Section 6 Mine Evaluation and Investment Analysis
D ONALD W. G ENTRY , A SSOCIATE E DITOR AND S ECTION C OORDINATOR
6.0 Introduction ....................................................... 387
6.1 Mine Valuation .................................................. 390
6.1.1 Approaches to Mine Valuation............. 390
6.1.2 Purpose of Mine Valuation Studies.. ... 391
6.2 Mine Feasibility Studies ................................... 393
6.2.1 Data Requirements ................................ 394
6.2.2 Cash Flow Analysis ............................... 396
6.2.3 Time Value of Money ............................ 397
6.2.4 Selecting a Discount Rate.. .................. 399
6.2.5 An Iterative Process .............................. 403
6.3 Costs and Cost Estimation .............................. 405
6.3.1 Estimation of Costs ............................... 405
6.3.2 Assessment of Mining Conditions
Affecting Costs ....................................... 405
6.3.3 Cost Guides for Capital Costs of
Mining Projects ....................................... 413
6.3.4 Cost Guides for Operating Costs of
Mines and Mills ...................................... 421
6.3.5 Conclusion .............................................. 424
6.4 Project Operating Strategy .............................. 425
6.4.1 Introduction ............................................. 425
6.4.2 Project Alternatives................................ 425
Chapter 6.0
INTRODUCTION
DONALD W. GENTRY
This section deals with one of the most fascinating aspects
of mining—the evaluation of mine investment opportunities. Be-
fore proceeding further, it is important to clarify the meaning of
some fundamental terms used frequently in the text.
6.0.1.1 Mine Valuation vs. Evaluation
The words “valuation” and “evaluation” in a mining context
are often used interchangeably. However, for the purposes of
this section, a distinction is made between the two terms in
accordance with commonly accepted practice. The word valua-
tion in a mining project context has the rather narrow meaning
of placing a dollar or other currency value on the worth of the
project as a whole. In other words, the value of a mining project
refers to a measure of the desirability of ownership of that prop-
erty. As such, the major item of interest is, “what is the mine
worth?,” or “what is the value of the mine?” The value of a
mining project may actually be determined in the marketplace
at any specific point in time, or it may be estimated by one of
several methods. The topic of mine valuation is discussed in
more detail in Chapter 6.1.
The word evaluation in a mining project context connotes
the broader meaning of determining the numerical values of all
387
6.4.3 Contract Mining Bidding Process.. ....... 428
6.4.4 Monitoring the Contract Miner ............. 437
6.4.5 Mine Leasing Process ........................... 438
6.4.6 Joint Venture Process ........................... 441
6.4.7 Evaluation of Alternatives.. ................... 446
6.4.8 Corporate Philosophy ............................ 450
6.5 Investment Analysis ......................................... 452
6.5.1 Objectives ............................................... 452
6.5.2 Types of Evaluations ............................. 452
6.5.3 Investment Criteria ................................. 452
6.5.4 Evaluating Alternatives .......................... 459
6.5.5 Handling Risk ......................................... 462
6.5.6 Example Evaluation ............................... 464
6.6 Mine Financing ................................................. 470
6.6.1 Financial Objectives of a Mining
Company ................................................. 470
6.6.2 Exploration Funding ............................... 473
6.6.3 Mine Development Funding.. ................ 475
6.6.4 Operating Mine Financing.. ................... 478
6.6.5 Mergers and Acquisitions ..................... 479
6.6.6 Information Requirements .................... 479
possible factors or variables that are important in establishing
the worth of a mining project. In other words, mine evaluation
denotes the assessment of the relative economic viability of the
mining project or investment opportunity. In this regard, esti-
mates of project ore reserves, mining rates, revenues, costs, ex-
pected returns and associated risks, etc., as well as the dollar
worth, are made for each project or investment opportunity
available to the organization. Various aspects of the mine evalua-
tion procedure are discussed in detail in subsequent chapters
contained in this section. For instance, Chapter 6.2 discusses
mine feasibility studies, Chapter 6.3 describes procedures for
estimating capital and operating costs, while Chapter 6.4 deals
with project operating strategies.
6.0.1.2 Investment Analysis
In this section the term investment analysis connotes continu-
ation of the project evaluation process. That is, after the numeri-
cal values of all possible project variables have been estimated
and the dollar worth of the entire project determined, appro-
priate evaluation criteria are calculated for each investment op-
portunity available to the firm. All projects are then ranked
388 MINING ENGINEERING HANDBOOK
Fig. 6.0.1. Generalized iterative procedure for mine evaluation.
according to the preferred investment criteria and incorporated
into the corporate capital budgeting process. Chapter 6.5 dis-
cusses mining project investment analysis as it relates to estimat-
ing project economic viability.
