Page 292 - Introduction to Mineral Exploration

11: PROJECT EVALUATION 275

Traditional finance

Sponsor Lender

Project finance
Project
Company
project
Lender Sponsor
FIG. 11.9 Traditional and project
financing of capital requirements
for mine development. For
explanation see text. Project

difference of emphasis in project development. Banks are not inherently concerned with the
A mining company will wish to achieve a posi- rate of return of the proposed project. Their
tive return on its investment (i.e. the equity of return is more or less fixed, based upon the
the project company) to satisfy the demands interest rate at which they agree to lend money.
of its shareholders. A bank, however, will wish Banks are more concerned with protection of
to ensure that its money is returned on time, their loans and they tend to examine cash
with interest and loan repayments taking pri- flow predicted in the feasibility study from this
ority over dividend payments to shareholders. perspective. A criterion is that the NPV at an
The payment of dividends, however, can have agreed rate of interest must be at least twice the
considerable effect on the price of the com- total initial loan plus interest payments. There
pany’s shares traded on stock exchanges. Con- is the obvious implication that a bank will lend
sequently, a compromise is usually reached money for a mineral project provided that its
where the major proportion of the cash flow is loan and interest payments are secure, even
reserved for project loan repayment, a smaller if actual project cash flows fall to half their
part (say 20%) is placed at the disposal of the estimated level.
project company.
It is a matter of opinion as to whether cash
flows used in DCF analysis should include 11.8.2 Risk in project finance
drawdown and repayment of debt (i.e. project Project loans are provided on an agreed time
finance), and interest payments. If not then schedule of drawdown and repayment, based
projects are evaluated as if they are financed on the technical data and cash flows in the final
by 100% equity, although in practice this feasibility report. The interest rate on loans is
will not happen (i.e. financing will be a com- usually a premium rate (say 3%) above an
bination of loan and equity). Such a proce- agreed national base rate. As this base rate fluc-
dure is said to separate investment decisions tuates the loan interest rate will also change,
from financing decisions (i.e. repayment of and in times of inflation with high base rates
debt, etc.). It is a fundamental principle that (as in 1990 and 1991) repayments can be oner-
a basically poor project cannot be trans- ous for a project company.
formed into an attractive one by the manner Even the best of feasibility studies may
in which it is financed. If an all-equity evalua- be incorrect in actual practice and events to
tion demonstrates a strong cash flow and which both sponsors and lenders particularly
meets standard parameters (see earlier), then look during the construction and operation of
after this it can be determined how it is best a new mineral project are as follows described
financed. below.