Chapter 6.

2
MINE FEASIBILITY STUDIES*
D ONALD W. G ENTRY AND T HOMAS J. O'N EIL

Feasibility studies are the heart of the mine evaluation pro- 6. Transportation: description of the additional, necessary
cess. A feasibility study of a mining project represents an engi- transportation facilities (roads, air strips, bridges, harbors, rail
neering/economic appraisal of the commercial viability of that lines).
project. As such, it is the result of a relatively formal procedure 7. Towns and Related Facilities: housing for workers, schools
for assessing the various relationships that exist among the myr- for children of workers, medical facilities, company offices.
iad of factors that directly or indirectly affect the project in 8. Labor Requirements: estimates of work force broken down
question. In essence, the objective of a feasibility study is to according to qualifications (skills) and local availability.
clarify the basic factors that govern the chances for project suc- 9. Environmental Protection: plans to reduce or minimize
cess. Once all the factors relative to the project have been defined environmental damage, description of relevant environmental
and studied, an attempt is made to quantify as many variables legislation.
as possible in order to arrive at a potential value or worth of the 10. Legal Considerations: review of mining laws, taxation,
property. foreign-investment regulations, political risk.
As a mining project progresses from raw exploration through 11. Economic Analysis: cost estimates for plant and equip-
to the time when a management decision is made to develop and ment, infrastructure, materials, labor, other factors; market anal-
mine the property, a number of analyses will be conducted on ysis, including production, consumption, and price formation
the property, each of which will be based on increasing amounts for the relevant minerals; revenue forecasts based on expected
of data, will require increasing amounts of time (and therefore production and mineral prices; cash flow and net present value
expense) to prepare, and will have increasing degrees of accu- analysis; sensitivity analysis.
racy. For example, as exploration occurs on a mining property, Assuming the project continues to appear favorable through-
the intersection of mineralization by a few drillholes typically out the intermediate economic studies, as these studies progres-
triggers the need for some type of initial analysis to assist with sively focus more on engineering and economic aspects and less
necessary decision making. These types of studies are identified on geologic parameters, the project must be formally assessed
by various names (Gocht et al., 1988; Taylor, 1977), but in each through a comprehensive feasibility study. The feasibility study
case they are designed to answer questions pertaining to (1) what represents a detailed analysis of all the parameters contained in
magnitude of deposit might exist rather than what is known to the intermediate economic studies, along with other pertinent
exist, (2) should further expenditures be incurred to look for factors relating to political and legal aspects affecting project
what might exist, (3) should the project be abandoned, or (4) viability. Specific data requirements for incorporation into feasi-
what additional effort and/or expense is necessary before making bility studies are contained in the following segment of this
any of these decisions. chapter; however, in general, the study contains analyses of the
Assuming a favorable decision for continuation of the proj- project’s geology and deposit characteristics, mineralogy, min-
ect, the next sequence of decisions must be predicated on studies eral processing characteristics, designs and plans for mining and
utilizing much more detailed information. These so-called pre- processing equipment requirements, construction schedules, in-
feasibility studies or intermediate economic studies are based on vestment requirements and timing, estimates of revenues and
increasing amounts of data pertaining to geologic information, costs, marketing plans, cash flow calculations, sources and meth-
preliminary engineering designs and plans for mining and pro- ods of financing, and risk and sensitivity analyses of important
cessing facilities, and initial estimates of project revenues and project variables. As stated previously, the purpose of the feasi-
costs. They are constructed to support a continuum of decisions bility study is to assess the technical and economic viability of
relating to the next major spending requirement. Intermediate the project and to assist the organization in making the “go/no-
economic studies of this type typically contain the following go” decision regarding project development.
information and analysis (Gocht et al., 1988): Although there is no prescribed format for reporting the
1. Project Description: geographic area, existing access routes, results of a project feasibility study, the final report must fulfill
topography, climate, project history, concessionary terms, the following essential functions (Taylor, 1977):
schedule for development of mine and any processing facilities. 1. Provide a comprehensive framework of established and
2. Geology: regional geology, detailed description of the proj- detailed facts concerning the mineral project.
ect area, preliminary reserve calculations, plans for detailed tar- 2. Present an appropriate scheme of exploitation complete
get evaluation. with plans, designs, equipment lists, etc., in sufficient detail for
3. Mining: geometry of the ore body, proposed mining plan accurate cost estimation and associated economic results.
(and alternatives), required plant and equipment. 3. Indicate the most likely profitability on investment in
4. Processing: technical descriptions of the ore and concen- the project, assuming the project is equipped and operated as
trate, processing facilities. specified in the report.
5. Other Operating Needs: availability of energy, water, spare 4. Provide an assessment of pertinent legal factors, financing
parts, and equipment (diesel oil, explosives, replacement parts, alternatives, fiscal regimes, environmental regulations, and risk
etc.). and sensitivity analyses on important technical, economic, politi-
cal, and financial variables affecting the project.
5. Present all information in a manner intelligible to the
* This chapter draws heavily from various chapters in Mine Invest- owner and suitable for presentation to prospective partners or
ment Analysis by D.W. Gentry and T. J. O’Neil (1984). to sources of finance. The document must be “bankable.”

