ECONOMIC EVALUATION OF MINERAL PROPERTY

Evaluation of a Mine Development Alternative

Year

1 2 3 4 5 6 7 8 9 10 Total

Revenue 8000 8000 8000 8000 8000 8000 8000 8000

64000
Operating cost 2650 2650 2650 2650 2650 2650 2650 2650 21200

Net Income 5350 5350 5350 5350 5350 5350 5350 5350 42800
Depreciation Allowan 2900 2900 2900 2900 2900 14500

Tax able income 2450 2450 2450 2450 2450 5350 5350 5350 28300
Tax 40 % 980 980 980 980 980 2140 2140 2140 11320

Capital Costs 7700 7700 15400

Return of W.C 900 900

Cash Flow 7700 7700 4370 4370 4370 4370 4370 3210 3210 4110 16980

Find the ROR of the project with the graph?

Cash flow is the difference between benefits and costs for a specified time period. An
annual period is usually suitable for evaluation purpose.

If the annual benefits exceed the annual costs, the net benefit is referred to as a positive
cash flow; if the annual costs exceed the annual benefits, a negative cash flow results.

Benefit Elements: Sale Revenue

Salvage Value
Return of Working Capital

Cost Elements: Capital Expenditure

Operating Cost
Taxation Payment
 CF
Year Capital Revenue Operating Net Depreciation Taxable Tax 40 % Return of Cash PV=
Cost Cost Income Allowan Income Work. Cap Flow (1+i)n

1 7700 7700 7623.762

2 7700 7700 7661.786
3 8000 2650 5350 2900 2450 980 4370 4355.530
4 8000 2650 5350 2900 2450 980 4370 4359.142
5 8000 2650 5350 2900 2450 980 4370 4361.312
6 8000 2650 5350 2900 2450 980 4370 4362.759
7 8000 2650 5350 2900 2450 980 4370 4363.792
8 8000 2650 5350 5350 2140 3210 3206.010
9 8000 2650 5350 5350 2140 3210 3206.453
10 8000 2650 5350 5350 2140 900 4110 4105.912

17035.362
 ECONOMIC EVALUATION OF MINERAL PROPERTY
Evaluation of a Mine Development Alternative
Arranged by M.A

VALUATION OF NEW OR PARTLY DEVELOP PROPERTIES

Source : Economic Evaluation of Mineral Property, Saml. VanLANDINGHAM, p. 62

Factors for Consideration

The value assigned to new or partly developed property is generally the difference
between the total present value, based on discount of all future earnings, and the value
assign to physical assets, working capital, and other costs that are necessary to get the
property into operation. A detailed field examination is necessary to ascertain any adverse
physical conditions that may be met and corrected before the final decision on methods of
mining and milling, the installation of various surface buildings and facilities, and on the
transportation needed to extract and prepare a marketable product. Thus, the valuation of
partly developed mineral property is basically an estimate of potential net income from
future exploration of known ore reserves even though mine facilities, plant, or other
surface facilities do not exist. Engineering skill and experienced judgment are required
because nearly all factors must be estimated. Adequate contingency allowance must be
provided. If the ore reserve has not been fully explored, a speculative element must be
considered.
Where there are no production experience records to serve as a guide at a new
property, the risk factor are of course greater than for a going mine for which the mining
and processing methods and costs have been worked out and actually demonstrated.
Thus, the investor or buyer is usually justified in demanding a higher rate of return on
such new or prospective mines.
The valuator (appraiser or valuation engineer) is usually confronted with the questions
of what constitutes ore reserves and how much ore is required to justify a project. He is
probably faced with measured ore, partly measured ore, geological ore, or wildcat
possibilities. Actually, the only firm basis for valuation will be found in the measured ore
category, where volumes and grades can be demonstrated. Other ore reserve categories,
which must be assumed or considered probable, should definitely be assigned to
speculative category. This speculative ores, however, may serve as a basis of trading
between the buyer and seller.
In the ideal situation, a property has sufficient ore blocked out to show clearly that the
operation (earning period) will be adequate to amortize the investment from earnings,
provide a return for use of invested funds, and give some indication of continuation of
profitable operations. Where the ore reserves are not clearly adequate for a reasonable
life of operation for a substantial investment for, say,15 to 20 years, then it rest with the
valuator to point out the speculative element or the chances of eventually developing
sufficient additional ores to pay out the investment. Where margin of profit is high, the
pay out period may be correspondingly less than the period just mentioned.
Sometimes it may be necessary to value mineral tracts not large enough to make a
mine in themselves. Adjoining active mine operations are then usually in the market for
such tracts and thus create a market for the limited ore reserves. The valuation can then
be considered on the basis or present worth of future royalties (after provision for federal
taxes) or present worth of future (deferred) earnings.
Properties having a limited ore showing may be considered in the speculative
development stage; the valuator must then use his judgment in advising the investor of
the amounts that he might be justified in spending on the prospect to try to bring it to the
stage of development for actual valuation of potential production.

