Guidelinesfor

TechnicalEconomicEvaluation
ofMineralsIndustryProjects


FinaldraftforpublicationintheAusIMMMineManagersHandbook
(dueforreleaseinNovember2012)

TheAusIMM
Level3,1531PelhamStreet
CarltonVictoriaAustralia3053
PostalAddress:
POBox660CarltonSouth
VictoriaAustralia3053
Telephone:+61396623166
Email:ceo@ausimm.com.au
Website:www.ausimm.com
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 TableofContents
1 INTRODUCTION...............................................................................................................................6

2 GUIDELINESFORSPREADSHEETMODELLING.................................................................................8

2.1 Purpose...................................................................................................................................8

2.2 KeyPrinciples..........................................................................................................................8

2.3 Easytofollow..........................................................................................................................8

2.3.1 IntuitiveandVisual.........................................................................................................8

2.3.2 Timetodoitproperly.....................................................................................................9

2.3.3 Architecture:WorkbookLayout....................................................................................10

2.3.4 WorksheetLayout.........................................................................................................10

2.3.5 ModularConstruction...................................................................................................11

2.4 TailoredtoPurpose..............................................................................................................12

2.4.1 Sizeandcomplexity.......................................................................................................12

2.4.2 Minimalistassimpleasappropriate...........................................................................12

2.4.3 Matchingdetailandcontentwithitsimportance........................................................13

2.4.4 MatchingDataandCalculations...................................................................................14

2.4.5 DirectinvolvementofProjectTeammembers.............................................................15

2.4.6 HelicopterView.............................................................................................................15

2.5 Transparent...........................................................................................................................15

2.5.1 Thecompleteevaluationflowslikeasimplestorybook..............................................15

2.5.2 Inputdataisexposed....................................................................................................16

2.5.3 Dubiousdataishighlighted...........................................................................................16

2.5.4 Sourceofdataisrecorded............................................................................................16

2.5.5 Algorithmsflowvisually................................................................................................16

2.5.6 Languageinfull.............................................................................................................17

2.5.7 Referencingotherworkbooksisavoided.....................................................................17

 2.6 Disciplined,RigorousandConsistent...................................................................................18

2.6.1 Trustwhatisseen.........................................................................................................18

2.6.2 DisciplineandRigour.....................................................................................................19

2.6.3 AggregatesandTotals...................................................................................................19

2.6.4 ColumnHeadings..........................................................................................................19

2.6.5 ReadymadeModelsandWorkedExamples................................................................19

2.6.6 LogofChangesandModelVersions.............................................................................19

2.7 RecordingSourcesofAllData...............................................................................................20

2.7.1 Rownotesofthesourceofthedata............................................................................20

2.8 RapidtoAudit.......................................................................................................................21

2.8.1 Speed.............................................................................................................................21

2.8.2 ProcessofAudit............................................................................................................21

2.8.3 AuditingReportsbasedontheEvaluation....................................................................21

2.8.4 AuditingMechanisms....................................................................................................21

3 GUIDELINESFORECONOMICEVALUATION..................................................................................23

3.1 Purpose.................................................................................................................................23

3.2 Context..................................................................................................................................23

3.2.1 TheoryandComputationofNPV,IRRandRisk............................................................23

3.2.2 EconomicEvaluationandFinancialModelling..............................................................23

3.2.3 Modelling,ValuationandEvaluation............................................................................23

3.2.4 StandAloneorIncrementalValue................................................................................24

3.2.5 StandAlone,Synergies,UsingTaxLosses.....................................................................24

3.2.6 Gearing(Debt)...............................................................................................................25

3.2.7 ExpectedValuesandResults.........................................................................................25

3.2.8 Alternatives...................................................................................................................25

3.2.9 RangesandLikelihoods/SensitivityAnalysis...............................................................26

3.2.10 InputDataQualityAssessment.....................................................................................26

 3.2.11 RealandNominal..........................................................................................................27