393
394 MINING ENGINEERING HANDBOOK
6.2.1 DATA REQUIREMENTS magnitude of mining revenues depends upon factors such as
ore reserves, production rates, commodity prices, markets, and
Nothing improves the results of a project feasibility study metallurgical recoveries. These variables are often extremely dif-
more than good input data. Unfortunately, those preparing feasi- ficult to estimate or predict—particularly for commodities
bility studies for mining projects never possess all the informa- traded in international markets. This topic is discussed in more
tion they would like. In addition to inadequacy or unavailability detail in the following portion of this chapter.
of some needed data, care must be taken not to overlook any The overall operating environment is another area of major
variable that may influence project viability. In this regard, it is concern. In recent years, the national and, to a lesser but growing
often helpful to compile an outline of factors to be considered extent, the international operating environment of mining prop-
when preparing feasibility studies on mining properties. erties has been impacted significantly by environmental and
other regulatory requirements. These constraints have invariably
increased operating and capital cost requirements for the indus-
6.2.1.1 Factors for Consideration try and have reduced or delayed the production of mineral com-
modities. The operating environment of mining operations is
Table 6.2.1. is an outline of some of the pertinent variables also affected by direct economic variables, such as royalties and
that must be studied, considered, and analyzed when evaluating taxes mandated by federal, state, and local taxing authorities.
mining properties. The significance of each variable will be a All these costs, whether direct or indirect, impact profit margins,
function of the specific property being investigated and the min- ore reserves, mineral conservation, and ultimately project via-
eral commodity (metallic, nonmetallic, fuel) involved. Nonethe- bility.
less, all these variables should be assessed during preparation of
the final feasibility study.
A review of Table 6.2.1. suggests there are some fundamental 6.2.1.2 Variable Quantification
issues that are applicable to all mining property feasibility stud-
ies—regardless of the commodity involved. For instance, one of As stated previously, the objective of any feasibility study is
the first tasks associated with any mining property is estimating to assess, clarify, and ultimately quantify the basic factors that
the magnitude and quality of the ore reserves (Chapter 5.6). Ore govern the chances for project success. Once all the geologic,
is, of course, an economic term and is a function of commodity engineering, and other technology-related factors relative to the
prices, production costs, mining method, recoveries, dilution, property have been defined and studied, an attempt is made to
and a number of other variables. Because ore reserves are deter- quantify as many of the variables as possible to arrive at a
mined by ever-changing economic conditions, the exact amount potential value or worth of the property. In this regard, two
of ore contained in a deposit cannot be precisely determined general categories of quantification are extremely important yet
until production ceases. This uncertainty with respect to ore quite troublesome to compute: revenue estimation and cost esti-
reserves has a significant impact on the evaluation of mineral mation.
properties where long-term contracts at stipulated selling prices Revenue Estimation: Annual mine revenue is calculated by
are not available. multiplying the number of units produced and sold throughout
Production technology is another key area of concern when the year by the sales price received per unit. While the arithmetic
performing mining feasibility studies. Technological advance- associated with calculating annual mine revenue is trivial, de-
ments in equipment, mineral processing, and other areas can termining the best value to use for each of these two critical
significantly impact projected operating and capital costs. A variables is much more difficult.
good example of the impact of technology changes on mining There are a number of important considerations in estimat-
costs is the comparison between direct mining costs per ton ing the number of units produced and sold annually. For exam-
(tonne) of rock for underground and surface operations. While ple, estimates must be made of the tonnage of ore produced, the
underground operating costs have been increasing at significant grade of ore mined (including dilution), the percentage recovery
rates in recent years (mainly because of the lack of major techno- of the valuable mineral in the ore, and, finally, the number of
logical advancements and the labor intensity that exists), unit payable units available for sale.
operating costs at surface operations have changed far less. The The second major component of the mine revenue calcula-
technological advancements in mining equipment, yielding pro- tion is the unit sales price. Estimating future mineral prices—
ductivity increases, have prevented direct operating costs in sur- particularly prices far enough into the future to be of use in mine
face operations from escalating at the rates experienced by under- investment analysis—is much more difficult than estimating the
ground producers. The relative stability in surface operating production-related variables and is an exercise in which a high
costs has not been entirely free, however. The technological error of estimation invariably exists. As pointed out in Section
advancements in mining equipment that contributed to this sta- 2.0, mineral prices, like those of any other product, are ultimately
bility in operating costs carried with them significant increases determined by supply and demand. However, there are major
in capital costs. complications on both sides of the supply-demand equation that
Operating and capital cost requirements must be determined seriously impair the value of quantitative econometric modeling
separately when formulating the feasibility study. However, in for estimating mineral prices.
the limiting case, it is the combination of the magnitude and Clearly, the analysis of supply and demand for most mineral
timing of both these costs that ultimately influence the analysis. commodities is complicated. In fact, few analysts are willing to
Any changes in future production technologies must be carefully suggest that reliable forecasts of prices useful in mine investment
analyzed and the impact assessed on overall operating and capi- analysis are possible. The current popular approach to this prob-
tal cost requirements. The estimation of capital and operating lem is for analysts to occupy safer ground and issue price projec-
costs for mining projects that have not progressed to the detailed tions—that is, prices that are likely if certain assumed events
planning and layout stage is discussed in Chapter 6.3. actually occur.
Another area of fundamental interest in feasibility studies of Regardless of the difficulties associated with forecasting or
mining properties that requires considerable data generation and projecting mineral prices into the future, estimates of mining
analysis is the estimation of project revenues. The timing and project annual revenue must be established. Generally, fungible
 MINE FEASIBILITY STUDIES 395
Table 6.2.1. Salient Factors Requiring Consideration in
a Mining Project Feasibility Study
I. Information on Deposit G. Government Considerations
A. Geology 1. Taxation: federal, state, local
1. Mineralization: type, grade, uniformity a. Organization of the enterprise
2. Geologic structure b. Tax authorities and regimes
3. Rock types: physical properties c. Special concessions, negotiating procedures, duration
4. Extent of leached or oxidized zones d. Division of distributable profits
5. Possible genesis 2. Reclamation and operating requirements and trends: pol-
B. Geometry lution, construction, operating and related permits, re-
1. Size, shape, and attitude porting requirements
2. Continuity 3. Zoning
3. Depth 4. Proposed and pending mining legislation
C. Geography 5. Legal issues: employment laws, licenses and permits, cur-
1. Location: proximity to population centers, supply depots, rency exchange, expatriation of profits, agreements
services among partners, type of operating entity for tax and other
2. Topography purposes.
3. Access H. Financing
4. Climatic conditions 1. Alternatives: sources, magnitudes, issues of ownership
5. Surface conditions: vegetation, stream diversion 2. Obligations: repayment of debt, interest
6. Political boundaries 3. Type of operating entity: organizational structure
D. Exploration 4. Division of profits: legal considerations
1. Historical: district, property Ill. Mining Method Selection
2. Current program A. Physical Controls
3. Reserves 1. Strength: ore, waste, relative
a. Tonnage-grade curve for deposit, distribution classifi- 2. Uniformity: mineralization, blending requirements
cation; computation of complete mineral inventory 3. Continuity: mineralization
(geological and mining reserves) segregated by ore 4. Geology: structure
body, ore type, elevation and grade categories 5. Surface disturbance: subsidence
b. Derivation of dilution and mining recovery estimates for 6. Geometry
mining reserves. B. Selectivity
4. Sampling: types, procedures, spacing 1. Dilution, ore recovery estimates
5. Assaying: procedures, check assaying 2. Waste mining and disposal
6. Proposed program C. Preproduction Requirements
II. Information on General Project Economics 1. Preproduction development or mining requirements:
A. Markets quantity, methods, time
1. Marketable form of product: concentrates, direct shipping 2. Layout and plans: schedule
ore, specifications, regulations, restrictions 3. Capital requirements
2. Market location and alternatives: likely purchasers, direct D. Production Requirements
purchase vs. toll treatment 1. Relative production
3. Expected price levels and trends: supply-demand, com- 2. Continuing development: methods, quantity, time require-
petitive cost levels, new source of product substitutions, ments
tariffs 3. Labor and equipment requirements
4. Sales characteristics: further treatment, sales terms, let- 4. Capital requirements vs. availability
ters of intent, contract duration, provisions for amend- IV. Processing Methods
ments and cost escalations, procedures/requirements for A. Mineralogy
sampling, assaying, and umpiring. 1. Properties of ore: metallurgical, chemical, physical
B. Transportation 2. Ore hardness
1. Property access B. Alternative Processes
2. Product transportation: methods, distance, costs 1. Type and stages of extraction process
C. Utilities 2. Degree of processing: nature and quality of products
1. Electric power: availability, location, ownership right-of- 3. Establish flowsheet: calculation of quantities flowing,
way, costs specification of recovery and product grade
2. Natural gas: availability, location, costs 4. Production schedule
3. Alternatives: on-site generation C. Production Quality vs. Specifications
D. Land, Water, and Mineral Rights D. Recoveries and Product Quality
1. Ownership: surface, mineral, water, acquisition or secure- 1. Estimate effects of variations in ore type or head grade
ment by option or otherwise, costs E. Plant Layout
2. Acreage requirements: concentrator site, waste dump lo- 1. Capital requirements
cation, tailings pond location, shops, offices, change- 2. Space requirements
houses, laboratories, sundry buildings, etc. 3. Proximity to deposit
E. Water V. Capital and Operating Cost Estimates
1. Potable and process: sources, quantity, quality, availabil- A. Capital Costs
ity, costs 1. Exploration
2. Mine water: quantity, quality, depth and service, drainage 2. Preproduction development (may also be considered op-
method, treatment erating costs)
F. Labor a. Site preparation
1. Availability and type: skilled/unskilled in mining b. Development of deposit for extraction
2. Rates and trends 3. Working capital
3. Degree of organization: structure and strength a. Spares and supplies (inventory)
4. Local/district labor history b. Initial operations
5. Housing and transport of employees c. Financing costs (when appropriate)
 MINING ENGINEERING HANDBOOK
4. Mining e. Engineering and contingency fees
a. Site preparation B. Operating Costs
b. Mine buildings 1. Mining
c. Mine equipment: freight, taxes and erection costs, re- a. Labor: pay rates plus fringes
placement schedule b. Maintenance and supplies: quantities, unit
d. Engineering and contingency fees c. Development
5. Mill 2. Milling
a. Site preparation a. Labor: pay rates plus fringes
b. Mill buildings b. Maintenance and supplies: quantities, unit costs
c. Mill equipment: freight, taxes and erection costs, re- 3. Administrative and supervisory
placement schedules a. Overhead charges
d. Tailings pond b. Irrecoverable social costs
Source: Gentry and Hrebar, 1978; Taylor, 1977.

