Mine Valuation

B S Choudhary
Department of Mining Engineering
IIT(ISM) Dhanbad
 Basic concept,
Contents 

 Earlier approaches to mine valuation,

 Recent approaches to valuation;
 Time value of money,
 Price information – revenue estimates, annuity, Accounting profits and cash
flows.
Basic concept
 The term mine valuation implies the assigning of a Rupees or other currency value to the worth of
a mine or mining project and provides a measure of the desirability of ownership of that property.
 Value is the amount of money which a purchaser desires to pay for the ownership of a mineral
property. The value arrived at is the mine value, i.e., todays money of future earnings that will be
generated by the mine/mineral property worth.
 The valuation of a mineral property involves gathering number of information's, like geology,
mining, market, etc. valuation differs from evaluation , where evaluation simply focuses on the
technical aspects of an asset, and valuation focuses on value of the asset.
As such, several types of value may be encountered in performing a mine valuation study. These are
 1. Market value.
 2. Full cash value.
 3. Salvage value.
 4. Replacement value.
 5. Capitalized value.
 6. Book value.
 7. Assessed value.
 8. Insured value.
Salvage Value: Salvage is the net sum, over and above the Cost of removal and sale,
realized for a property or asset when it is retired from service. Salvage value and scrap value
are synonymous when the property or asset retired from service is scrapped for the value of
its materials.
Replacement Value: Replacement value refers to the existing value of a property or asset as
determined on the basis of what it would cost to replace the property or its service with at
least equally satisfactory and comparable property and service. The concept of replacement
value is fundamental to the cost approach utilized by appraisers.
Book Value: Book value is the original investment in the property or asset as carried on the
organization’s books less any cumulative allowance for depreciation or amortization entered
on the books.
Assessed Value: The assessed value of a property is the value entered on the official
assessor’s records as the value of the property applicable in determining the amount of ad
valorem taxes to be paid by the property owner.
Insured Value: The insured value of a property refers to that value at which the property has
been insured against loss or disaster. This value is generally associated with replacement
value for tangible assets and earning capacity for property such as mines (ore deposits).
Capitalized Value: The capitalized value of a property is the sum of discounted future annual
net earnings generated by the property. The capitalized value concept is synonymous with
the income approach to value estimation for mining properties.
Methods of valuation

The process of determining the value or worth of a mining property

 Income/cash flow approach

 Market related approach
 Cost approach
 Option pricing
Earlier Methods of Mine valuation

 For mine valuation Hoskold developed the concept of present worth of mining
project and written as:

1. This formula results in an

undervaluation of mineral property
2. Two rates of return

Where, Vp is present worth, i is safe rate on redemption of capital, i’ is

speculative/risky rate on invested capital and A is uniform annual annuity, n is
years of operation

Morkill formula
 Income/cash flow approach
 In the income approach, manager calculate net present value of an investment project and
accept the project if it has a positive NPV. In corporate valuation, discounted cash flow model is
also called the Net Present Value
 (NPV) model which is the present value of future cash inflows of an investment or project minus
the present and any associated future cash outflow. The NPV is widely used to appraise a
project or investment. If the NPV arrives greater than or equal to zero, then theoretically the
project or investment should be implemented; if the NPV is less than zero, the project should
be discarded
 The approach assumes that a purchaser would not be justified in paying more to acquire
income-producing property than the present value of the income stream to be derived from the
property.
 Because mines have limited operating horizons, and because there are well-established markets
for most mineral commodities, the income approach is widely used in valuing mineral
properties. The approach is commonly used by the mining industry in the assessment of
investment rates of return and to determine appropriate purchase prices for mines or mineral
prospects.
 It depends on reserves, production rate, operating cost, capital cost, environment and
redemption cost, commodity price, discount rate
The discounted cash flow (DCF) model has evolved over
last 60 years and is essentially used to estimate the
company’s value in terms of time value. Time value is
assumed as a passage of time goes by, there should be a
given amount of interest or inflation incurred.
Market (Comparable Sales) Approach
 This approach is an indicator of market value of an item or any project, including a mineral
project. The value of a mine is reflected by balance of supply and demand in the market,
particularly for an operating mine.
 This approach is considered by most appraisers and the courts to provide the best indicator of
fair market value, since it reflects the balance of supply and demand in the marketplace.
 The market approach assumes that a purchaser would not be justified in paying more for a
property than it would cost him to acquire an equally desirable substitute property. The
concept of market value also presumes conditions of an open market, exposure for a
reasonable time, knowledgeable buyers and sellers, absence of pressure on either the seller to
sell or the buyer to buy, and a sufficient number of transactions to create a stable market.
 The market approach encounters serious practical problems when applied to mining
transactions. This is mainly due to two facts: first, there are very few sales of mining
properties, and therefore few comparative data are available; and, second, since each mineral
deposit is unique in quality, size, geographical location, degree of development, and many
other parameters, any market data are of modest value at best. To be applicable, the market
data must not only relate to similar assets but must also be for a similar point in time.
 Experience in the area of mineral property transactions suggests that the open-market,
unpressurized dealing and other assumptions previously mentioned in association with this
approach are seldom reflected in reality. When such criteria and assumptions are met, it is
often extremely difficult to ascertain the actual or true value of the sale because of
stipulations pertaining to production commitments, deferred payments, exchanges of stock,
production payments, and other subtle factors that can affect the value significantly.
Cost Approach
 The cost approach to mine valuation attempts to determine the depreciated replacement
cost for the asset in question. That is, what would it cost to reproduce an asset of identical
quality and state of repair? The fundamental concept with this approach is that a purchaser
would not be justified in paying more for a property than it would cost him to acquire land
and construct improvements that had comparable utility with no undue delay.
 The cost approach is rarely applicable in mining because the correlation between
construction costs and the value of the property is very imperfect. For example, if one were
to build mines with production capacities of 100 tpd each, one on a very rich ore deposit and
one on an economically marginal deposit, construction costs might be very similar, but fair
market values of the two mines would, clearly, be substantially different.
 Another problem arises when the cost approach is applied to newly discovered mineral
properties that have no surface improvements or equipment of any kind. The very nature of
mineral exploration and mining dictates that the discovery value of an ore deposit is
generally greater than the cost incurred in making that discovery. If this were not true in the
aggregate, investment could not be justified for exploration.
 The cost approach is not only the least applicable method in the valuation of mining
properties, but it generally is the least reliable also.
Option pricing
Models used to price options account for variables such as current market
price, strike price, volatility, interest rate, and time to expiration to theoretically
value an option. Some commonly used models to value options are Black-
Scholes, binomial option pricing, and Monte-Carlo simulation.