3.2.12 LifeoftheEvaluation....................................................................................................27

3.2.13 AfterTax........................................................................................................................28

3.2.14 RiskandUncertainty.....................................................................................................29

3.2.15 Materiality.....................................................................................................................30

3.2.16 EvaluationFramework..................................................................................................31

3.3 Process..................................................................................................................................32

3.3.1 ProductPrices,TreatmentandRefiningCharges,andForeignExchangeForecasts....32

3.3.2 Sales:Volumes,qualities,workingstocks/capital........................................................32

3.3.3 Production:Volumes,headgrades,recoveries,productgrade,delivery.....................33

3.3.4 CapitalCosts..................................................................................................................34

3.3.5 OperatingCosts.............................................................................................................35

3.3.6 ClosureCosts.................................................................................................................36

3.3.7 Taxes(directcompanyleveltaxes)andCarbonCosts..................................................37

3.3.8 DiscountRateandNPV.................................................................................................37

3.3.9 Auditing.........................................................................................................................38

3.3.10 Graphs...........................................................................................................................39

3.3.11 HelicopterView.............................................................................................................39

3.3.12 Avoid.............................................................................................................................40

3.4 AlternativeEvaluationandAssessmentMethodologies......................................................41

3.4.1 RealOptionsValuation(ROV).......................................................................................41

3.4.2 ValueatRisk(VaR)........................................................................................................42

APPENDIXAWORKEDEXAMPLE........................................................................................................43

ExampleofaSummarypage.........................................................................................................46

ExampleofanExistingCasesheet................................................................................................47

ExampleofanAlternativecasesheet...........................................................................................48

FinancialAnalysis..........................................................................................................................47

APPENDIXBINTRODUCTIONTODISCOUNTRATES...........................................................................48

WeightedAverageCostofCapital....................................................................................................48

TheCapitalAssetPricingModel(derivingtheCostofEquity).........................................................49

AccountingforInflation....................................................................................................................51

DiscountRatesandNPVsRealandNominal,BeforeandAfterTax..............................................51

AdditionstoDiscountRates..............................................................................................................52

FinancingCashFlows........................................................................................................................53

DiscountRatesinOtherValuationMethodologies..........................................................................53

ConcludingComments......................................................................................................................54

APPENDIXCRECOMMENDEDREADINGLIST........................................................................................56

APPENDIXDTECHNICALECONOMICEVALUATIONGUIDELINESCOMMITTEEMEMBERS...................57

1 INTRODUCTION
TheAustralasianInstituteofMiningandMetallurgy(TheAusIMM)istheleadingorganisation
representingtechnicalmineralssectorprofessionalsintheAustralasianRegion.Membersarebound
byaCodeofEthics,andcontinualimprovementofprofessionalandindustrystandardswithinthe
sectorinwhichtheywork.

Themineralsindustryhasabadhistoryofdecisionsbeingunderpinnedbyfaultyeconomic
evaluationmodelling.Thesehaverangedfromminorminesitedecisionstomajorcorporate
acquisitions.Toooftenthemodellingwasconvoluted,sophisticatedandpersonalised,soauditwas
tediousandfrustrating.Consequently,peopleatalllevelshavecalledforsimpleevaluationmodels.
Whattheymeanismodellingthatiseasytofollowevenwhenthesubjectiscomplexandsothe
modelbecomeslonganddetailed.Ifthemodelsaremadetobetransparent,intuitiveandfastto
auditthentheseerrorscanbeeliminated.

TheAusIMMhastakenupthischallengeandestablishedtheAusIMMGuidelinesforTechnical
EconomicEvaluationofMineralsIndustryProjects.Itisacollationofsoundpracticesthat
competentpractitionersineconomicevaluationhaveestablishedovertheyearsforthetechnical
economicevaluationofmines,processes,projects,studies,businesses,companiesandindustries.

