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Mine Project Valuation Using Monte Carlo

Analysis

This model and exercise were created by Alpay Sergi, Visiting Scholar, and
Graham A. Davis, Associate Professor, Division of Economics and Business,

Problem Definition

A mining corporation is evaluating a small underground gold mining project


containing an estimated 1 million ounces of gold. The project is based on the
example given in "Optimum Production Rate Selection" by Bruce Cavender, Mining
The property has been explored, but there is still some uncertainty over the total
tons of ore. This translates into an uncertain project life. We also assume
uncertain capital costs, mining costs, milling costs, working capital, production
rates, gold prices, ore grades, and ore recoveries. We allow for reasonable
The problem is to value the project using traditional DCF analysis, but to take the
valuation impacts of these geological and economic uncertainties into account.
Monte Carlo analysis is useful in this case because 1) the correlations between the
uncertain variables that are multiplicands and 2) the non-linearities in the cash
flows created by taxes and an uncertain mine life mean that the expected NPV
value
a staticany
analysis
is not
equal to
the mean
NPV Avalue
from
the Monte
We dofrom
not model
decision
variables
in this
problem.
natural
extension
would be to have the level of production contingent on the outcome of the
random draw for prices and costs, as in a real options model. This would prevent
many of the highly negative NPV values that the current mining plan creates, and

Real vs. Nominal Analysis


Mining industry practitioners typically perform real NPV analysis, projecting
constant costs and metal prices in real terms. The resultant cash flows are then
discounted by a real risk-adjusted discount rate. We have conformed with this
practice here, but have adjusted depreciation for the fact that tax shelters must
be calculated in nominal terms. That is, we calculate depreciation in nominal

Assumption Cell Distributions

The initial reserve level at economic cutoff is 8.3 million tons, lognormally
distributed with a standard deviation of 200,000 tons. Reserves are positively
correlated with the ore production rate and year 2 ore grade and gold price. If
reserves turn out to be higher than expected, or mill production lower than
expected,
we allow
for additional
of mining
in year distributed
6 and 7, upwith
to a a
The expected
ore production
rate days
is 6,000
t/d, normally
standard deviation of 500 t/d. Production is positively correlated with mine
capital cost and mill capital cost, and negatively correlated with mine operating
cost and mill operating cost. This distribution, as are many in this spreadsheet, is
truncated to prevent unreasonable values. Uncertain production is resolved

Mine capital cost and mill capital cost are triangularly distributed with means of
$24,420,000 and $54,318,000 respectively. Minimum costs are 90% of means
and maximum costs are 115% of means. They are positively correlated.
Working capital is triangularly distributed with a mean of $12,000,000. Minimum
costs are 90% of mean and maximum costs are 115% of mean. Working capital is
positively correlated with mine operating cost and mill operating cost in year 2.
Average grade of the ore (mill feed) in any one year is normally distributed with a
mean of 4.05 g/t and a standard deviation of 0.41 g/t, positively correlated with
the same year's mill recovery.
Mill recovery for each year is uniformly distributed between 93% and 97%. Each
year's mill recovery is positively correlated with ore grade and the previous year's
recovery.
Gold price is lognormally distributed with a mean of 10.50 g/t and standard
deviation of 10%. Prices year to year are highly correlated. We implement this
by setting the mean value for year n+1 equal the random draw for year n.
Yearly mine operating costs are lognormally distributed, with a mean of $2.62/t
and a standard deviation of 1/4 of the mean. Mill operating costs are also
lognormally distributed, with a mean of $6.88/t and a standard deviation of 1/4 of

Results

The expected after-tax NPV based on a static analysis using expected values of
the uncertain variables is $22.392 million, with a payback period of 4.0 years and
an IRR of 20%. The mean NPV from the Monte Carlo analysis is $23.405 million,

251410062.xls.ms_office
PROPOSED GOLD MINE PROJECT
Technical and Financial Project Parameters
(Assumption Cells in Bright Green)
Technical Parameters
Average Grade (g Au/ton)
Cutoff Grade (g Au/ton)
Reserve Level at Cutoff (million
Contained Value (kg Au)
Stripping Ratio
Ore Production Rate (t/d)
Mill Recovery
Operating days/year
Mine Life (year)

Year

Financial Parameters
10.50
Current Gold Price ($/g)
Mine Operating Cost ($/t)
2.62
Mill Operating Cost ($/t)
6.88
Total Operating Cost ($/t)
9.50
Mine Capital Cost ($ 000)
24,420
Mill Capital Cost ($ 000)
54,318
Total Capital Cost ($ 000)
78,738
Working Capital ($ 000)
12,000
Capitalized Exploration Cost ($ 000)
910
Depletion Allowance (%)
15%
Royalty (% Net Smelter Return) 5%
Income Tax Rate (%)
46%
Salvage Value (% of Capital Costs)
10%
Real Risk-adjusted Discount Rate10%
(%)
Inflation (%)
3%