The mine evaluation procedure used for investment analysis
is usually iterative in nature. The general procedure may be
represented by Fig. 6.0.1 (Gentry and O’Neil, 1984). The ton-
nage and grade of the estimated ore reserve established from
the exploration program are important variables in determining
optimum mine size. Mine size, in turn, affects production costs,
as economics of scale are often enjoyed with larger production
rates. Finally, the level of production costs for the project as a
whole determines what material can be mined at a profit (cutoff
grade) and therefore determines the magnitude of the ore reserve.
The important point here is to recognize that each time a
variable changes, the analyst must assess the impact of this
change on all other project variables and on the subsequent
financial and economic results. This iterative procedure must be
repeated until the most economical design is achieved for the
mining project being analyzed. This is, indeed, a time-consuming
process, but it represents the essence of the mine evaluation
process for investment analysis purposes.
6.0.1.3 Capital Budgeting
As noted in the previous section and as discussed in detail
in Chapter 6.5, the mine evaluation procedure and associated
investment analysis are incorporated into the corporate capital
budgeting process. The capital budgeting process refers to the
sequence of decisions that ultimately lead to the firm’s accept-
ance or rejection of investment proposals along with subsequent
management of the proposals accepted (Gentry and O’Neil,
1984). The capital budgeting process is normally considered to
comprise the activities of planning, evaluation, selection, imple-
mentation, control, and, finally, continual reevaluation and
auditing of results. In essence, capital budgeting is that element
of capital investment dealing with the allocation of capital to
projects in some optimal manner. The perceived benefits from
these projects are projected to be realized at some time in the
future.
After the firm has reconciled the investment decision, the
financing decision must be addressed. The financing decision
concerns the selection of source(s) and timing of new capital
necessary to implement the investment decisions. This aspect of
financing mining projects is discussed in Chapter 6.6.
6.0.1.4 Wealth Maximization
Although economic theory usually assumes that both private
and public organizations strive to maximize profits from their
investment decisions, various portions of this section are formu-
lated on the premise that the fundamental objective of any pri-
vate organization is to maximize its value or wealth to its owners
(stockholders). In this sense, the term wealth refers to the total
current market value of the firm’s assets. In the case of corpora-
tions, the wealth or value is considered to be represented by the
market price of the firm’s common stock.
It is important to note that wealth maximization is a more
appropriate and inclusive goal for a firm than profit maximiza-
tion. Indeed, there is a difference between the two objectives in
most situations. For example, there are a number of ways for a
firm to increase profits, but many of these activities would rarely
cause net shareholder worth to increase. Indications are that
total profits are not as important to the investment community
as are other indicators. Over the long term, the success or failure
of an organization will be a function of how well the management
of the organization handles investment and financing decisions,
for the results of these decisions will directly impact the value
of the firm in the marketplace.
6.0.1.5 Mining as a Unique Investment
Environment
Certainly the investment environment associated with the
mining industry is unique when compared with the environment
encountered by most other industries. Section 2 of this book
discusses various aspects of minerals commodities markets, sup-
ply-demand relationships, pricing, trading, and taxation issues
that are often unique to the mining industry. Many of these
unique characteristics are the result of some fundamental fea-
tures of the minerals industry, which, in their combination, result
in a unique business environment. These special features are
described by Gentry (1988) and Gentry and O’Neil (1984) as
follows.
Capital Intensity: Mining ventures are extremely capital in-
tensive. Although the magnitude of the capital investment re-
quired for a new mining venture varies with the type of commod-
ity, mining method, mine size, location, and other parameters,
major new mines may require financial commitments that range
from $500 million up to as much as $8 to $10 billion. The
infrastructure alone for mines in remote locations may cost sev-
eral hundred million dollars. Even small, high-grade precious-
metals operations that employ a small work force may require
multi-million dollar investment.
Cost Structure: The capital intensity results in a unique cost
structure for the mining industry. The total average cost of
production —including fixed and variable costs—per unit of sal-
able product is often higher than the marginal or variable cost
for the same unit. The average cost includes a high fixed-cost
component, which primarily represents capital recovery. Conse-
quently, in periods of low demand and price, a mining operation
may be covering its marginal cost but actually losing money if
the average cost per unit is considered.
Also, because high fixed costs represent a large component
of a mining operation’s total costs, the breakeven production
level for mining facilities is closer to capacity than for other
types of facilities with lower fixed costs. This is one reason why
operators attempt to run mines at capacity, often employing
three-shift, seven-day/week work schedules.
Long Preproduction Periods: Once the occurrence of an ore
deposit has been established, several years of intensive effort are
required before the property is brought on stream and ore is
produced on a continuous basis. The preproduction period may
range from 3 to 12 years, depending on the mining and processing
methods, size and location of the deposit, and complexity of the
 MINE EVALUATION AND INVESTMENT ANALYSIS
operating and environmental licensing procedures, as well as
other factors.