Thesemodellingpracticesareeasytounderstandandfasttoadopt.Theinitialmodelmighttake
fractionallylongertocreate,butfromthenonanyuse,updating,expansion,modificationand
checkingismuchfasterespeciallyforothers.Theresultingmodeliseasierandfastertoaudit.If
theevaluationpersonsuddenlyisunavailablethenotherscantakeacopyanduseitconfidently.For
everyonethemodelisfriendlyandintuitive.Themodellingstyledoesnotbelongtoonepersonbut
isfamiliaracrossthemineralsindustryandisrigorous.Errorsinlogicanddataareeasytoidentify.
Themodelbecomesausefultoolforall,helpingtosteertheprojectandgivingconfidenceinthe
results.

ThepracticesaredescribedimmediatelybelowinSection2:GuidelinesforSpreadsheetModelling.
Thereisnosupportforaprescribedmethod,auniversalmodelorablackboxmodel.Insteada
workedexampleisshowninAppendixA.

Section3:GuidelinesforEconomicEvaluationisnotpartofthecorepurposebutisthesharingof
experiencesandapproachesatahighlevel.AppendixB:Isabriefintroductiontodiscountratesfor
analystswhodonothavefinancialtraining.

TheGuidelinesarerecommendedfor:
Daytodayassessmentofoperationsatminesites
Highlytechnicalstudies
ProjectsandStudies
Corporateandcompanywidemodels
MajorCorporatedecisionmaking
Theyarerecommendedforadoptionby:
EvaluationSpecialists,whetherfromanoperating,technicalorcommercialbackground.
Consultantswhoneedtobetransparentintheiradvice.
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 Technicalspecialists,evenifthemodelisnotforeconomicevaluation.
PlantManagerswhodemandthatassessmentsbereadilyunderstood.
ProjectManagersandStudyLeaderswhodemandthattheeconomicevaluationbeaneasy
touseworkingtoolthathelpssteertheproject,eveniftheprojectismostcomplexandso
themodelevolvestobelonganddetailed.
Seniordecisionmakersincompaniesandorganisationswhowantsimpleevaluations.They
usuallywillnotinterrogatethemodelbutmustbeconfidenttherearenohiddenmajor
errors.

2 GUIDELINESFORSPREADSHEETMODELLING

2.1 Purpose

TheGuidelinesforSpreadsheetModellingoutlinethekeyprinciplesandmechanicsthatshouldbe
adopted,notonlyforeconomicevaluationmodelling,butalsoascurrentBestPracticeGuidelines
withinourindustryforanyspreadsheetmodellingexercises.Itisrecommendedthatthese
GuidelinesareappliedbyCompanies,Organisations,ConsultantsandIndividualswhilstrecognising
thattheiradoptionisvoluntary.Workedexamplesthatservetoillustratetheseprinciplesandthe
mechanics(alongwiththosefortheGuidelinesforEconomicEvaluation)areprovidedinAppendix
A.

ThefollowingdiscussionusestheterminologyandnomenclatureusedbyMicrosoftExcelTM,whichis
thesoftwareusedalmostuniversallybyindustrypractitioners.Thesameprinciples,however,apply
regardlessofthesoftwareused.

2.2 KeyPrinciples
Thekeyprinciplesoneshouldadheretowhenspreadsheetmodellingaresimplebutextremely
effective.Theyare:

Easytofollow

TailoredtoPurpose

Transparent

Disciplined,Rigorous,andConsistent

RecordingSourcesofAllData

RapidtoAudit

Theymakethemodelintuitiveandreadilyfollowedevenwhenitbecomeslonganddetailed.

2.3 Easytofollow

2.3.1 IntuitiveandVisual
Ifyoucannotreadilyunderstandmymodelyoudonothaveaproblem,Ido!

Apersonunfamiliarwiththebusinessshouldbeabletoreceivetheevaluationmodelremotelyand
beabletoreadilyunderstandandfollowtheevaluationfrombeginningtoend.

