© MEA 2006 V 1.
0 08/2006
FINANCIAL TECHNICAL
MODELING (FTM)
• What is FTM (Financial Technical Modeling)?
• Revenue Assumptions
• Evaluation Guidelines
• The Frame Work of Evaluation
• Project Cost of Capital
• Conclusions
Copyright © 2007-2010 MEA
This slide presentation was created by
Mr Edmund Malone/Dr Serkan Saydam/Emmanuel Chanda
2010; revised by EC (2013)
The moral right of the author has been asserted
The presentation forms part of the Mine Planning, an MEA Course
All rights reserved. The presentation is licensed to MEA for
educational purposes in MEA courses only
WHAT IS A FINANCIAL TECHNICAL
MODEL (FTM)?
Financial/technical models of mining projects are
spreadsheets in which the technical processes of ore
and waste mining, ore processing and production of
salable product are incorporated as quantities mined,
processed and sold and, in turn, as generating the
revenues earned and costs incurred in such processes.
The revenues earned depend on forecasts of product
prices, generally supplied by sources external to the
mining operation.
The costs are determined by technical analysis of the
project by project staff.
WHAT IS A FINANCIAL TECHNICAL
MODEL (FTM)?
Other financial inputs, such as interest rates, debt
raisings and repayments and depreciation
schedules will normally be supplied by head office
corporate staff.
Forecasts of future inflation rates and exchange
rates may well be supplied by external sources.
Example 1 of Financial Technical Model
REVENUE ASSUMPTIONS - 1
World market prices dominant but hard to predict
World economic conditions are volatile
Uneven outlook throughout the world
Supply and demand dominates - excess supply is
usual but not now (China!)
Potential for major economic disruptions, e.g. oil
price shocks, Soviet collapse, GFC, war, China
effect, etc.
PROJECT FINANCE
Money lent for developing a project
Secured against assets and cash flow of project
Repayable from earnings of project
Limited recourse (sometimes no recourse) to
other assets of project owners
SOURCES OF FINANCE
EQUITY:
New Issues (shares, options, hybrids, units)
Asset sales
Retained earnings
Term loans
Securities (bills, bonds, notes, debentures)
Commodity loans-Leases
Project finance
DEBT: security, recourse
ADVANTAGES OF EQUITY FINANCING
It's less risky than a loan because you don't have to pay it
back, and it's a good option if you can't afford to take on
debt.
You tap into the investor's network, which may add more
credibility to your business.
Investors take a long-term view, and most don't expect a
return on their investment immediately.
You won't have to channel profits into loan repayment.
You'll have more cash on hand for expanding the
business.
There's no requirement to pay back the investment if the
business fails.
DISADVANTAGES OF EQUITY FINANCING
It may require returns that could be more than the rate you
would pay for a bank loan.
The investor will require some ownership of your
company and a percentage of the profits. You may not want
to give up this kind of control.
You will have to consult with investors before making
big (or even routine) decisions -- and you may disagree
with your investors.
In the case of irreconcilable disagreements with investors,
you may need to cash in your portion of the business and
allow the investors to run the company without you.
It takes time and effort to find the right investor for your
company.
ADVANTAGES OF DEBT FINANCING
The bank or lending institution has no say in the way you
run your company and does not have any ownership in
your business.
The business relationship ends once the money is paid
back.
The interest on the loan is tax deductible.
Loans can be short term or long term.
Principal and interest are known figures you can plan in a
budget (provided that you don't take a variable rate loan).
DISADVANTAGES OF DEBT FINANCING
Money must paid back within a fixed amount of time.
If you rely too much on debt and have cash flow
problems, you will have trouble paying the loan back.
If you carry too much debt you will be seen as "high risk"
by potential investors – which will limit your ability to raise
capital by equity financing in the future.
Debt financing can leave the business vulnerable during
hard times when sales take a dip.
Debt can make it difficult for a business to grow because of
the high cost of repaying the loan.
Assets of the business can be held as collateral to the
lender.
EQUITY/DEBT FINANCING MIX
Most businesses opt for a blend of both equity and
debt financing to meet their needs when expanding a
business.
The two forms of financing together can work well to
reduce the downsides of each.
The right ratio will vary according to your type of
business, cash flow, profits and the amount of money
you need to expand your business (50:50; 30:70, etc)
PROBLEMS OF F/T MODELS
INACCURATE RESOURCE ESTIMATES
but good technical work can reduce this problem
OPTIMISTIC REVENUE ASSUMPTIONS
are frequently the main problem
Declining long term commodity prices in real terms
But year average prices can be 50% +/- trend
F/T modelling necessary and powerful tools for
operational decision making
EVALUATION GUIDELINES
Made at a point in time
Sunk costs (don’t worry!)
