Page 288 - Introduction to Mineral Exploration

11: PROJECT EVALUATION 271

upwards but are not likely to increase at a rate and also the probability of a certain rate of re-
exceeding 15% a year. However selling prices, turn (Wanless 1982, Goode et al. 1991, Hatton
and particularly for those commodities sold on 1994b, Decisioneering 2003).
exchanges, may decrease or increase and in
extreme instances can either double or halve in
a year (Figs 1.5 & 1.6). Forecasting commodity 11.7 INFLATION
price trends is a specialist operation and there
are groups who provide this service on a con- Mining is among the most capital intensive of
sultancy basis, such as Brook Hunt, London. If industries, and ranks near the top of the indus-
no reliable price trend predictions are available trial sectors in this respect. This is related to
a break-even price can be calculated from a the complex technology of modern production
cash flow at a required rate of return – this is systems; high investment in major infrastruc-
the price at which operating and financing tures such as town sites, railways and ports,
costs can be met and the mine can continue and expenditure on social and environmental
in production. Once this minimum price is aspects. To offset this trend projects became
known, the possibility of its being maintained larger (i.e. higher production) to benefit from an
over a standard 10-year period can be assessed. economy of scale which would either control
These sensitivity results are best appreciated or reduce increasing capital (and production)
graphically with variation in the single com- costs per unit of production. Generally, how-
ponent concerned plotted against the related ever, the capital cost of mineral projects is
DCF ROR (Box 11.3). rising significantly. This inherent increase is
exacerbated by inflation. As an example, an
inflation rate of 7% a year for 5 years will in-
Quantitative assessment
crease estimates by 40% in year 5. The impact
Discussion on components used in the cal- of high inflation rates on capital (and operating
culation of a cash flow has not included any costs) for projects with a long pre-production
quantitative statement of risk. Each compon- period of several years can be considerable.
ent has been thought of as if it were a constant Related to inflation, monetary exchange rates
with a probability of occurring of 1.0. Most are an important item to consider in mine
of these components are variables, a concept evaluation. When a company operates a mine
readily apparent from considering the grade of under one currency but sells its products in an-
a deposit which is an average value within other, changes in exchange rates between them
its own distribution and probability of occur- can have serious consequences for cash flows.
rence. The same principle applies to estimates When inflation was in low single figures its
of mining cost, recovery, selling price, etc. effect on the valuation of mineral projects was
Normally a spreadsheet model will only negligible and could be ignored but with higher
reveal a single outcome, generally the most rates its effect on calculated rates of return may
likely or average case. The use of simulation be considerable. The value of money, measured
enables the user to automatically analyze the by what it will buy, becomes progressively less
effects of varying inputs on the modeled sys- as time passes. The overall rate of increase in
tem. Probability of occurrence can be com- price (or fall in the value of money) is measured
puted in a spreadsheet, by randomly generating by a gross national product deflator and is the
values for uncertain variables many times over. weighted average of the various price increases
The result is a probability distribution of the within a particular national economy. There
uncertain variable, or a simulated model. One are other measures of inflation (Camm 1991)
type of spreadsheet simulation is referred to as which may be more appropriate in particular
Monte Carlo simulation (Decisioneering 2003, circumstances such as retail and wholesale
Lumina 2003). price indices (Economagic 2003), the indices of
It is possible to use these component dis- capital goods in various categories, and wage
tributions in the calculation of a cash flow with indices for a country, an industry, or a particu-
their probability of occurrence, instead of fixed lar skill.
values with no risk element. The probability The differential inflation (or escalation)
distribution of DCF or NPV can be calculated which exists between the various components