Thewholeworkbookshouldhaveanobviousvisualflowfromlefttoright,acrosslabelled
worksheets,anddowneachworksheet.

Withineachworksheet,thecolumnsandrowsshouldhaveobviousvisualflowsjustlikea
simpletextbook.

Thetitlesandsubtitlesusedineachsheetshouldcascadelikeonewouldseeinacontents
page.

Theworkbookshouldbeginwithabriefintroductionwhichexplainsthepurposeand
contextofthedocumentandhowtointerprettheformattingforfasterunderstanding.

Eachworksheetshouldhaveitsboldheadingfollowedbyanoutlineofitspurposeandits
broadlinkswithotherworksheets.Sectionswithineachworksheetshouldbediscrete,with
obviousinputs,computations,outputsandgraphs.

Everycellshouldadhererigidlytotheformattingconventionandsocanbeinterpreted
visually.

Thisprincipleshouldnotbeseenasarequirementtodumbdownamodelofcomplexprocesses.
Itmeansthateverypartshouldbeintuitive,eventononexperts.

2.3.2 Timetodoitproperly
"Likepaintingaroomathomeitis90%preparation."

Timeshouldbetakentounderstandtheactivitybeingmodelledfromrawmaterialinputs
tofinishedproductoutputs,beitabusinessactivity,atechnicalactivityoranintellectual
activity.

Theevaluationmodelshouldbebuiltspeedilybutcarefullyandmethodically,rigorously
usingthemodellingpractices,soastobeeasytofollowandmakinganyerrorsrecognisable
duringaquickaudit.

Shortcuttingofmodellingpracticesfrequentlyproduceshiddenerrorsbecausethereis
inadequatetransparency,consistencyandrigour.

Beforeanyresultsarereleased,graphsshouldbegeneratedofthekeyinputsandresultsas
essentialchecks.

Beforeanyresultsarereleasedthemodelshouldbeproperlyauditedinternally,thenby
anexternalparty.

2.3.3 Architecture:WorkbookLayout
Themodelsarchitectureshouldbeintuitive,eventoanonexpert,sothatitsstructureisobvious
andnavigationaroundthepartsofthemodelisrapid.

Thereshouldbecompleteflexibilityinthewaythemodelisstructured.Somemodelswill
evolvefromoneworksheettomultipleworksheetsasmoredetailedmodellingisjustified.

Theflowofmultipleworksheetsshouldbealogicalsequencefromlefttoright.Each
Worksheethasatabnamethatshowsitspurpose.

Usuallythemodelshouldbesavedsothatitopensatthetopofthefirstworksheet,where
thereisabriefdescriptionof:

1. Thepurposeofthemodel,

2. Contactdetailsoftheauthorandusers,

3. Thedirectorylocationwhereitissecurelystored,

4. TheModelsarchitectureiftherearemanyworksheets,

5. Anywarningsorlimitations,

6. Auditscompleted,

7. Themodellingpractices/formatting,and

8. Listallothermodelsthatareusedforinputsorthataredirectlylinked.

Themodelshouldthenincludeasummaryofresultsandkeyinputsinnumericandgraphic
forms.Themodellingmaycommenceunderthatsummarybutmorecommonlyon
subsequentworksheets.

2.3.4 WorksheetLayout
Anonexpertshouldreadilyunderstandthefunctionofeachworksheet,howitisarrangedinto
componentparts,howthedataisentered,thecomputations,andtherelativeimportanceofthe
parts.

Thevisualflowdownandacrosseachworksheetshouldbeintuitiveandlogical.

Eachworksheetshouldhaveaboldheadingfollowedbyabriefoutlineofitspurpose,and
wherehelpful,itsimportantlinkswithotherworksheets.

Sectionswithineachworksheetshouldbeindiscreteworkblocks,withobvioussubsections
andsubheadingsusingacascadinglayoutforsubtitles.