KEY TAKEAWAYS
 Options contracts can be priced using mathematical models such as the
Black-Scholes or Binomial pricing models.
 An option's price is primarily made up of two distinct parts: its intrinsic value
and time value.
 Intrinsic value is a measure of an option's profitability based on the strike
price versus the stock's price in the market.
 Time value is based on the underlying asset's expected volatility and time
until the option's expiration.
 The primary goal of option pricing theory is to calculate the probability that an
option will be exercised at expiration. The underlying asset price (e.g., a stock
price), exercise price, volatility, interest rate, and time to expiration, which is
the number of days between the calculation date and the option's exercise date,
are commonly-employed variables that input into mathematical models to derive
an option's theoretical fair value.
 Options pricing theory also derives various risk factors or sensitivities based on
those inputs, which are known as an option's "Greeks". Since market conditions
are constantly changing, the Greeks provide traders with a means of determining
how sensitive a specific trade is to price fluctuations, volatility fluctuations, and
the passage of time.
 It is claimed that valuation procedure related to option pricing theory provides an
alternative to discounted cash flow analysis. This procedure is advantageous
because it does not require explicit cash flow forecasts or risk adjusted discount
rates.
 The development of valuation procedure by option pricing is to recognize the
similarity between a mine and a stock option. The buy or sell option in stocks
depends on its price. Similarly, a mine may be opened or closed, depending on the
price of the ore and its production cost.
 The similarity to stock option suggests that there is a relationship between price
volatility of minerals. Two mines which produce different minerals but possess
identical capacities, cost structures and product prices will be valued differently, if
the price volatilities of their mineral product differs.
Purpose Of Mine Valuation Studies

 Acquisition
 Taxation
 Financing
 Regulatory Requirements
Time value of money

 Time value of money means that a sum of money is worth more now than the same
sum of money in the future. This is because money can grow only through
investing. An investment delayed is an opportunity lost.
 The formula for computing the time value of money considers the amount of
money, its future value, the amount it can earn, and the time frame.
 Interest is generally defined as money paid for the use of borrowed money.
 Interest may be likened to a rental charge for using an asset over some specific
time period.
 Interest exists to compensate for a number of concerns experienced by lenders;
these are related primarily to risk, inflation, transaction costs, opportunity costs,
and postponement of pleasures. The level of interest is, like the price of other
assets, determined by supply and demand.
The six basic interest equations are developed and described.
1. Single payment compound amount, (F/P,i,n).
F is a future sum of money, P is a present sum of
money,
A is a payment in a series of n equal payments,
made at the end of each period of interest,
2. Single payment, present worth (P/F,i,n). i is effective interest rate per period, and n is number
of interest periods.

3. Uniform series, compound amount (F/A,i,n).

If payments of $725 are made at the end of

each year for 12 years to an account which pays interest at the
rate of 9% per year, what will be the terminal amount?
 4. Uniform series, sinking fund, (A/F,i,n).
With interest at 6%, how much must be
deposited at the end of each year to yield a final amount of
$2825 in 7 years?

5. Uniform series, present worth (P/A,i,n).

An investment will yield $610 at the end of

each year for 15 years. If interest is 10%, what is the maximum
purchase price (i.e., present value) for this investment?

6. Uniform series, capital recovery, (A/P,i,n)

If an investment opportunity is offered now for $3500, how

much must it yield at the end of every year for 6 years to justify
the investment if interest is 12%?
Cash flow (CF)

This is the flow of

cash from the project
owners for the capital
expenditure
to get the project into
operation (negative)
and the flow of cash
from the
project to the owners
after all costs (which
should be positive).
In the mine life three periods will be considered
 - pre-production period, and
 - production period.
 the post-production or closure period in which final reclamation takes place.

The pre-production period which is assumed to require 7 years, can be

broken down into 3 different and distinct expenditure categories:
- detailed exploration,
- property acquisition, and
- infrastructure and mine development.
 Typical pre-production cash flow categories
List of Sequences for
Economic Evaluation
Thanks