The significance of these long lead times is amplified when
considered in conjunction with the capital intensity of the indus-
try. Not only are companies committing extremely large capital
resources to a new mining venture, but they also are exposed
financially for a considerable period prior to project start-up. The
longer the lead time, the higher is the probability of undesirable
change in key engineering and economic parameters that were
utilized in the initial investment decision. Also since expendi-
tures of capital are required throughout the preproduction pe-
riod, the longer the lead time, the greater are the returns required
to offset the lost investment opportunities represented by the
preproduction period.
Nonrenewable Resource: The aspect of the minerals industry
that perhaps distinguishes it most from other industries is the
fact that it deals with the extraction of a nonrenewable resource.
The implications of a depletable resource are numerous. For
example, one result is that revenues from mining are derived
from a piecemeal disposal of the project’s major asset, the ore
body. As a result, the return of and return on the capital invest-
ment must be obtained within the finite life of the ore body. This
unique feature has led many countries to provide for special tax
treatment of mining ventures in the form of a depletion (or
equivalent) allowance.
Because mines have finite lives that are determined by the
size of the ore deposit and the mining rate, new deposits must
be discovered and developed through continuing programs of
exploration. Also the fact that a mining operation has a finite
life may cause government agencies to require special conces-
sions from the developer as a result of the finite nature of the
benefits. One example may be special fiscal requirements that
stem from the realization that government-provided infrastruc-
ture will no longer be required after the inevitable exhaustion of
the deposit.
Indestructibility of Product: Another special feature of the
mining industry centers on the fact that many metals are, essen-
tially, indestructible. The consequence is a secondary market
and a reduction in the amount of primary ore necessary to
provide the required supply. Recycling has considerable eco-
nomic advantages due to energy and other cost savings and
contributes significant percentages to the US consumption of
such metals as aluminum, copper, lead, zinc, silver, and iron and
steel. In addition to reduced energy consumption and further
increase in supply, recycling also affects metals markets in the
following ways (Gocht et al., 1988):
1. The new supplier can weaken oligopolistic or monopolistic
market positions.
2. World trade diminishes because recycling takes place di-
rectly in the consuming countries, with few exceptions.
3. Mineral resources are preserved.
389
4. Recycling of waste contributes to protecting the envi-
ronment.
In the planning for any new mining venture, projections of
recycling volumes and the growth in secondary markets should
be included when estimating the overall future supply of the
commodity considered for production.
High Risk: In addition to the obvious risks associated with
capital intensity and long preproduction periods, the risks associ-
ated with mining ventures include some that may be under the
control of the investor and others that are clearly uncontrollable.
In general, these risks may be placed under the general headings
of technical risks (geologic and engineering risks), economic or
market risks, and political risks.
Although technical risks have been notably reduced in recent
years, business risk—the chance of major loss due to market
factors—has increased dramatically. This has been caused, fun-
damentally, by two primary factors: the rapidly rising capital
requirements of new projects and the increasingly unpredictable
future economic conditions. These difficulties, of course, are
compounded by the long preproduction periods required for
large, new mining projects (O’Neil, 1982).
In addition to the obvious risks associated with mineral
markets and widely fluctuating metals prices, another economic
risk is that associated with inflation. The impact of high rates of
inflation on mineral project evaluation can be significant indeed.
Also related to inflation, monetary exchange rates have recently
become an important consideration in mine evaluation. When a
firm sells its product in one currency and buys services in an-
other, changes in exchange rates between the currencies can have
grave consequences.
Political risk, although often overlooked, has become in-
creasingly important in recent years when considering mining
investments. There is an accelerating trend to greater participa-
tion in mining projects by host governments throughout the
world. In the limit this can take the form of outright expropria-
tion. Therefore, mining companies contemplating any new ven-
ture must assess these growing political risks to ensure that the
added financial exposure is warranted.
The chapters that follow deal with the more important issues
associated with mine valuation, mining project evaluation, in-
vestment analysis, and mine financing. The reader is referred to
the references at the end of each chapter for further information
on these topics.
REFERENCES
Gentry, D.W., 1988, “Minerals Project Evaluation—An Overview,”
Transactions, Institution of Mining and Metallurgy, Vol. 97, pp.
A25-A35.
Gentry, D.W., and O’Neil, T.J., 1984, Mine Investment Analysis, SME-
AIME, New York, 488 pp.
Gocht, W.R., Zantop, H., and Eggert, R.G., 1988, International Mineral
Economics, Springer-Verlag, New York, 252 pp.
O’Neil, T.J., 1982, “Mine Evaluation in a Changing Investment Cli-
mate,” Mining Engineering, Vol. 34, pp. 1563-6, 1669-72.