable costs. As production
increases/expands, fixed costs are unchanged, so average cost of production
decreases.
Not always so straightforward; system efficiency may be an issue

1 truck with 1 shovel average cost of

production is high since fixed costs of owning
and operating shovel are spread over small
production.
2 trucks with 1 shovel production increases,
lower average cost, potential for queuing.
>2 trucks with 1 shovel rate of production
increase declines, average cost changes, but
depends on efficiency of system

Unit Costs ($ per unit of production)

Consider a truck and shovel operation:

Marginal Cost
Average
Cost/Unit
P1
P
P2

M2
M
M1
Output (Production)

Types of Cost Estimates

Four types:
1. Order of Magnitude

To assist in making decision regarding potential project feasibility

-30 to +50% accuracy
<0.5% of pre-production capital
Only adequate to reject a project

2. Preliminary

Refine order of magnitude

Used to indicate or determine budget for project
-15 to +30% accuracy.
2-5% of pre-production capital

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Types of Cost Estimates

3. Definitive

Based on definitive mine/mill plans and layouts.

Preliminary drawings for buildings and site development.
-5 to +15% accuracy
10-20 % of pre-production capital
Used as a basis to establish contract price and for
appropriation of funds.

4. Detailed (contractors estimate)

Based on completed engineering designs, specifications and
site surveys
Provides basis for securing funding and authorization to
proceed with construction and development.
-2 to +10% accuracy
50-60% of pre-production capital

Estimating Capital Costs

Capital Cost is the amount of dollars required to bring
mining property into production.
Fixed amount required to procure site and other physical assets
Working amount beyond fixed needed to start actual operations
10-20% of fixed capital cost
A portion of annual operating costs

Working Capital

OC tons mined Y months

ton
year
12 months

Contingencies unforeseeable cost elements /errors in estimation

Approx. 10-15% capital costs
Engineering expense designs, contract admin, equip. selection
10% of capital cost for complex projects; 1 to 2% for simple projects

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Basis for CAPEX Estimates

Land Acquisition
Exploration Expense
Engineering and Legal (Feasibility Studies)
Infrastructure:
Buildings - Construction (including Foundations, Erection, & Labor)
Major Equipment (including Freight & Installation) with Instrumentation and Control
Networks
Shaft Sinking & Equipping, Drifting, Raising & Stope Preparation
Ventilation Equipment & Network Installation
Major Roads & Haul Roads Construction
Installation of Utilities - Electrical, Sewage, Water, Gas and Air
Drainage Network Design & Construction Sumps, Pipe, Valves, and Fittings &
Instrumentation

Major Pre-Production Overburden Stripping

Pre-Production Operations:
Heating of Facility: Source, Insulation, Transmission
Research & Development: Environmental Containment, Project Development,
Advanced Technology Research Capacity Base
General Overheads: Land Claims, Treaty Obligations, Project Administration in the
Development Phase

Capital Cost Estimating Methods

0. Conference Method
Reps from Various Departments confer on Estimates in a RoundTable Forum
Jointly Estimate Project Cost as a Lump Sum
Used as Preliminary Cost Estimate
Demerits:
Lack of Analysis
Lack of Underlying Verifiable Facts on Cost Estimate
Comparison to Similar Projects, which may be very misleading

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Capital Cost Estimating Methods

FIXED COSTS
1. Unit Cost method
Simply multiplies capacity by a unit cost factor
Total Cost = k x Total annual capacity
$97,200,000= $10,800 x 9000tpy

2. Turnover ratio
Also uses historical data from similar plants and operations to
calculate fixed capital cost.

TR

Product value per ton

Investment

Capital Cost Estimating Methods

FIXED COSTS
3. Scaling or exponential capacity adjustment Method

Cost k (capacity) x

Cost A capacity A

Cost B capacity B

Relationship between
cost and capacity

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Capital Cost Estimating Methods

FIXED COSTS
3. Exponential Capacity Adjustment Method contd

Capacity - Cost curve showing determination of x after Gentry(1984)

Capital Cost Estimating Methods

FIXED COSTS
3. Exponential Capacity Adjustment Method contd
Curvilinear fit:

Cost,
Log Scale

1.1

0.4

0.7
Capacity, Log Scale

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Capital Cost Estimating Methods

FIXED COSTS
3. Exponential Capacity Adjustment Method contd
Do not use beyond a 10-fold range of capacity
Example:

Suppose a new 20,000 tpd mining complex cost $250,000,000 in

1990. What would be the estimated cost of a new 35,000 tpd
mining complex today if the scaling factor is 0.7

Cost A capacity A

Cost B capacity B

Capital Cost Estimating Methods

FIXED COSTS
4. Cost Ratio Method
Total project capital cost is assumed to be proportional to the
capital cost of major equipment.

Total project cost k total equipment cost

k is Lang factor, 3 k 6

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Review Of Main Points

Types of costs:
Direct vs. indirect
Operating, Capital, Sunk, Opportunity, Marginal

Types of cost estimates:

OME, Preliminary, Definitive, Detailed

Capital cost estimating approaches:

Working:
% capital total fixed capital cost
Portion of annual operating cost
Fixed:
Unit cost
Turnover ratio
Exponential ratio adjustment (or scaling)
Cost ratio

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