Visuallyeachworkblockshouldbeselfcontainedwithanobviousstepbystepdevelopment
towardaboldsubtotalforthatworkblock.
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 Theseparateworkblocksshouldbeinalogicalsequencedownandacrosstheworksheet
andtheiraggregationbeobvious.

Complexandextendedcomputationsshouldbeshowninaseriesofsmallstepssothatthe
logicisvisibleandtheinputparametersareobvious.Thereshouldbenoneedto
interrogatethealgorithm.Explainthelogicofcomplexalgorithmsinavisiblerownote.

Usuallyifarowofdatathathasalreadybeenpresentedaboveisneededagaininawork
blockthentheentirerowshouldberepeatedsothatthereisvisualflowofthelogic.If
referencedfromanotherworksheetthenitshouldbecolouredcoded.

Keyinputsandresultsshouldbeshowningraphsasaselfcheckandforrapidunderstanding.

TheDataGroupandOutlinefacilitycanbeusedtodefineworksheetstructure,collapse
relatedgroupsofrowsorcolumnstoreducevisualclutter,andaidnavigation.

Eachworksheetshouldhaveaheaderand/orfootersothesource,date,etccanbe
identifiedwhenlookingatprintedcopies.

2.3.5 ModularConstruction
Asmuchaspossible,themodelshouldbeconstructedasmodules,eachhavingaclearsetofinputs,
calculations,andoutputsthatareusedinvariousothercalculationsdownstream,orpresentedas
finalresults.

Calculateanyparametersonlyonceinthewholeworkbook,thenusethatoneresultinall
otherplaceswhereitisrequired.Changesneedonlybemadeinoneplace,ratherthan
havingtosearchthroughthemodeltofindallplaceswherethesameparametershavebeen
calculated.

Thetestingofsmallindependentmodulesfacilitateserrorcheckingandauditing.

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2.4 TailoredtoPurpose

2.4.1 Sizeandcomplexity
Greatersophisticationandmathematicalcomplexitydoesnotautomaticallydeliverabettermodel.

Somemajordecisions,synthesesandriskscanbeevaluatedwithsmall,simplemodels,
whereassomeminorinvestigations/synthesesrequireelaboratemathematicalmodelling.

Ingeneralthesizeofamodelincreasesasastudyprogressesthroughconceptual,pre
feasibility,andfeasibilitylevelsbuteverymodelshouldmatchthematerialityofaparameter
tothedetailofitscomputation.

Longanddetailedmodelsmayberequiredforsometasks.

Increasingdetailandsizedecreasesthemodelsuniversalappeal,includingitsauditability.

Wherealonganddetailedmodelisrequireditshouldbemadeeasytofollow.

Intellectualprowessshouldbeusedtotransformcomplexityintosmallsteps.

Modellingshouldproceedasaseriesofvisuallyeasytofollowstepsratherthanusing
complexalgorithmsandinbuiltsoftwarefunctions.

Modelsshouldtakethereaderthroughthelogicprocessinsmallstepsratherthanusinga
trustmymodellingapproachinasinglecellorcomplexalgorithm/function.

Thereisalevelofdetailnecessarytogetagoodoutcome,butamoredetailedlevelof
analysismayberequiredtoprovethatitisgood,particularlywhereresultsarecounter
intuitiveorunexpected.

2.4.2 Minimalistassimpleasappropriate
Eachevaluationshouldbeginwiththethoughtofhavingtheentireactivitysensibly
representedinoneworksheet.

Asthemodelmaturesandexpandsitispreferabletohaveonlyonemainmodeltohandleall
thevariations.Itisdifficulttomanageandcontrolmultipleversionsofthesamemodelfor
differentscenarios,especiallywhenmorethanonepersonisusingthemorifaretrospective
changeisneededtoeachversion.

Itmaybeusefultohavestandalonesubmodelsthatevaluatesubordinateissues.Once
resolvedtheoutcomeshouldbeincorporatedintothemainmodel.