commodities—such as most metals traded on exchanges—suffer must contain operating and capital cost estimates based on actual
from the greatest future price uncertainty. Most metal markets design and layout drawings, manning tables, flow charts, and
are notoriously cyclical, and the amplitude and the period of the equipment lists, specifications, and manufacturer quotations.
cycles defy accurate prediction. The recommended approach to These estimates should be predicated on data relative to unit
mineral price forecasting is not limited to the application of any operations, job functions, job requirements, timetables, and so
one or two specific analytical techniques, and it definitely is on. This requires considerable time and effort; there are few, if
not a mechanical process. Rather, it is a painstaking blend of any, acceptable shortcuts.
economic theory, industry analysis, market analysis, and com-
petitor analysis combined with sound, experienced judgment.
Cost Estimation: The economic evaluation portion of a feasi- 6.2.2 CASH FLOW ANALYSIS
bility study ultimately must be based on information that pro-
vides an answer to the question, “what is it going to cost?” The importance of the pro forma income statement in estab-
lishing the value of a mining project via the income (earnings)
Unfortunately, the answer to this question is not simple, primar-
approach was alluded to in Chapter 6.1. Inasmuch as there
ily because of the significant misunderstandings associated with
are generally major differences between accounting profits and
cost data. Therefore, the components of so-called “total produc-
actual net cash benefits derived from an investment, investors
tion cost” or “total operating cost,” for example, must be care-
are using almost exclusively the concept of project cash flows as
fully identified and defined.
the primary measure of real benefits produced by a capital proj-
When preparing a mine feasibility study, it is essential also
ect. This is predicated on the knowledge that cash flow analyses
to distinguish between operating costs, expenses, and capital
and accounting concepts depict investments differently, as a re-
costs. Operating costs are considered to be all expenses incurred
sult of the timing of costs, and on the belief that the proper
at the plant site, whereas general expenses are off-site manage-
method for evaluating a capital investment is to compare the
ment or corporate-level expenditures. This latter classification
present investment outlay with the expected positive net cash
of expenses may be directly related to mine or plant size, or it flows that will accrue from the project in the future. In making
may contain indirect items incurred by headquarters and allo- this comparison, it is essential that the timing of the various
cated across all production divisions in accordance with some cash flows be recognized by the use of an appropriate interest
corporate allocation scenario. (discount) rate. This aspect of cash flow analysis is discussed
Direct costs, or variable costs, relate to items such as labor, briefly in the following portion of this chapter.
materials, energy, and supplies that are consumed directly in the As indicated, cash flow analyses relate the expenditures asso-
production process and are used roughly in direct proportion to ciated with investment to the subsequent revenues or benefits
the level of production. On the other hand, indirect costs, or generated from such investment. Cash flows are routinely calcu-
fixed costs, are expenditures that are independent of the level of lated on an annual basis for evaluation purposes and are deter-
production— at least over certain ranges. It is obvious that, in mined by subtracting the annual cash outflows from the annual
the limit, few costs are absolutely fixed. cash inflows that result from the investment. Consequently, a
Capital costs (or first cost, or capital investment) are those cash flow analysis may be performed for any investment with
expenditures made to acquire or develop capital assets, the bene- which income and expenditure are associated. Also the annual
fits of which will be derived over several years. The largest cash flows resulting from an investment may be either positive
portion of capital costs is incurred in the initial stages of project or negative. Typically, the net annual cash flows for a new mining
start-up, but some capital expenditures are incurred annually property will be negative during the preproduction years due to
throughout the life of the mine. large capital expenditures. After production commences, the
In general, capital costs fall into one of three classes, de- cash flows will usually be positive, and an inflow of cash results
pending on the treatment of the cost for tax purposes. These are from investment in the project.
depreciable investment, expensed or amortizable investment, and In the US income tax law, net annual cash flow is treated
nondeductible investment. Because of differing tax treatments, basically as a combination of two components: the return on the
the type of capital expenditure involved can be a very important investment and the recoupment of the investment. In the miner-
factor in the evaluation of a new project, in addition to its mag- als industry, net cash flow is generally defined as net profit after
nitude. taxes plus depreciation and depletion minus capital expenditures
The estimation of operating and capital costs for mining and working capital. Within this definition, net profit after taxes
projects is extremely difficult and must be performed with great represents the return on the investment, whereas depreciation
care. Chapter 6.3 illustrates procedures for estimating initial and depletion represent the recoupment of the investment.
capital and operating costs for mining projects being analyzed In a cash flow analysis, each investment receives credit for
via intermediate economic studies. However, the final feasibility income taxes saved. Since the accounting allowances for depreci-
 MINE FEASIBILITY STUDIES 397
Table 6.2.2. Components and Basic Calculation ing activities that require consideration in the preparation of
Procedure for Developing Cash Flows cash flow analyses. The appropriate use and manipulation of
these input variables are an extremely important facet of the
cash flow analysis. The concept of a cash flow analysis is a
Calculation Component
particularly useful technique for the evaluation of mineral-
Revenue related projects because of the important impact of the depletion
Less Royalties allowance in the United States.
Equal Gross income from mining In view of the foregoing, it is worthwhile to reiterate the fact
Less Operating costs that in a cash flow analysis, each investment receives credit for
Equal Net operating income
Depreciation and amortization allowance
income taxes saved. Therefore, for profitable organizations, it is
Less
Equal Net income after depreciation and amortization advantageous to maximize pretax deductions and thereby reduce
Less Depletion allowance the amount of taxable income and, consequently, income taxes
Equal Net taxable income paid. In order to take advantage of these tax savings as soon as
Less State income tax possible, the firm would opt to expense all possible expenditures
Equal Net federal taxable income in the year incurred as opposed to capitalizing them followed by
Less Federal income tax subsequent write-offs over the amortization period. Although
Equal Net profit after taxes the total amount of the pretax deduction would be the same in
Add Depreciation and amortization allowances either case, by expensing as soon as possible, the firm realizes an
Add Depletion allowance
Operating cash flow
earlier return of the resulting tax savings. This early return of
Equal
Less Working capital tax savings enables the firm to utilize these dollars sooner than
Equal Net annual cash flow would otherwise be possible.