Reminder List for Determining Value of New Mine Venture

The following steps are handy reminders for organizing a commercial valuation:
1) Calculate the ore reserves and indicate grade or quality under the following
classifications: measurable ore and speculative ore. (This requires a preliminary estimate
of costs and determination of mine cut-off-grade.)
2) Estimate recoverable ore, taking into consideration such factors as mine dilution,
mine losses, and cost of making ore available.
3) From study of flow sheets and metallurgical test, calculate the treatment losses or
metallurgical recovery.
4) Estimate rate of production as determined from the mine potential, and the sales
possibilities, as well as limitations, such as availability of power and water.
5) Divide reserves by annual production to obtain life of property or operations.
6) Using recovery and treatment factors, calculate total yield of saleable product.
Calculate the smelter settlement value of the ore or concentrate, or saleable products.
7) Estimate average sales price per annum and total average sales volume and total
annual gross revenue.
The following example shows the evaluation of revenue for a lead-zinc-silver deposit.

Mining method cut-and-fill

Geological ore reserves: 120 mil. tonnes
@ 11.7 % Pb, 12.7 % Zn, 124 gpt Ag
dilution factor : 10 %
mine recovery factor : 90 %
mill recoveries : Pb 94 %
Zn 76 %
Ag 90 %
mill capacity : 6,000,000 tonnes per year
metal price Pb 284 money units/tonne
Zn 394 money unit/tonne
Ag 0.0633 money unit/gm
Net smelter return Pb 50 %
Zn 40 %
Ag 80 %

Geological reserves, mil. tonne 120.0 11.7 % Pb 12.7 % Zn 124 gpt Ag

Mine recovery @ 90 % 108.0 11.7% Pb 12.7 % Zn 124 gpt Ag
Dilution @ 10 % 10.8 - - -

Recoverable Ore Reserves 118.8 10.6 % Pb 11.5 % Zn 113 gpt Ag


Source: Brian W. Mackanzie, Economic Evaluation Techniques for Investment Decisions.
Annual Revenue Estimate:

Lead 6.0 (10.6 %) (94 %) (284) (50 %) = 84.89 mil. money units
Zinc 6.0 ( 11.5 %) (78 %) (394) ( 40 %) = 84.82 mil. money units
Silver 6.0 (113) (90 %) (0.0633) (80 %) = 30.90 mil. money units

Total = 200.61 mil. money units

8) Estimate cost of sales (per ton basis), labour, materials and supplies, and overhead.
9) Estimate selling (marketing), administrative, and central office costs.
10) Subtract cost of sales from sales income to get gross profit.
11) Subtract selling and administrative expenses from gross profit to get profit before
depletion allowance also any interest payments.
12) Subtract depletion and depreciation allowances to obtain basis for computing in
come tax.
13) Determine the income taxes.
14) Estimate the total annual net profit after taxes.
15) Set up work sheet to show estimated cash flow including payments of such items as
interest, principle on loans, tax allowances for period of operations, and repayment of
initial investment though depreciation and depletion.
16) Consider special risks and hazards to operation and consider a reasonable rate of
return on investment, or discount factor to be used.
17) Estimate ultimate speculative tonnage that may be expected in additional to the
measured reserves.
18) Determine the net income before depletion and deduct return on working capital,
return on investment in mine, plant and facilities, and return on investment in non mineral
land. This give the residue earnings applicable to mineral property.
19) Discount the total residue over the life of operations to get the gross present value
of the residue.
20) Adjust for any unrecoverable working capital such as obsolescent spare parts
inventory or accounts receivable.
21) Add present value of salvage and of operations.
22) Adjust for any cost of deferring investment in mineral land and any cost of proving-
up mineral reserves.
23) Compare earnings against investment with those current in alternative enterprises.
DEPRECIATION
Source: Energy Economic, 1983, Seymour Kaplan. P.109

Physical assets, such equipment and machinery acquired by a business or organization,

are ordinarily used over a period of time. Therefore, it is common to allocate the cost of
such asset to different time periods over which such use occurs, rather than at a single
point in time, such as when the asset is purchased.
The process of allocating the asset cost over different time periods is called
depreciation. Alternative models for determining the fraction of the total cost to be
charged to different time periods result in different methods of depreciation. The principle
methods which will be considered in this chapter are straight-line depreciation,
declining-balance depreciation, and sum-of-the-years-digit depreciation.
Since the depreciation charges are considered costs in the period where they are taken,
even though no actual cash outlays occur, they will affect the amount of income taxes the
business organization must pay to the government .Generally, all other things being
equal, the greater the depreciation during a period, the less taxes will have to paid, the
less taxes paid, the more cash the organization will have for future investment
opportunities. Depreciation policy and allowable rates are formulated by federal
government tax policy and are subject to change from year to year.