Constant $ or current $
For comparing alternatives, make sure techniques used
permit fair comparisons
Computer financial models (spreadsheet modeling)
Investment decision versus sale/purchase evaluation
FRAMEWORK OF EVALUATION
A construction of cash flows - in and out
Express every aspect in terms of cash
Express uncertainty in ranges of values,
creating multiple models of the one project
Cash flows not accounting profits
Evaluate on a stand alone basis
Ignore side issues unless the side issue is
the purpose of the project
MAJOR ITEMS IN FTM
CASH ($):
Cash is the lifeblood of the enterprise
“Cash flows” are actual $ spent or received
Non-cash items (e.g. depreciation) are
important as far as they affect cash flows
Project cash flows for a period are inflows
minus outflows - may be +ve or -ve
Periods are usually years; may be quarters
or months, depending on the size of the
project
INFLOWS AND OUTFLOWS*
Inflows: sales revenue; may include other minor
items
Outflows: Initial capital expenditure, working
capital, maintaining capital, operating costs, taxes,
royalties, rehabilitation costs, etc
Royalties: ?Treat as reductions in revenue
Off site costs, such as realisation costs, ? Treat as
reductions in revenue
* Very important!
WORKING CAPITAL
Component of initial Cap. ex. - to fund op. costs
until sales revenues arrive - in theory recovered
at end of mine life
Required throughout project life but generally
supplied by sales revenues
Itemised on a period by period basis in detailed
financial models
Avoid double counting in financial model but must
be counted in initial funding requirement
CURRENCY
Local currency (A$ for Australian projects in Australia)
Because costs in local currency
Convert revenues to local currency
Forecast exchange rates can dominate the evaluation
Foreign projects in host country currency - limited
conversion to A$ needed
In cases of foreign country hyperinflation, use a stable
currency, e.g. US$, if sales revenues in US$
EXCHANGE RATES
A$ EXCHANGE RATE IS QUITE VOLATILE
Moves with commodity prices but affected by other influences
as well.
Forex turnover in all currencies in Australian market represents
4.3% of global turnover, 7th largest forex market in the world.
A$/US$ pair ~45% of total turnover. Euro/US$ pair ~14%.
A$/JPY only 1%
Aust. forex market grew with world market. Also, helped by
carry trade and hedge fund activity, plus growing funds under
management in Australia seeking to invest overseas. Bulk of
trades with overseas FIs
Aust. banks hedge ~ 100% of forex deals.
CONSTANT VS CURRENT $
$ change in value over time
Constant $ - generally average value of $ of the day at
time of evaluation, preserved throughout project life.
Current $ - $ of the day for each period in the future -
requires calculation of the change in value from period
to period, i.e. usually inflation rates
Costs affected by local inflation, revenues by world
inflation, up to a point. Mineral commodity revenues
controlled by supply and demand most of the time.
MORE CONSTANT VS CURRENT $
Constant $ evaluation easier
Present day costs known but not future revenues
Current $ evaluation both costs and revenues based on forecasts of
future events
But current $ are the real world - constant $ is artificial simplification
Constant $ evaluations can be misleading by ignoring inflation but can
be very effective in choosing between alternatives
Constant $ cost of funds different from current $ cost of funds
INTEREST RATES
A function of the time value of money
On debt, represent low risk return
Therefore, risky investments offer higher return
Diversified equity investments offer about 6%
above the risk free rate
Government bonds represent risk free rate
Interest rates and discount rates closely linked
PROJECT COST OF CAPITAL
Invested funds are recovered from future returns with
interest
What rate of interest is appropriate for using funds in this
project?
Must be above the risk free rate but how much above?
Individual resource projects generally have a slightly
higher cost of capital than the company as a whole
Function of project risk, diminishing reserves and need
for exploration
The appropriate cost of capital should be the discount
rate for project evaluation purposes.
COMPANY COST OF CAPITAL
Co funds - equity plus debt
Cost of equity - empirical measures
Cost of debt - average after tax interest
rate on debt - factual
Cost of funds = weighted average cost of
equity and debt
Current $ cost of capital - includes
allowance for inflation -can be converted to
constant $
CURRENT $ TO CONSTANT $
1 + CONSTANT $ COST OF CAPITAL
= (1+ CURRENT $ COST OF CAP)/(1+ INFLATION RATE)
MORE ON COST OF CAPITAL
Cost of equity capital applies for 100% equity
funding
Debt lowers the cost of capital but increases risk
What is the minimum acceptable return on equity?