Source: Gentry and O’Neil, 1984.

6.2.3 TIME VALUE OF MONEY
If it were not for the existence of interest, the analysis of
Table 6.2.3. Parameters for Consideration in Cash Flow investment opportunities would be greatly simplified. In the ab-
Analysis of a Mining Property sence of interest, investors would be indifferent as to when cash
outlays are made or cash benefits received. It would, in fact, be
Preproduction Period irrelevant whether the outlays preceded or followed inflows, as
Exploration expenses Land and mineral rights long as both amounts are known with certainty.
Water rights Environmental costs Of course, it does make a considerable difference whether,
Mine and plant capital Development costs for example, a firm receives $1 million now or five years from
requirements now. The reason is that money does have a value, which is a
Sunk costs Financial structure function of time. Interest is how this time value is measured.
Working capital Administration Interest is generally defined as money paid for the use of
Production Period
borrowed money. Interest may be likened to a rental charge for
Price Capital investment—replacement
of expansions using an asset over some specific time period. The rate of interest
Processing costs Royalty is the ratio of the interest chargeable at the end of a specific
Recovery Mining cost period of time to the money owed, or borrowed, at the beginning
Postconcentrate cost Development cost of that period. Interest exists to compensate for a number of
Revenues and percent Exploration cost concerns experienced by lenders; these are related primarily to
removable risk, inflation, transaction costs, opportunity costs, and post-
Grade General and administration ponement of pleasures. The level of interest is, like the price of
Investment tax credit Insurance other assets, determined by supply and demand.
State taxes Production rate in tons per year
The history, philosophy, and theoretical underpinnings of
Federal taxes Financial year production begins
Depletion rate Percent production not sent to interest are covered exhaustively in a large number of texts and
processing plant reference books (e.g., Newman, 1980; Smith, 1973). This mate-
Depreciation Operating days per year rial need not be repeated here.
Postproduction It is sufficient simply to recognize that money has earning
Salvage value Contractual and reclamation power. That is, the timing of when payments are made and
expenditures earnings are received in a capital project is very important.
Source: Laing, 1977.
6.2.3.1 Interest Formulas
Cash flows at different points in time are related by a series
ation and depletion reduce the amount of taxable income (and of six basic interest formulas. These formulas in turn are based
therefore reduce the amount of taxes paid), they have the effect on five variables, as follows:
of saving the organization money. Consequently, they constitute F is a future sum of money, P is a present sum of
a credit in the cash flow calculation and are added to net income
money, A is a payment in a series of n equal payments,
after taxes. It must be recognized that depreciation and depletion
made at the end of each period of interest, i is effective
are noncash items and do not actually “flow” anywhere.
interest rate per period, and n is number of interest pe-
Table 6.2.2. illustrates the components and basic calculation
riods.
procedure for determining annual cash flows for a mining proj-
ect. Table 6.2.3. lists some of the more important parameters Every interest problem is composed of four of these variables:
relating to preproduction, production, and postproduction min- three are given, and the fourth must be determined. The standard
398 MINING ENGINEERING HANDBOOK
notation for describing the particular type of problem involved
lists all four variables of concern, in the following manner:

For example: (F/P,i,n), means, “Find F, given P,i, and n”

Multiplying Eq. 6.2.3 by (1 + i) yields
Similarly, (A/F,i,n), means, “Find A, given F,i, and n”

The notation is often shortened to simply F/P or A/F, etc.,

where it is understood that i and n are given. This notation is
widely accepted in the field of engineering economy.
The six basic interest equations are developed and described. Now subtracting Eq. 6.2.3 from 6.2.4,
1. Single payment compound amount, (F/P,i,n).