DEPRECIATION METHODS
The three most common depreciation methods are called straight-line depreciation,
declining-balance depreciation, and sum-of- the-years-digits depreciation. We assume in
each method that the asset has an initial cost P and a useful life N. The anticipated value
of the asset at the end of its useful life is called its salvage value. If no appreciable
salvage value is anticipated, the salvage value is assumed equal to zero. Let L denote the
salvage value. If the asset is held for N years, the cost of holding the asset is (P-L)
dollars. This amount is the total depreciation of the asset over its useful life.

Straight-Line Depreciation
With straight-line depreciation, we assume that the total depreciation is spread uniformly
over useful life, so that the amount taken as depreciation charge in each year is constant
and equal to (P-L)/N. That is, if Dn is the depreciation in year n, than

P- L
Dn = for n = 1,2,, N
N
P-L
Bn=P- n ( )
N

We note that with this depreciation method, BN = L

Example 6-1 Facilities cost $800,000, will last 8 years, and have an estimated salvage
value of $100,000 after the eighth year. If straight-line depreciation is used, find the
depreciation charge in the third year and the book value at the end of 3 years

P-L
Solution Dn =
N

$800,000-$100,000
D3 = = $87,500
8

$700,000
B3 = $800,000 3 ( )= $537,500
8

Declining-Balance Depreciation
With this method, the depreciation charge each year is fixed percentage of the book value
of the asset at the beginning of the year. If this fixed percentage is denoted as f, where
0<f<1, then the depreciation during year n is given by Dn = fBn-1, since Bn-1 is the book
value of the asset at the beginning of year n (end of year n-1). The depreciation in the first
year is D1 = fP. Therefore, B1= P-D1= P-fP = (1-f)P. The depreciation in year 2 is
D2= f(1-f)P. The book value at the end of 2 years is

B2 = B1-D2 = (1-f)P -f(1-f)P = (1-f)2 P

It can be seen that the book value at the end of n years will be given by
Bn = (1-f)n P
The depreciation charge in year n is Dn = Bn-1-Bn
= (1-f)n-1 P-(1-f)n P= f(1-f)n-1 P

If the declining-balance method is used, we are not permitted to depreciate the asset after
any point in time where the book value equals the salvage value. That is, the total
depreciation permitted is equal to (P-L) as in the straight-line method. However, the
salvage value L does not explicitly enter into the depreciation computation for each year,
as it does in the straight-line method.
The federal government also has set limits on the maximum allowable value of f.
For newly acquired assets, f cannot exceed the value 2/N. If N = 5 years, then

f 2/5 = 0.4

If the value of f used is exactly 2/N, the depreciation methodology is called double-
declining balance. (For used equipment or machinery, f 1.5/N.
Use of the declining-balance method results in grater depreciation charges during the
early years of the life of the asset, when compared with the straight-line method.
However, depreciation charges decline each year and may eventually be less than
depreciation by the straight-line method, if the asset has a relatively long life and a low
salvage value.
 Example 6-2 Facilities are purchased for $800,000 and have an estimated life of N= 8
years. Salvage value is estimated as $100,000. Double-declining balance
depreciation is used. What is depreciation charge in the third year and the book value
at the end of three years ?

SOLUTION
Dn = f(1-f)n-1 P

D3 = 2/8(1-2/8)3-1 $800,000 = $112,500

B3 = (1-2/8)3 $800,000 = $337,500

Sum-of-the-years depreciation

P-L
Dn = (N-(n-1) S = N(N+1)/2
S

Bn = P D1-D2-.-Dn

Example 6-3 For the asset of example 6-1 and 6-2, find the depreciation in the third
year and the book value at the end of 3 years using sum-of-the-years-digits
depreciation.

SOLUTION

700,000
D3 = (8-(3-1) S = 8(8+1)/2
36

D3 = $116,667

Bn = P D1-D2-.-Dn

B3 = $800,000-$155,556-$136,111-$116,667 = $391,666

The depreciation percentages

The depreciation percentages are based on declining-balance depreciation for the first
year and straight-line depreciation for the remaining years. The rate under declining
balance is 1.5/N for assets placed in service during 1981-1984. The rate is 1.75/N for
1985 and goes to 2/N for 1986 and afterward. Furthermore, the asset is assumed to be
placed in service during the middle of the first year of use.
As an illustration of the derivation of the rates, consider an asset placed in service in
1982. Because only half the first years depreciation is allowed in 1982, the 1982
depreciation is (1.5/N)(1/2) = 0.75/N. For N = 3, the first-year depreciation is 0.25 of the
cost. For N = 5, the depreciation in 1982 is 0.15 of cost. After the first year, the remaining
value of the asset (75 percent of first coast of the 3-year 1982 asset 85 percent of first cost
of the 5-year 1982 asset) is depreciated by straight-line method over the remaining life.
For the 3-year asset, we take half of 75 percent, rounded to 38 percent for year 2, and the
remainder of 37 percent in year 3. For the 5-year asset, we take one-fourth the 85 percent
in each of year 2,3,4 and 5. With rounding in year 2, this results in the percentages shown
in Table 6-1.

