Page 285 - Introduction to Mineral Exploration

268 B. SCOTT & M.K.G. WHATELEY

years. From this two important characteristics The NPV method includes three indicators
in valuing mineralisation and mineral projects regarding the value of a mineral project, pro-
develop. Firstly, as discount factors are highest vided that the net present value summation is a
in the early years, the discounted value of any positive sum:
project is enhanced by generating high cash 1 the initial capital investment is returned;
flows at the beginning of the project. That is, 2 the financial return on this investment is the
the ability to extract higher grade and more specified interest rate;
accessible (lower mining cost) ore at the begin- 3 the net present value summation provides a
ning of a project can significantly enhance its bonus payment which is sometimes called the
value. This is the declining cut-off grade acquisition value of the mineralisation con-
theory. Not all mineralisation is amenable to cerned. Projects can be ranked according to the
this arrangement but if this can be achieved size of this bonus provided that the same inter-
it will provide a higher value than a comparable est rate is used throughout (Box 11.2). The
location in which this is not possible. Sec- reason why project B is superior to projects D
ondly, discount factors decrease with time and and C is that the cash flows in project B are
by convention and convenience cash flows larger in the earlier years and the initial invest-
are not calculated beyond usually a 10-year ment is returned sooner.
interval as their contribution to the value The selection of an appropriate interest rate
becomes minimal. This has the added advan- is critical in the application of NPV as a valua-
tage of limiting future predictions. In cash tion and ranking technique, as this discounts
flow calculations it is difficult to predict with the cash flow and determines the net present
some degree of accuracy what is to happen next value. A minimum rate is equal to the cost
year – several years ahead is in the realm of of initial capital used to develop the project.
speculation although best estimates have to Additional factors such as market conditions,
be made. tax environment, political stability, payback
Thus the value of money today is not the period, etc. have to be considered over the
same as money received at some future date. proposed life of the project. This is a matter of
This concept is concerned only with the inter- company policy and usually the interest rate
est that money can earn over this future inter- for discounting varies from 5% to 15% above
vening period and is not concerned with the interest rate of the required initial capital
inflation. In this calculation money received at investment. In times of high interest rates this
some time in the future is assumed to have the discount rate is particularly onerous.
same purchasing power as money received
today; it has constant purchasing power and is
referred to as constant money. The effect of Discounted cash flow rate of return
inflation on project value, however, is import- (DCF ROR)
ant and is considered in section 11.7. This technique is a special case of NPV where
the interest rate chosen is that which will ex-
actly discount the future cash flows of a project
Net present value (NPV)
to a present value equal to the initial capital
The second formula above is used to determine investment (i.e. the NPV is zero). This DCF
the present value of the expected cash flow return is employed for screening and ranking
from a project at an agreed rate of interest. The alternative projects and is commonly used in
cash flow from each year is discounted (i.e. industry. Since this discount rate is not known
multiplied by the factor from Table 11.1 appro- at the beginning of a calculation an iterative
priate to the year and interest rate). A summa- process has to be used which is ideally suited
tion of all these yearly present values over the for computer processing. A very approximate
review period provides the present value (PV) of first estimate can be obtained by dividing the
the evaluation model. From this PV the initial total initial capital expenditure by the average
capital investment is deducted to give the net annual cash flow, and dividing the result into
present value (NPV). Some cases are given in 0.7, but it is dependent upon the shape of the
Box 11.2. overall cash flow (Box 11.2). Also over a narrow