(6.2.5)
Example 6.2.1. Find the amount that will accrue at the end
of 7 years if $1250 is invested now at 8%, compounded annually.
Given: P = $1250, n = 7 years, i = 8%.
Solution.
Example 6.2.3. If payments of $725 are made at the end of
F = P(1 + i) = $1250 (1 + 0.08)7 = $2142.28 each year for 12 years to an account which pays interest at the
rate of 9% per year, what will be the terminal amount?
The quantity (1 + i)n = (F/P,i,n) has, like other interest Solution .
factors, been tabulated for various values of i and n in so-called
interest tables. Such tables are provided in the appendix of this
volume for select interest rates and discrete compounding.
However, many hand-held calculators can now solve such
problems directly so that interest tables are becoming less nec-
essary.
2. Single payment, present worth (P/F,i,n).
This is Eq. 6.2.1 solved for P.
It obviously makes a considerable difference if the annual
payments are made at the beginning of the year (an annuity
due) rather than at the end of the year (an immediate annuity).
However, the end-of-year convention is more common, and
Example 6.2.2. If $6500 will be needed in 5 years, how much
nearly all interest tables and computer programs are constructed
should be invested now at an interest rate of 7.5%, compounded
on this basis. To verify easily that any particular table or com-
annually?
puter program adheres to this convention, note that for n = 1,
Solution. Given: F = $6500, n = 5 years, i = 7.5%
F = A regardless of the interest rate.
4. Uniform series, sinking fund, (A/F,i,n).
Solving Eq. 6.2.5 for A will enable the analyst to determine
what annual payments must be made to accumulate a specified
amount by some future date at an interest rate i:
Using interest tables to solve this problem becomes some-
what more difficult because one must interpolate between 7
and 8%. For most interest problems, a linear interpolation is
satisfactory. The widespread use of programmed calculators and Example 6.2.4. With interest at 6%, how much must be
computers for solving interest problems facilitates exact solu- deposited at the end of each year to yield a final amount of $2825
tions so that interpolation is often unnecessary. However, the in 7 years?
intellectual problem of calculating exact solutions from highly Solution .
inexact data is of major concern in all investment studies.
3. Uniform series, compound amount (F/A,i,n).
Here the concern is to determine the terminal amount when
equal annual payments are made to an interest-bearing account
for a specified number of years. It is important at this point to
recall that A is defined as occurring at the end of the interest
period. Therefore, for
The concept of a sinking fund is well known, so that the A/
n =1 , F = A F interest factor is often called the sinking fund factor.
5. Uniform series, present worth (P/A,i,n).
n = 2 , F = A(1 + i) + A (6.2.3) This type of problem arises when the current value of a
2
future series of cash flows is desired. This is often the case with
n = 3 ,F = A (1 + i) + A (1 + i) + A investments in securities where an expenditure now will provide
equal interest or dividend payments for several future periods.
or in general, For Eq. 6.2.5,
 MINE FEASIBILITY STUDIES 399
be—particularly when values are extracted from interest tables.
Following are some relationships based on given values of i and
n.
Substitute Eq. 6.2.1, 1. The single payment compound amount factor (F/P,i,n)
and the single payment present value factor (P/F,i,n) are recip-
rocals:

2. The sinking fund factor (A/F,i,n) and the compound

amount factor for an ann uity (F/A,i,n) are reciprocals:

(6.2.7)

Example 6.2.5. An investment will yield $610 at the end of

each year for 15 years. If interest is 10%, what is the maximum 3. The capital recovery factor (A/P,i,n) and the present value
purchase price (i.e., present value) for this investment? factor for an annuity (P/A ,i,n) are reciprocals:
Solution.

4. The capital recovery factor (A/P,i,n) is equal to the sinking

fund factor (A/F,i,n) plus interest rate:

5. The present value factor for an annuity (P/A,i,n) is equal

to the sum of the first n terms of single payment value factors
6. Uniform series, capital recovery, (A/P,i,n) (P/F,i,n):
This is the reverse of the previous problem, and the equation
is derived simply by solving Eq. 6.2.7 for A:

6. The compound amount factor for an annuity (F/A,i,n)

is equal to 1.00 plus the sum of the first (n-l) terms of the
single-payment compound amount factor (F/P,i,n):
Example 6.2.6. If an investment opportunity is offe red 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%?
Solution.
6.2.4. SELECTING A DISCOUNT RATE
As indicated in the previous section of this chapter, future
project receipts and expenditures must be discounted to permit
valid comparisons with current cash flows. Although the concept
of discounting is widely accepted, selection of an appropriate
discount rate has been the source of considerable debate and
much disagreement.
The fact that interest exists suggests that all money has a
cost associated with its use. The cost of this money may be the
The preceding formulas pertain to annual compounding and, result of either explicit or implicit charges or some combination
where A enters the problem, to annual cash flows. In practice, of the two. Indeed, any time an individual or a firm consumes
these constraints are routinely violated as neither payments/ less than the total earnings generated in a specified time period,
receipts nor compounding need be on an annual basis. In fact, that individual or corporation has either consciously or uncon-
there is a continuous spectrum of possibilities with discrete an- sciously decided to “invest” these excess funds in some type of
nual compounding and discrete cash flows at one end of the activity—even if the funds are maintained in a cash account.
continuum, and continuous compounding and continuous flow Intuitively, it seems reasonable to accept the fact that no
of funds at the other end. The reader interested in learning money is free. Certainly, there is a cost associated with raising
more about the procedures for handling specific cases within this investment capital. For instance, there is a cost associated with
spectrum is referred to Chapter 3 in Gentry and O’Neil (1984). going to the debt markets and borrowing money for investment
purposes. This explicit cost of borrowing results from the fact
that interest exists. Similarly, it is important to recognize that
6.2.3.2 Interest Factor Relationships an investor who purchases the firm’s common stock (equity) has
The relationships between the interest factors identified in the same expectations of making a return on his investment as
the preceding formulas are often not as clear as they might a banker who loans money. Additionally, it is important to
400 MINING ENGINEERING HANDBOOK
Transaction Cost: Whether corporate investment capital is