Table 6-1 Depreciation Percentages ACRS

Year placed in service

1981-1984 1985 1986 and afterwards

Year 3 5 3 5 3 5

1 25 15 29 18 33 20
2 38 22 47 33 45 32
3 37 21 24 25 22 24
4 21 16 16
5 21 8 8

Example 6-4 Smith buys a light-duty truck in 1983 for $10,000. What is the depreciation
permitted each year under the ACRS ?

SOLUTION
1983 depreciation = 0.25 ($10,000) = $2500
1984 depreciation = 0.38 ($10,000) = $3800
1985 depreciation = 0.37 ($10,000) = $3700

Total depreciation = $10,000

DEPLETION
Source : Energy Economic, 1983, Seymour Kaplan. P.109

DEPLETION

For the owner of an oil or gas well, timberland, or mineral deposit, depletion represents a
mechanism for the recovery of the cost of the property. Just as depreciation allows the
purchaser of plant, machinery, and equipment acquired for business use to recover the
cost of the asset over its useful life, depletion allows for the recovery of costs as the
extracted resource is sold in the marketplace.

They are two methods of determining the amount of depletion which can be considered
as a cost in calculating income subject to taxes. These methods are cost-depletion and
percentage-depletion.
Example 6-6 Cost Depletion Suppose a mineral property containing an estimated
50,000 tons, of recoverable ore is purchased for $4,000,000. Operating expenses during
the first year are $900,000, and gross income of $2,000,000 was received from the sale of
5000 tons of the mineral. What is the income subject to income taxes (before-tax income)
for the year if cost depletion is used?

SOLUTION The $4,000,000 is called the basis of the mineral property. If we divided the
basis by the number of recoverable units in the deposit, we obtain a value of
($4,000,000)/50,000 = $80 per ton as the cost per unit. This value is called the depletion
rate. Under cost depletion, the depletion for the year is found by multiplying the depletion
rate by the number of unit sold during the year. The depletion cost would be
(80/ton) (5000 tons) = $400,000. The income subject to tax would be
$2,000,000-$900,000-$400,000 (depletion) = $700,000.

At the beginning of the second year, the adjusted basis of the property is equal to
$4,000,000-$400,000 = $3,600,000. If the estimate of recoverable mineral ore is 45,000
tons, the depletion rate in the second year will remain at $80 per ton ($3,600,000/45,000)
= $80/ton). If however, the estimate of recoverable ore changes in the second year, the
depletion rate could increase or decrease.

Example 6-7Percentage Depletion With percentage depletion, the amount of

depletion, subject to certain limitations, is an allowable percentage of the gross income
from property. Allowable percentages for some of the more common minerals are given
in Table 6-2. Suppose the mineral in the mine of Example 6-6 has an allowable
percentage of 22 percent. Find the income subject to taxes if percentage depletion is used.

SOLUTION Since the gross income received is $2,000,000, the depletion for the year is
(0.22) ($2,000,000) = $440,000. The income subject to taxes is $2,000,000 - $900,000 -
$440,000 = $660,000.

The deduction for depletion under the percentage method cannot exceed 50 percent of the
next taxable income (before-tax income) from the property, calculated without the
depletion deduction is $2,000,000 - $900,000 = $1,100,000, 50 percent of which is
$550,000. Since $440,000 is less than $550,000, the depletion of $440,000 is allowed.
Table 6-2 Depletion Percentage for some of
the more common natural deposits. Source: Tax
Guide for Small Business, Department of the
Treasury, Internal Revenue Service, Publication

Deposits Percent

Sulfur and uranium and, if from deposits in

the United States, asbestos, lead, zinc,
nickel, mica, and certain other ores and
minerals 22
If from deposits in the United States, gold,
silver, copper and iron ore, and oil shale 15
Coal and sodium chloride 10
Clay and shale used in making sewer pipe
or bricks or used as sintered or burned
light weight aggregates 7 1/2
Clay (used or sold for use in manufacture
of drainage and roofing tile, flower pots, and
kindred products), gravel, sand, and stone 5
Most other minerals and metallic ores 14

Factor Bearing Upon Potential Earnings

In the process of developing all the major elements bearing upon earnings, the data
should be set up in a useful and timesaving manner (as shown herein) since many of these
data are used subsequently for various purposes in the valuation procedure.
Ore Reserves and Life of Project with supporting data must be given both to
substantiate the quantity and grade of the recoverable ore reserves and to indicate the
development problems met in making them available for mining. To take care of
considerable variations in the grade of ore, which would appreciably affect the total
earnings, particularly in the early operating stage, the ore reserves should be shown by
level (bench or horizon) and by grade in order to develop a production schedule for
specific sections of the property. Where loan capital is involved it may be desirable to
show the possibility of mining high-grade ore during the early payout period so as to
speed up payments if necessary. The possibilities for developing additional ore should be
adequately covered. All yield and mill recovery factors should be supported by test data
and volume factors that demonstrate the tonnage and quality of marketable products. If
the physical nature of the deposit indicates a limited productive capacity for the project,
this should be clearly presented.