4.05
0.65
tons)
8.300
33,615
2.0
6,000
95%
355
6

PRODUCTION
Operating days/year
0
249
Waste (t/day)
0
12,000
Ore (t/day)
0
6,000
Waste Prestripping (000 t)
3,579
2,982
Ore milled (000 t)
0
1,491
Ore grade (g/t)
0
4.05
Mill recovery (%)
0
95%
Gold recovered (000 g)
0
5,737
Remaining recoverable gold (000 g)
31,934
26,198
REVENUE
Gold price ($/g)
10.50
Gross income ($ 000)
0
60,235
OPERATING COSTS
Mine Operating Cost ($/t)
2.62
Total Mining Cost ($ 000)
0
11,719
Mill Operating Cost ($/t)
6.88
Total Milling Cost ($ 000)
0
10,258
Total Operating Cost ($ 000)
0
21,977
DEPRECIATION
Var. Dep. Year 1 (DB-SL) ($ 000)
16,732
12,183
Var. Dep. Year 2 (DB-SL) ($ 000)
0
3,650
Var. Dep. Year 4 (DB-SL) ($ 000)
0
0
Cumulative Depreciation ($ 000)
16,732
15,833
DEPLETION
Adjusted Cost Basis ($ 000)
910
910
Cost Depletion Allow. ($ 000)
0
163
Percentage Depl. Allowance ($ 000)
0
7,782
50% Taxable Income Limit ($ 000)
0
7,036
Depletion Taken ($ 000)
0
7,036
Cumulative Depletion ($ 000)
0
7,036
TAX
Gross Revenue ($ 000)
0
60,235
Less: Refinery Charges ($ 000)
0
5,622
Net Smelter Return ($ 000)
0
54,613
Less: Royalty Payment ($ 000)
0
2,731
Net Revenue ($ 000)
0
51,882
Add: Salvage Value ($ 000)
0
0
Less: Operating Costs ($ 000)
0
21,977
Less: Development Expen. ($ 000)
6,564
0
Less: Depreciation ($ 000)
16,732
15,833
Less: Amortization ($ 000)
563
563
Less: Depletion ($ 000)
0
7,036
Taxable Income ($ 000)
-23,858
6,473
Less: Tax ($ 000)
-10,975
2,978
CAPITAL INVESTMENT
Mine/Mill Capital ($ 000)
66,927
11,811
Working Capital ($ 000)
12,000
0
Total Capex Cash Flow ($ 000)
78,927
11,811
CASH FLOW
Net Income After Tax ($ 000)
-12,883
3,496
Add: Depreciation ($ 000)
16,732
15,833
Add: Depletion ($ 000)
0
7,036
Add: Amortization ($ 000)
563
563
Less: Capital Cost ($ 000)
68,896
11,811
Less: Working Capital ($ 000)
12,000
0
Net Cash Flow ($ 000)
-76,486
14,554
Cumulative Cash Flow ($ 000)
-76,486
-61,932
NPV @ 10% ($ 000)
22,391
IRR
20%
Payback Period
CCF-Negative CCF-Negative

TOTAL

355
12,000
6,000
4,260
2,130
4.05
95%
8,195
18,002

355
12,000
6,000
4,260
2,130
4.05
95%
8,195
9,807

355
12,000
6,000
4,260
2,130
4.05
95%
8,195
1,612

70
12,000
6,000
838
419
4.05
95%
1,612
0

0
12,000
6,000
0
0
4.05
95%
0
0

10.50
86,049

10.50
86,049

10.50
86,049

10.50
16,927

10.50
0

2.62
16,742
6.88
14,654
31,396

2.62
16,742
6.88
14,654
31,396

2.62
16,742
6.88
14,654
31,396

2.62
3,293
6.88
2,883
6,176

2.62
0
6.88
0
0

57,104
122,342

8,871
2,480
0
11,352

6,460
1,686
2,151
10,296

5,857
1,283
1,044
8,184

5,687
1,245
608
7,540

0
0
0
0

55,790
10,344
3,803
69,937

0
0
11,118
15,685
11,118
18,153

0
0
11,118
16,212
11,118
29,271

0
0
11,118
17,268
11,118
40,389

0
0
2,187
432
432
40,820

0
0
0
0
0
0

1,820
163
43,322
56,633
40,820
135,669

86,049
8,031
78,018
3,901
74,117
0
31,396
0
11,352
563
11,118
19,689
9,057

86,049
8,031
78,018
3,901
74,117
0
31,396
0
10,296
563
11,118
20,744
9,542

86,049
8,031
78,018
3,901
74,117
0
31,396
0
8,184
563
11,118
22,857
10,514

16,927
1,580
15,347
767
14,580
8,268
6,176
0
7,540
563
432
8,137
3,743

0
0
0
0
0
0
0
0
0
0
0
0
0

335,310
31,296
304,014
15,201
288,813
8,268
122,342
6,564
69,937
3,376
40,820
54,042
24,859

0
0
0

3,937
0
3,937

0
0
0

0
-12,000
-12,000

0
0
0

82,675
0
82,675

10,632
11,352
11,118
563
0
0
33,101
-28,831

11,202
10,296
11,118
563
3,937
0
28,679
-152

12,343
8,184
11,118
563
0
0
31,644
31,493

4,394
7,540
432
563
0
-12,000
24,366
55,859

0
0
0
0
0
0
0
0

29,183
69,937
40,820

CCF-Negative

CCF-Negative

Page 3

4.00

CCF-Positive

1,383
20,179
8,300
31,934

335,310
65,238

84,644
0
55,859

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