procured from the debt market or the equity market, the firm
will experience transaction costs regardless of whether or not a
new security issue is involved. These costs include broker and
investment banker fees, costs of prospectuses and various filings,
sales discounts, and other flotation costs. Although the aggregate
transaction costs are generally much less than the base opportu-
nity cost, they are significant and should be incorporated into
Fig. 6.2.1. Relationship between investment decision and financing the determination of the appropriate discount rate.
decision.
Increment for Risk: The cost of procuring funds, either debt
or equity, includes a component for the investor’s perception
recognize that a firm may allocate investment capital to alterna- of risk. Consequently, some organizations add some additional
tive investment opportunities that may be available and that percentage increment for risk to the cost of raising investment
promise specific rates of return on the investment capital. This capital before applying this rate to discounted cash flow analyses.
concept of alternative investment opportunities suggests that The rationale here is that high-risk projects should be discounted
there also are opportunity costs (implicit costs) associated with at some higher rate to compensate for their relative riskiness.
investment capital. Clearly, then, there are explicit and implicit There are two fundamental problems associated with this
costs associated with procuring and utilizing investment capital, approach to accounting for project risk. First, the increments
and, at least to some extent, these costs are influenced by infla- for risk assigned to the discount rate are subjective by nature and
tionary trends and expectations. cannot be quantitatively equated to project risk in any systematic
Remembering that the firm’s primary objective should be manner. The second problem with this procedure is the manner
the maximization of shareholder wealth, it then intuitively seems in which project risk (business risk) is addressed. Clearly, the
reasonable to suggest that the firm should not invest in any discount rate only adjusts for the present value of money; it does
project where the anticipated return does not exceed the cost of not by itself adjust for project business risk, as measured by the
funds (capital) committed to the project. Indeed, if the firm variability in annual project cash flows. Thus the discount rate
always invests in projects having returns in excess of the cost of provides no information on how annual project cash flows might
capital committed to them, then the wealth of the firm (as mea- vary, nor does it provide any insight into why these cash flows
sured by the price of common stock) should be increased to the might fluctuate from year to year. Consequently, the discount
stockholders. This cost of funds, known as the cost of capital, rate does not provide a measure of project risk and, in general,
is the direct linkage between investment policy and the firm’s should not be used to do so. Superior approaches to accounting
objective. for project risk are discussed in Chapter 6.5.
Further, the cost of capital also relates the financing decision Increment for Inflation: It seems reasonable to assume that
to the investment decision. Indeed, the cost of capital is the only investment capital raised in the marketplace includes some cost
link between these two decisions. The relationship between the premium for investor expectations of future inflation. Therefore,
financing decision and the investment decision in corporate fi- presumably a market-determined cost of capital includes a com-
nance via the cost of capital is illustrated in Fig. 6.2.1. ponent that is based on investors’ perceptions of future inflation.
An alternative way to view the cost of capital is to recognize As a result, this market-determined cost of capital should be
that the minimum acceptable rate of return (MARR) on an used as the appropriate discount rate when analyzing inflation-
investment may be defined as the minimum rate of return a firm adjusted project cash flows. The amount of downward adjust-
must earn on its investments in order to leave unchanged the ment in the market-derived cost of capital for use with constant-
value of existing shares of its common stock. Investing at the cost dollar analyses can be shown to be roughly equal to the general
of capital will achieve this objective, and therefore the MARR is rate of inflation.
quantitatively equal to the cost of capital. The logical conclusion
from this observation is that this cost of capital represents the
“hurdle rate” or the appropriate discount rate to be used in
conjunction with discounted cash flow analyses of investment 6.2.4.2 Cost of Specific Types of Capital
opportunities.
The manner in which a firm chooses to finance itself will
6.2.4.1 Components of Discount Rate largely determine the cost of capital to the organization, since
Following are four major components to the discount rate. each source of financing has a specific cost. Thus the capital
Some of these components stem from sound theoretical and structure of the firm, defined as the mix of long-term sources of
practical foundations, while others are judgmental. Rarely is the funds used to finance assets, becomes important in that the
combined discount rate calculated by summing these separate resulting cost of capital to the firm directly influences the invest-
components, as the capital markets do a good job of determining ment decision. Since the firm’s investment decisions influence
the overall cost of funds to various uses. Nonetheless, the com- common stock prices and therefore the value of the firm, the
bined rate must be sufficient to cover these four elements. capital structure of the firm and the resulting cost of capital
Base Opportunity Cost: There is always some base opportu- become key parameters in corporate finance.
nity cost associated with procuring and utilizing investment capi- Many corporations choose to develop a capital structure by
tal. This cost is the return foregone by diverting funds from the utilizing a mixture of debt, preferred stock, and equity financing.
next most attractive project and exists whether the funds are Each of the various financial instruments available within these
obtained externally or internally. In either case, funds appro- general categories has its own specific cost to the organization.
priated for a particular use will carry a cost related to the return The cost of each specific type of financing follows; however, the
those funds could have achieved elsewhere. The other compo- cost is essentially that rate which equates the funds received with
nents of the discount rate are typically added to this base oppor- all discounted future outlays relevant to that source. This may
tunity cost for investment capital. be expressed as
 MINE FEASIBILITY STUDIES 401
.....