Table 12.1 will be helpful in developing economic factors such as practical mining rate
and volume and grade trend with deepening of the mine.
In this example ore reserves have been scheduled on 25-full-year basis, largely
dictated by market considerations.
 Markets and Future Price Levels are keys to the future earning of any mining project.
To substantiate the estimates relative to future markets, analysis of statistical data on
production and consumption (consumption-in-use pattern or historical price trends) may
be useful. Where the marketing is complex, a careful study and investigation of
consumers and competitors may be required before reasonable estimates can be made of
the time required and possible share of the market (sales volume) anticipated after
launching the project. The market study also convincing evidence about the acceptability
of the product (grade, quality, etc.); this is important not only for metal products but
particularly for most non-metallic products.

Table 12.1 Summary Ore Reserves by Levels or Benches

Mine Level Grade
or Quarry Tons Ore or Value
Bench No. Recoverable Yield per Ton

(A)
Total 23,000,000 Average $5.02 (B)

Note: (A) Data covering each level or bench should be listed here.
(B) Mining staffs nearly always carry out ore reserves estimates to cents. Figures
used herein follow the same practice to facilitate checking. Rounding out to
requisite accuracy is done with final figures.

In highly competitive markets, trade discounts may be important aspects in determination

of net sales income.
If long-term contracts can be made, future prices may be projected with considerable
accuracy. However, some long-term contracts have escalator clause tying in prices with
fluctuation in labour and materials. The valuator must usually estimate future long-term
price levels based on the demand and supply outlook as foreseen at date of valuation. For
some large projects, it may be necessary to determine the effect of increased volume of
production on the market price of the product. And because transportation may limit the
market area and sale income, a careful study of delivery costs may be essential. Where
mineral products having a long record of price stability or uniformity of rising price are
involved, it may be assumed that over a long period changes in costs of operation will be
accompanied by corresponding change in price of products. This may be likely for such
commodities as gold and oil. Other mineral commodities, however, have shown rather
violent fluctuations in the past, copper for example. Thus, future estimates of prices must
be based on the known facts and trends at the time of the report; but at the same time
estimates of operating costs must be adjusted in line with any price adjustments likely to
result from inflation.
The market potential may limit the size of the operations, but the desired payout
period and the physical limitations of the mine may also be factors. If there are not
restrictions it may be desirable to schedule the operations for the optimum economic rate
of return.
Development of the sales realization will be required, taking into consideration sales
discounts or other allowances which tend to reduce income from sale of products. In the
example given herein the average sales realization or net sales income is estimated to be
$4.78 per ton (compare with $5.02)
Capital costs can be developed only after fairly complete mine and plant layout plans
are made (Table 12.2). Consideration must be given (1) use of existing physical assets on
the property, if any, as well as (2) new equipment and facilities. A detailed listing can be
made under each of the following major headings:

1) Cost of Property
2) Preproduction Cost
3) Mining Buildings, Equipment, and Facilities
4) Milling Buildings, Equipment, and Facilities
5) General Buildings, Equipment, and Facilities (includes housing, schools,
recreation buildings, hospitals)
6) Working Capital Requirements

Table 12.2Design Capacities for Mine and Mill (Tons)

Average
Daily Hourly
Capacity, Capacity,
Designed 5-Day 7 Hr
Total Capacity Week per-
Ore Annual 2-Shift Shift
Material Reserves Basis Basis Basis

Run-of- 23,000,000 1,000,000 4,000 240
mine

To make the foregoing data useful in the subsequent cost analysis procedures, such as
developing a depreciable base, insurable values, and income tax allowances, it is
desirable to separate capital costs into Buildings, Building Equipment, Equipment and
Machinery.
The date should be indicated for the estimates covering construction costs involving
prices of materials, labour, and other expenses, so that if is an inflationary trend and the
project is delayed, all the figures can be adjusted.

Initial Working Capital requirements may constitute a substantial portion of the total
capital or financing necessary for a new project. Sufficient working capital must be
assured to sustain the project that is, to provide funds to fill the pipe line or build up
operations, including raw material in stock pile or bin, etc,; inventory stores, usage of
materials during tune-up period, semi finished or materials en route to market, and
payrolls (accounts receivable) and other costs. Table 12.3 is an example or reminder list.
 Table 12.3 Estimated Annual Workings
Capital Requirements (Basic, Tons Annually)

Total
Annual
Amounts,
Item $

1. Inventories
Raw materials (months)
Supplies (months)
Spare parts (months)
Work-in-process (months)
(between usage and monetary
return) including
Payrolls
Raw materials
Supplies
Other operating cost
2. Preparation and training
Payroll (months)
Raw material usage
Supplies usage
Other operating costs
Contingencies
3. Accounts receivable
Total initial working capital
requirements