Historically, 8% real on all equities - therefore, higher
in current $ terms
Should it be higher for “risky” mining investments?
CAPITAL ASSET PRICING MODEL
Developed from long term studies of equity
markets in USA:
R = Rf + B(Rm -Rf)
Where:
R = required rate of return
Rf = risk free interest rate
B =relative risk of particular stock
Rm = average market return
MARKET RISK PREMIUM
Rm-Rf = market risk premium
Expected premium, but based on historical
data as proxy
Australian data over 100 years indicates
5% to 6% arithmetic average - 6%
geometric average
US data indicates 5% to 6% geometric average
Volatility of returns means (Rm-Rf)
geometric average is 2% to 10% with 95%
confidence. A pretty big range.
WEIGHTED AVERAGE COST OF CAPITAL
WACC* = (E/A)R +(D/A)Rd(1-tc)
Where;
E = market value of equity
D = debt
A =debt + equity
R = cost of capital, from CAPM
Rd = interest rate on debt
and tc = corporate tax rate
R is after tax, Rd is pre-tax
*used where a mix of DEBT & EQUITY applies
WEIGHTED AVERAGE COST OF CAPITAL
ASSUME:
$1,000,000,000 = E
$1,000,000,000 = D
$2,000,000,000 = A
16% = R
10% = Rd
30% = tc
1000000 1000000
WACC 0.16 0.11 0.3 11.5 12%
2000000 2000000
PROJECT PERIODS
Equal length periods cover entire life of project
Permits use of standard compound interest
relationships and rules
Periods = years, generally
May be quarters or months for small projects
Project commences with the first period of
investment
Evaluation relates to beginning of first period
SUNK COSTS:
Past expenditures have no bearing on the
evaluation,e.g., exploration expenditure.
The evaluation is considering future expenditures
and revenues resulting from a decision yet to be
made.
True of cost of evaluation and confirmatory work
except for tax benefits
END OF PERIOD CONVENTION
Expenditures and receipts occur irregularly
through time - but, for purposes of
evaluation, all cash flows are deemed to
take place at the end of the period
Generally conservative
Midpoint of period can be used
DEPRECIATION
Depreciation is the means of recovering capital
expenditure
Depreciation deducted from cash flow to determine
taxable income, and thus tax payable
Depreciation then added back to after tax profit to
determine period cash flow
Dividend payments are not part of the project evaluation.
Positive NPV of cash flows mean capital has been
serviced at the discount rate while invested, has been
recovered and excess return has been received
Capital Expenditure
Expenditure providing for mine operations for
longer than one year
Expenditure for operations within the year are
expensed, not capitalised
Depreciation schedules – straight line over life of
asset, life of mine or 10 years; declining balance
depreciation can defer tax but eventually returns
to straight line.
Tax payable calculations
Taxable income = sales revenue for year
minus all operating costs, overhead costs,
interest payments and depreciation
Tax rate 30% at present
Negative taxable income, no tax paid and
no tax refund except where group taxation
makes immediate use of tax losses
possible
Usually, tax losses carried forward to
reduce taxable income in later years
Period cash flows
Project cash flows for each year (or shorter
period) made up of:
After tax profit or loss
Plus any depreciation added back
Plus adjustments for any after tax items such
as capital expenditures, loan drawdowns or
loan repayments made or received during the
year.
ROYALTIES
Charge levied by State or Federal Government in
return for permission to mine
Reflects “Crown” ownership of minerals
Various forms of royalty: ad valorem, pro rata,
profit share, resource rent taxation in different
jurisdictions
Check what applies to specific project and treat
as a reduction in revenues
LAGGED REVENUE
Example: Smelter pays to the company based on
the waiting period to produce the expected amount
of product depending to the shipping capacity.
For gold it is not much time to produce gold from
ore/concentrate to gold bullion, say1 week, but base
metals may take more time, say 2-3 months
lagged.
Example of FTM (Canvas File)
PAUSE – REFLECT!
• Revenue assumptions
• Sources of finance
• Cash
• Currency, Exchange rates
• In- Outflow $
• Constant vs Current $
• Lagged revenue
• Sunk Costs
• Project periods
•WACC
• Cost of Capital
• Working Capital
• CAPM
• Interest rates
• Equity vs Debt Financing
• Royalties
• End of period convention