where Io is net proceeds received at time zero, Ci is cash outflow

in the ith period, and k is cost of this specific source of financing.
The Ci ’s are fairly easily determined in the case of debt and where PO is value of stock at time O, Di is dividend payment in
preferred stock financing. Equity financing costs, however, have the ith year, and ke is cost of equity applicable to firms in this
generated a great deal of debate, and, while Eq. 6.2.9 applies in risk class.
theory, one of several proposed simplifying approximations must Obviously, dividend payments in future periods are un-
be adopted to determine the costs of equity financing in practice. known at the present time. Investors, however, have subjective
Cost of Debt: In keeping with the preceding discussion, the estimates of what these payments will be, and these estimates
cost of debt is that discount rate that equates net proceeds from are generally based on the current dividend and the historical
the debt issue to the future cash outlays. Further, these future long-run growth of dividends. An intuitive expression of these
payments are net of taxes. This is very significant with debt relationships might be:
financing since interest payments, unlike dividends, are tax de-
ductible. If kd is the cost of debt and k is the yield to maturity
of the debt issue determined by the application of Eq. 6.2.9, then (6.2.13)

where Do is current dividend and g is annual growth rate of

dividends.
Another popular method for computing the cost of common
where t is the marginal corporate tax rate. stock financing is the earnings:price ratio (E/P ratio). This ap-
Cost of Preferred Stock: In theory, because preferred stock proach is based on the assumption that investors really purchase
dividends do not represent a legal obligation on the part of earnings when buying common stock and that anticipated future
the firm, preferred stocks offer a distinct advantage over debt earnings per share determine the value of a share of common
financing. In practice, however, the omission of a preferred stock stock.
dividend is viewed by the financial community as an indication The E/P model obviously is more suitable than the dividend
of serious financial difficulty in the firm. Thus firms usually view valuation model for firms that pay low dividends or none at all.
preferred stock dividend payments as de facto obligations. For firms that have strong earnings growth records, a growth
The cost of preferred stock is usually computed in a manner term is sometimes appropriate in the E/P model to reflect share-
similar to debt perpetuities since both instruments have fixed holder expectations that such growth will continue. The mathe-
annual costs and no maturity. There is one important difference, matical expression for this model is
however. Preferred stock dividend payments are not tax deduct-
ible to the firm.
If the annual dividend paid is D dollars, and Io represents (6.2.14)
the net proceeds per share for a new stock issue, the cost of
preferred stock, kP, is where E represents current earnings per share, PO is value of
stock at present, and g is growth term for earnings per share.
It should be noted that both of these models incorporate
market prices for common stock. However, if a new common
(6.2.11)
issue is planned, net proceeds per share, Pf should be used rather
than the current market price, PO . Pf will be lower than PO by
the amount of discount required to sell the new issue, plus the
From an investment viewpoint, preferred stocks offer one underwriting costs.
advantage over bond investments to a corporation. Eighty-five Although other models exist for estimating the cost of equity,
percent of the dividend income to the corporation is nontaxable, they are more complex to use in practice and are not covered
while interest income from bonds is taxable at the full applicable here (see Gentry and O’Neil, 1984, for more complete coverage).
rate. That there is also a cost of retained earnings (net profits
Cost of Equity Capital: Equity financing comes from two minus dividends) is less obvious than for common stock. How-
sources—new common stock issues and retained earnings. ever, if the firm retains, rather than distributes, earnings, and if
Clearly, there is a cost of funds obtained through the issuance it is dedicated to the maximization of shareholder wealth, it
of new common stock. Proceeds from such a transaction must clearly must invest these funds above some minimum rate of
be invested to return sufficient earnings to maintain the firm’s return. Furthermore, the minimum rate in general is the cost of
earnings per share. While all analysts agree that there are real common stock financing, for this is the rate the investor implic-
costs involved in equity financing through the issuance of com- itly agreed to by purchasing stock in the first place. If no invest-
mon stock, no such agreement exists on calculating these costs ment opportunities are available to the firm above this minimum
in practice. rate, all earnings should be returned to the owners (shareholders)
The so-called dividend valuation model is one of the popular to enable them to reinvest the funds themselves. Thus the cost of
methods for calculating the cost of equity financing. The premise retained earnings is equal to the cost of common stock financing
for this model is that common stocks only have a value because adjusted, where applicable, for flotation costs.
of an expected future stream of dividends. In theory, this model Readers interested in the application of the foregoing equa-
is consistent with the generalized cost of capital model previously tions to calculating a firm’s cost of capital are referred to Chapter
discussed and may be represented as 11 in Gentry and O’Neil (1984).
 MINING ENGINEERING HANDBOOK
In other words, the project should just break even after
6.2.4.3 Weighted Average Cost of Capital
returning the investment plus the 12% cost of capital. This is
Given that each of the various types of financing available verified in the following.
to a corporation has a specific cost, it seems reasonable to con- Solution .
clude that it should be possible to combine these various forms
of financing into a corporate capital structure that would result
in a minimum weighted average cost of capital to the firm. In
other words, the implication is that there should be an optimum
capital structure that minimizes the firm’s weighted average cost
of capital. Thus if a firm finances itself in this optimum manner,
it should generate the lowest possible weighted average cost of
capital. If this cost of capital is then used as the appropriate
discount rate when evaluating new investment opportunities, the
firm should find that more investments become acceptable. This
should subsequently result in an optimum investment program
and generate more wealth to shareholders. Thus the discounting procedure assures that all project costs
Gentry and O’Neil (1984) provide more extensive discus- are covered—including return of and return on capital. To have
sions on the issues of optimum capital structures, marginal levied financing charges explicitly against the project prior to
weighted average cost of capital calculations, and the practical discounting would clearly have forced the project to pay these
problems associated with these calculations. costs twice.
Nonetheless, it continues to bother many that interest pay-
6.2.4.4 Common Errors in Evaluation ments resulting from additional debt obligations are not charged
directly to the project, even though these obligations must be
One of the most common errors made in discounted cash met from the earning power of the firm’s investments. This has
flow financial analysis involves using the cost of specific financ- caused some firms to incorporate a procedure whereby projects
ing in evaluating projects rather than the average cost of all are evaluated on (1) a full equity basis and (2) various degrees
capital used by the firm. When a capital project involves an of debt leveraging. The following example serves to illustrate the
expenditure of, say, $20 million through a bank loan carrying types of calculations resulting from this improper procedure.
an interest rate of 12%, it often is difficult to understand that Example 6.2.8. (Gentry and O’Neil, 1984)
(1) the interest charges from the loan should not be levied against An underground conveyor system is proposed to reduce
the project for evaluation purposes, and (2) the appropriate dis- haulage costs at a zinc mine. Benefits to be derived from this
count rate to use is not 12% (or its approximate after-tax equiva- project are estimated to be $200,000 annual savings in operating
lent), but rather the marginal weighted average cost of all capital costs. Depreciation is straight-line, and the income tax rate is
used by the firm. 50%. Depletion is constrained by 22% of gross income from
Another common error in financial analyses is the inappro- mining and can, therefore, be ignored as being constant in all
priate use of a market-derived cost of capital as the discount rate alternatives. If the total investment is estimated to be $1,146,000,
with constant dollar project cash flow estimates. These errors and the service life is 12 years with no salvage value, calculate
are sufficiently common to deserve further discussion. the rate of return on equity capital for (1) all equity case, (2) 50/
Error No. 1: Charging Specific Capital Costs to the Project. 50, debt/equity financing, and (3) 95/5, debt/equity financing.
The cost of capital, being the link between the investment deci- Assume the before-tax cost of debt is 8% compounded annu-
sion and the financing decision, occupies a unique place in the ally, and for simplicity assume that the entire principal amount
evaluation procedure. All other project costs (i.e., operating will be repaid at the termination of the project.
costs, plant overhead, depreciation, etc.) are handled explicitly Solution .
in the pro forma income statement. The cost of capital, however, 1. Equity investment
is the discount rate and does not receive a separate line in these A. $1,146,000
statements. While such a procedure may be applicable in other B. $ 573,000