Total capital cost requirements for financing purposes may be conveniently

summarized as in Table 12.4 which may be used as a guide for depreciation and depletion
and as an aid in other calculations for earnings statement purposes.
Costs of Production incurred in producing a marketable product must reflect actual
conditions and difficulties to be experienced in the operation of the property. Each of the
major items of operating costs is discussed in the following:

1) Labour costs, including complete manning requirements or development of the

payroll, establish a basis for ready calculation of such expenses as Public Liability,
Workmens Compensation, Use and occupancy, Unemployment, Federal Old Age
Benefits, Health and Accident, Holiday and Vacation Pay, Housing, Medical, Recreation,
and Outside Transportation. Table 12.5 is a useful form for developing the working force
2) Materials and supplies to cover all needs must be estimated on an annual basis.
Firsthand knowledge of operations and of
 Table 12.4 Preliminary Estimate Capital Cost M.E. Mine

Mineral Machinery
Land Buildings Building and
(Or Prepa- and Equip- Equip-
Reserves) ration* Facilities* ment* ment* Total

Preproduction
expenses $1,900,000 $198,000 $333,000 $9,000 $2,440,000
Mining 106,000 10,000 $710,000 826,000
Milling 994,000 45,000 2,470,000 3,509,000
General 475,000 25,000 301,000 801,000

Total $1,900,000 $198,000 $1,908,000 $89,000 $3,481,000 $7,576,000
Contingency 5 %
except mineral
land 284,000

$7,860,000
Working capital 1,300,000

Total investment requirements for financing $9,160,000

*Includes engineering, supervision, and contactors fees

($9,160,000-$1,900,000 = $7,260,000) represents the capital requirements to get the
property into production, exclusive of the cost of the mineral property.
Table 12.5 Estimated Working Force and Annual Payroll (Basic Tons Annually

Straight
Number Hourly Total Time Shift
Personal Rate Hours Earnings Differential Payroll

Production
(a) Mine*
(b) Mill*
(c) General surface*
Engineering*
Selling, administrative,
and accounting (1)
Total

*Detailed list of jobs or labour categories to be given here.

The equipment is needed here. Table 12.6 gives the general headings to be followed with
detailed listing requiring separate tables.
3) Overhead costs are likely to involve numerous items such as those listed in Table
12.7 for convenience of checking and estimating.
4) Depreciation (not general, ordinary, special maintenance) involves all mine and mill
operations. It includes only the replacement cost of major equipment and facilities that
wear out or become obsolete before the end of the life period for the project. Such
expenditures are necessary to sustain operations but since they do not occur uniformly, a
reserve is set up. Such depreciation is an important cost item that has an important
bearing upon the earnings of the project. Sound judgment should be used in establishing

Table 12.6 Detailed Estimate of Materials and Supplies

(Basis, working Day Tons Annually)

Total
Cost
Freight On
Quanti- Unit and the
Items tity Price Total Handling Job

*Detailed items may be listed and allocated

to mining, milling, etc., in cost estimates.

depreciation rates, taking into consideration the life of all equipment and facilities
involved. The actual replacement expenditure may not be made during the first three to
five years, perhaps, and it may not be practical to make any significant replacements at a
period when the mineral reserves offer only a few remaining years of operation, but the
depreciation reserve should be adequate to meet these replacements (even with inflated
costs) when necessary to maintain the project in a satisfactory operating condition and
recover the cost of equipment and facilities. The depreciation cost should also allow for
replacement of obsolescent equipment. Table 12.8 is a general check list to ensure that
this item is adequately provided for in the operation cost estimate. (Depreciation, as
discussed herein, is not straight-line depreciation as applied for tax purposes, which takes
into account only the original cost of the item purchased.)
5) Selling and Administrative costs are developed separately as they are likely to be
off-the-property costs. In this example, the figure of $105,000 per year or $0.12 per ton of
run-of-mine ore is used. To simplify the calculations at this point, no interest on borrowed
money is assumed but if present, this would affect the cash flow and income tax
calculations.
The check list in Table 12.9 gives the summary of the production cost items

Income Taxes
Income taxes must be carefully determined, particularly making allowances for such
tax deductions as depletion, depreciation, and amortization of preproduction expenses.

Table 12.7 Estimated Overhead Costs (Annual Basis)

Basis of Calculation: Total Cost per Ton

Expense Item Quantity, Rate, Other Annual Run-of-Mine Ore

Telephone and telegraph

Stationary and printing
Miscellaneous office supplies
Traveling expenses
Employee training
Engineering
Research
Property tax
Franchise tax
Fire insurance
Public liability insurance
Use and occupancy insurance
Medical and first aid
Hospitalization
Payroll tax
Workmens compensation
Vacation pay provision
Fringe benefit
Holiday pay
Health and accident insurance
Group insurance
Occupational disease insurance
Pension
Total

 Table 12.8 Depreciation

Non depreciable Depreciable Depreciation Annual

Cost Portion Portion Rate Depreciation
Items $ $ $ % $

Building
Machinery and
equipment
Service systems
Land improvements

Total

Table 12.9 Summary Operating and Fixed

Charges (Basis: 265 Working Days, 900,000
Tons Capacity)

Total
Annual Costs
Costs, per Ton
Average Run-of-
Operating Mine
Element of Cost Basis, $ Ore. $

Labour
Direct and in direct 902,000 1.00
Raw materials)
Supplies ) 973,000 1.08
Spare parts )
Overhead 83,000 0.09
Unit depletion 74,000* 0.08
Depreciation (ordinary
and replacements) 520,000** 0.58
Selling and administra-
tive 105,000 0.12

Total 2,657,000 2.95

*Unit depletion here provides for the return of all original

costs of the mineral land. This is obtained by dividing
original cost (1,900,000) by total ore reserves (23,000,000) tons
to be produced for sale over life of property. That is (1,900,000/23,000,000) x 900,000.
**This figure can best be derived by first-hand
knowledge of the particular industry: knowing the
life of the type of equipment used, knowing the
amount of replacements and adjustments experienced
from obsolescence (this is substantial in some
industries where the treatment is not well
developed)). and making provision for any inflationary trends
in prices. In this particular case the unit depreciation figure
includes depreciation of original investment in plant and facilities
($5,960,000) as well as investment for replacements and
obsolescence ($7,300,000). That is $5,960,000+$7,300,000):25.5

The impact of these items may well be a critical factor in financing. Income taxes
must be estimated and deducted to obtain the amount of net earnings and to establish the
actual return on the investment. Current tax rates should be obtained from reliable
sources and the tax computed and applied in the prescribed manner, since there is
considerable variation according to the mineral involved for each state and for each
country. Knowledge income tax application will allow proper handling of deductible
items like depletion and depreciation and permit taking advantage of tax-free periods
where these deductions are allowed. Such knowledge will also enable one to secure
maximum benefits from fast write-offs, and tax deduction for interest on loans where
such are involved. Detailed of U.S. income taxes are discussed in Chap. 4.17.
In the example of the M.E. Mine cited herein, a Canadian case used to show how the
tax-free period and the other tax allowance for depletion and depreciation create unequal
annual earnings. For those who wish to compare United States Taxes with Canadian
taxes, an example of United States application is presented:
U.S. Income Tax Percentage Depletion.
Example The percentage depletion allowance for purpose of estimating Federal In
come Tax is based on a percentage of gross income from the sale of product and has no
relation to costs.
For the product involved herein, the percentage allowed in 23 % (if the mine wire in
the United States), not to exceed 50 % of taxable income computed with depletion. The
data for calculation of the Federal Income Tax as given in Table 12.10 are from Work
Sheet II.
In considering foreign investment the taxes of both the country of operation and the
country of residence must be considered.

Time factors
Time factors are of utmost importance to the investor and are:
1) Time required for preproduction work to reach the first production stage.
2) Time required to get the property up to the designed production stage or rate.
3) Time required to recoup the investment or to pay debt retirement.
The answers to the foregoing will allow the valuator to (1) estimate the interest
charges during the preproduction period, and (2) to establish the deferment period
before the earnings start and to calculate present worth of future earnings; and (3)
to indicate the financing problems or the possibility of financing the project. If the
analysis of the cash flow in relation to time shows that the income to the investor is likely
to be inadequate during the early period of operations or is too long delayed, the project
might prove difficult to finance. If the analysis shows that the property can pay for itself
in three to ten years, the project probably can be financed.

Table 12.10Calculation of United States

Federal Income Tax (Based on Data from
Works Sheet II for Average Year)

Gross annual income from sale

product (900,000 tons), price $4,78/ton, $4,302,000
Royalty (would be subtracted) (non)

Base for applying percentage
depletion $4,302,000
Allowance: 23% of $4,302,000 989,460
or 50 % of taxable income (maximum) 818,500*
The allowable deduction 818,500
Taxable income (before depletion) 1,637,700
(Revenue-operating cost)
Less percentage depletion allowable 818,500

$818,500
Taxable income
U.S Federal income tax:
Normal 30% on $818,500 = $245,550
Surtax 22% on (818,500-25,000) = 174,570

$420,120
General Engineering Economy Models
Source; Phillip F. Ostwald, Cost Estimating for Engineering and Management, p. 324.
Without any further ado, the following general engineering economic model is proposed:

N (Sn-Cn) N A(d)n Fs
Px = (1-t) [ ] + t + (10-9)
n=1 (1+i)n n=1 (1+i)n (1+i)N

Where Px = present worth for reference year x; total discounted cash flow, dollar
Sn = sales or revenue in nth year, dollar
Cn = total cost (except depreciation charge) required to obtain Sn sales for nth
Substituted, dollars
Fs = Future value of salvageable items (land, working capital, physical salvage),
year, dollars
A(d)n= annual depreciation in nth year; form allows any depreciation procedure to be
substituted, dollars
i = effective interest rate, decimal
t = tax rate, decimal
n = end-of-year age for which computation is made
N = life of asset, years