types of economic studies or analyses of financing alternatives, C. $ 57,000
it is incorrect to do so in discounted cash flow analyses. 2. Debt investment to be repaid at the end of the year 12
Unfortunately, this procedure has led many practitioners to A. 0
believe that the cost of funds has been omitted in the analysis B. $ 573,000
and should be listed separately in a manner similar to the other C. $1,088,700
cost items. This misconception occurs most frequently when 3. Annual cash flows
debt capital is raised and the accompanying interest payments Case A Case B Case C
are not charged directly to the project in the discounted cash Net operating savings $200,000 $200,000 $200,000
flow return on investment (DCFROI) calculations. However, it Less: depreciation — 95,500 — 95,500 — 95,500
is important to recognize that to do so would clearly double- : interest 0 — 45,840 — 87,096
count the cost of capital—once through the discount rate and a Pretax net income 104,500 58,660 17,404
second time through the explicit interest charges. This point is Less: income tax 52,250 29,330 8,702
illustrated in the following. Incremental net profit 52,250 29,330 8,702
Example 6.2.7. (Gentry and O’Neil, 1984) Add: depreciation 95,500 95,500 95,500
Suppose Hikki Mining Co. contemplates an investment op- Incremental net cash
portunity having the following anticipated revenues and costs. flow $147,750 $124,830 $104,202
Investment = $100
Net annual cash flows (year 1-5) = $27.74 4. DCF return on equity
Cost of capital = 12% Case A: $1,146,000 = 147,750 (P/A, i, 12)
NPV = $27.74 (P/A, 12, 5) – 100 = 0 i = 7.5%
 MINE FEASIBILITY STUDIES 403
Case B: $573,000 = 124,830 (P/A, i, 12)–573,000)(P/F, i, 12) Thus over the three-year period by using the cost of a specific
i = 14.8% source of debt as his investment criterion, the treasurer had
invested $1.7 million at a weighted average return of 12%. It is
Case C: $57,300 = 104,202 (P/A, i, 12)–1,088,700 (P/F, i, 12) clear, however, that the treasurer’s eagerness to accept projects
i = 182.5% in year 1 precluded the acceptance of better projects in year 3.
The foregoing analysis seems to suggest that the use of debt In fact, the same $1.7 million could have been invested to yield
financing can turn a very marginal project into one yielding a an average rate of 13.3% by accepting projects in the following
phenomenal rate of return. However, it must be recognized that sequence:
the DCFROI on the equity portion of the investment is always
increased with leveraged financing if the after-tax cost of debt is
Year 1 A, B, C, D
less than the DCFROI of the project figured for the all-equity
Year 2 A, B, C
case. Thus the most marginal of investments can often be made to
Year 3 A, B, C
appear positively superb when a high percentage of debt capital is
used!
A basic principle of investment analysis is that a project This example illustrates that debt financing is only possible
must stand on its own merits and must compete for funds on if an adequate equity base exists. Clearly, the marginal cost of
an equal basis with other investment opportunities. Each such capital is not simply the cost of debt but also the cost of equity
opportunity must share fully in the benefits of debt leveraging if that will be required in the future to support the added debt.
the same weighted marginal average cost of capital is used for Thus every investment must carry its proportionate share of
all projects. the necessary—but higher cost—equity funds whenever debt is
In summary, the following should always be observed in added to the capital structure of the firm. In the foregoing exam-
project investment analysis: ple, using the marginal weighted average cost of all capital
1. To avoid counting capital costs twice, do not charge costs sources would have resulted in rejecting the lower-value projects
of specific capital sources against the project. These charges are in year one, thereby permitting the acceptance of higher-value
embedded in the discount rate. projects in year three.
2. Calculate returns on investments on total capital invested In summary, it is important to recognize that it is incorrect
(i.e., all-equity case) to insure that all projects are compared on to use the cost of a specific source of capital as the cash flow
an equal basis. discount rate, or equivalently, as the minimum acceptable rate
Error No. 2: Using Specific Capital Costs as the Discount of return for capital projects.
Rate. Debt financing is the source of another common error in Error No. 3: Using the Appropriate Discount Rate with
capital project evaluations. There is a tendency on the part of Inflated and Constant Dollar Cash Flows. Some organizations
some analysts to use the cost of a specific source of financing— insist on performing cash flow analyses in terms of constant
rather than a weighted average of all capital sources—as the dollars, while others prefer to perform analyses in terms of in-
discount rate in measuring the attractiveness of a project. The flated cash flows. Although the preparation of constant dollar
following example illustrates this flaw. pro forma cash flows is highly recommended to promote better
Example 6.2.9. (after Quirin, 1967) technical understanding of the project, discounting should al-
Global Mineral Ventures, Inc. was presented with a similar ways be performed on inflated dollars to avoid miscalculation of
set of investment opportunities in three successive years, as income taxes. Although there are specific virtues associated with
shown: both approaches, the important point here is to recognize that a
Year 1 Year 2 Year 3 market-determined cost of capital includes a component that is
Rate Rate Rate based on investors’ perceptions of future inflation. As a result,
Amount of of Amount of of Amount of of this market-derived cost of capital should be used as the appro-
investment return investment return investment return priate discount rate when analyzing inflation-adjusted project
Project $ $ $ $ $ $ cash flows. If this rate is applied to project cash flows that are
A 100,000 20 100,000 20 100,000 20 not adjusted for inflation, the project will be seriously underval-
B 200,000 15 200,000 15 200,000 15 ued. The amount of downward adjustment in the market-derived
C 200,000 11 200,000 11 200,000 11 cost of capital for use with constant-dollar analysis is roughly
D 200,000 8 200,000 8 200,000 8 equal to the general rate of inflation.
E 200,000 6 200,000 6 200,000 6 A more complete discussion of the impact and treatment of
inflation in mining investment decision analysis is provided in
Chapter 10 of Gentry and O’Neil (1984).
Solution.
In year one, Global had no long-term debt, and the corporate
treasurer found that the full $900,000 could be raised by selling
debentures bearing an annual interest rate of 5½%. He convinced 6.2.5 AN ITERATIVE PROCESS
Global’s board that, since every project returned more than
5½%, they should all be accepted. This chapter has focused on the engineering and economic
In year two, the treasurer was able to borrow a further parameters associated with project feasibility studies. Estimates
$700,000 at 7%, and using the same logic as the previous year, necessary for the quantification of many of these parameters in
accepted all projects except E, which offered a return below the the pro forma income statement are provided in Chapter 6.3.
7% marginal cost of debt. The calculation of project net annual cash flows can be per-
In the third year, however, Global’s treasurer found only a formed after completion of the pro forma income statement using
limited amount of additional debt available to him—$100,000 at the appropriate cost of capital or discount rate. Given these
18% from a finance company. Since this was still below the estimates of relative benefits, costs, and annual cash flows for a
estimated 19% for a new equity issue, the treasurer used the project, it then becomes necessary to convert these estimates into
debt to accept only project A. measures of relative desirability or attractiveness. The criteria
404 MINING ENGINEERING HANDBOOK
and techniques typically utilized to determine project acceptabil- REFERENCES
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Gentry, D. W., and Hrebar, M.J., 1978, “Economic Principles for Prop-
It must be remembered, however, that completion of a feasi- erty Valuation of Industrial Minerals,” Short course, SME-AIME
bility study or an intermediate economic study incorporating Fall Meeting, Nassau, Bahamas, Sep., 153 pp.
one set of project parameters represents only one alternative in Gentry, D.W., and O’Neil, T.J., 1984, Mine Investment Analysis, SME-
an iterative process. As noted in the introduction to this section, AIME, New York, 502 pp.
the process of evaluating mine investment opportunities is itera- Gocht, W.R., Zantop, H., and Eggert, R.G., 1988, International Mineral
tive nature. Each time a project variable or parameter changes, Economics, Springer-Verlag, New York, 252 pp.
Laing, G.J., 1977, “Effects of State Taxation on the Mining Industry in
it is necessary to assess the impact of this change on all other the Rocky Mountain States,” Colorado School of Mines Quarterly,
project variables and on the subsequent financial results. Vo1.72. No. 1. 126 pp.
This iterative process must be repeated until the most eco- Newman, D.G., 1980: Engineering Economic Analysis, Engineering
nomic design is achieved for the project being analyzed. This Press, Inc., San Jose, CA, 460 pp.
may require changes in cutoff grade, mining reserves, mine size Quirin, G.D., 1967, The Capital Expenditure Decision, Richard D. Irwin,
or mining rate, or alternative extraction scenarios having dif- Inc., Homewood, IL, 258 pp.
Smith, G.W., 1973, Engineering Economy: Analysis of Capital Expendi-
fering capital and operating cost characteristics. Whatever the tures, 2nd ed., Iowa State University Press, Ames, IA, 621 pp.
case, the most efficient combination of project parameters must Taylor, H.K., 1977, “Mine Valuation and Feasibility Studies,” Mineral
be combined to meet the firm’s primary objective: wealth maxim- Industry Costs, Northwest Mining Association, Spokane, WA, pp.
ization to its shareholders. 1-18.