The following example considers the discounted cash flow method where
non uniform income is expected. It is seen that it is a trial and error approach to
determine the nominal interest which makes the cash flow receipts equivalent to the
initial disbursements for an investment. A machine will cost $175,000 installed and will
be capitalized prior to the installation. The earnings as anticipated are not uniform since
the market will not be prepared for the product until several years have passed.
Additionally, it is presumed that technology will improve on the product and that the
income peak will decline. The economic life of investment is forecast to be 12 years,
while the depreciable investment will be recovered over 10 years by accelerated method
such as sum-of-the-years-digits (SYD). Salvage is estimated to return no value over
disposal costs at the end of 12 years. The composite tax rate, including all relevant taxes,
is assumed to be 55%.

Using

2(N-n+1)(P-Fs)
A(d)n = (10-10)
N(N+1)

Where A(d)n = annual depreciation amount varying with year n

N = useful life
P = investment costs
Fs = salvage value
n = current year number from start of investment, n = 1,., N
Depreciation charges can be calculated. Using various nominal values for yearly interest,
the present worth can be computed. In the iterative plan, value of 0%, 10%, 15% are used
Analysis is given in Table 10.3. Using a linear graph of Figure 10.1 the rate of return
is found to be 11.6 %. The summation procedure of Equation (10-9) must be followed
year by year for each term from zero time to the last year of the project. The several
forms of depreciation from Table 4.7 can be substituted for A(d )n. Straight-line
depreciation, sum-of-the-year digits, or other accelerated procedures can be considered.
The refinements of non uniform depreciation (other than straight-line) are shown to be
and advantage, particularly with larger interest values.
Model (10-9) may be further broadened by having it describe the un recovered balance
or net cash flow position at any time. The each cash flow positions are discounted to time
0 whit a predetermined interest rate. This model shows the number of earning periods to
have a zero un recovered balance between discounted revenues and the initial asset value.
INTERATIVE METHOD FOR EQUATION (10-9)

1 1
Cash Profit Net Discounted Discounted
Year, Earning Depreciation Taxable After Cash (1+i)n Cash (1+i)n Cash
n Sn-Cn A(d)n Income Taxes Flow 10 % Flow 15% Flow

0 (175,000) (175,000) 1.000 (175,000) 1.000 (175,000)

1 35,000 31,818 3,182 1,432 33,250 0.909 30,224 0.869 28,894
2 35,000 28,636 6,364 2,864 31,500 0.826 26,019 0.756 23.814
3 35,000 25,454 9,546 4,296 29,750 0.751 22,342 0.658 19.575
4 40,000 22,273 18,727 8,427 30,700 0.683 20,968 0.572 17,560
5 45,000 19,091 25,909 11,659 30,750 0.621 19,096 0.497 15,283
6 45,000 15,909 29,091 13,091 29,000 0.565 16,385 0.342 12,528
7 45,000 12,727 32,273 14,523 27,250 0.513 13,979 0.376 10,246
8 50,000 9,545 40,455 18,204 27,749 0.467 12,959 0.326 9,046
9 40,000 6,364 32,636 14,686 21,050 0.424 8,925 0.284 5,978
10 35,000 3,183 31,817 14,317 17,500 0.386 6,755 0.247 4,322
11 25,000 25,000 11,250 11,250 0.351 3,949 0.215 2,419
12 25,000 25,000 11,250 11,250 0.319 3,589 0.187 2,104

$300,999 $185,190 $151,769

Investment
0.58 0.94 1.15
Total discounted CF

1.00 determine with the graph, like Figure 10.1

 ECONOMIC EVALUATION OF MINERAL PROPERTY
Evaluation of a Mine Development Alternative

A case study

Year

1 2 3 4 5 6 7 8 9 10 Total

Revenue 8000 8000 8000 8000 8000 8000 8000 8000

64000
Operating cost 2650 2650 2650 2650 2650 2650 2650 2650 21200

Net Income 5350 5350 5350 5350 5350 5350 5350 5350 42800
Depreciation Allowan 2900 2900 2900 2900 2900 14500

Tax able income 2450 2450 2450 2450 2450 5350 5350 5350 28300
Tax 40 % 980 980 980 980 980 2140 2140 2140 11320

Capital Costs 7700 7700 15400

Return of W.C 900 900

Cash Flow 7700 7700 4370 4370 4370 4370 4370 3210 3210 4110 16980

Find the ROR of the project with the graph?

Cash flow is the difference between benefits and costs for a specified time period. An
annual period is usually suitable for evaluation purpose.

If the annual benefits exceed the annual costs, the net benefit is referred to as a positive
cash flow; if the annual costs exceed the annual benefits, a negative cash flow results.

Benefit Elements: Sale Revenue

Salvage Value
Return of Working Capital

Cost Elements: Capital Expenditure

Operating Cost
Taxation Payment