InalonganddetailedmodelitmaybehelpfultohaveadiagraminthefrontIntroduction
worksheetshowinghowthemodelssheetsinteractandflow.

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 Modelsshouldbecommencedasminimalist.Computationsshouldnotbeincludedincase
theymaybeneededinthefuture.However,aspartoftheoverallprojectspecification,
modelcapabilitiesthatmightbeneededshouldbeidentifiedatthestartoftheprojectand
themodelconstructedinsuchawaythattheyarenotprecludedandcanbeeasilyadded
laterifrequired.

Extradetailmaybeintroducedwhentheextrarowsofcomputationsarejustified.

Computations,whereused,shouldbesteppedoutrowbyrowwithoutskippingobvious
steps.Algorithmsshouldbekeptshortsoastomakethemodeleasiertounderstandand
follow.

Computationsshouldalsonotbecomplicatedbymixingmultipleactivities,e.g.havinga
mathematicalformulathatmodelstheprocessandalsoincludesachangeinunits.

Someresultsmaybecomputedtosufficientprecisionusingsimpleapproximations.For
example:

o Operatingcostsmaybesimplefixedandvariableuntiladetailedbottomup
computationiswarranted.

o Mineralconcentratepricesmaybebettercomputedasapercentageofcontained
valuesratherthanusingthedetailofcomplexhistoricalpricingmechanisms.

However,caremustbeexercised,assimplerelationshipswilltypicallyhaveasmaller
rangeofvaliditythanmorecomplexrelationships,whichmaylimittherangeofsensitivity
analysesthatcanbevalidlyconducted.Thelimitsofthevalidityofsimplerelationships
shouldbeascertainedandclearlyspecifiedinavisiblerownoteabovetheassociateddata
itemsorcalculations.

2.4.3 Matchingdetailandcontentwithitsimportance
Computationsshouldbetailoredtomatchtheirimportance.

Thecomputationsthathavegreatestimpactontheresultshouldbegiventhemost
attention.

Thecomputationsofsecondaryandtertiaryimportanceshouldbegivenlesspriorityand
detail.

Computationsthatareafocusofaparticularpersonshouldnotbegivenundueattention,
forexampleworkingcapitalbyanaccountant.

Incometaxandworkingcapitalmaybeapproximatedinafewcoarsecomputations,rather
thantoaccountingdetail.

13

 Accountingstatementsshouldbederivedfromthetechnicaleconomiccashflows,rather
thanviceversa.

Itisrecognisedthatsomekeydecisionmakersandinfluencersmayhavestronglyheldviews
whichmayneedtobeprovenordisprovenbyextraevaluationdetail.

Selectappropriatetimescalesforcalculationofphysicalquantities,cashflowsandreporting.
Thesemayallbedifferent.Thereisatradeoffbetweenaccuracy,complexityandmodelsize.

o Smalltimeincrements(e.g.daily,weekly,monthly)maybetoodetailedforthelevel
ofstudy,implyanaccuracythatdoesnotexist,andincreasethemodelsize
unnecessarily.

o Largetimeincrements(e.g.yearly)maybetoocoarseforsomepurposes,requiring
complexlogictohandleinteractionsbetweentimeperiods(e.g.ifthemodelis
generatingautomatedscheduleswithpredecessor/successorrelationships).

o Anintermediatetimeframe(e.g.quarterly,halfyearly)mayprovideabalance
betweenthevariousconsiderations.

o Smallermodellingtimeincrementscanbeeasilysummarisedforfinalreportingof
results.

2.4.4 MatchingDataandCalculations
Createdataentryareasinalayoutthatmakesiteasyandnaturalfortheusertounderstand
andtoentertherightdataaccurately.

Ifnecessary,preprocesstheentereddatatoconvertunitsusedorintoadifferentformat
thatfacilitatesthedevelopmentofsimple,robust,errorfreemodellogic.

o Donotforcetheusertoenterdatainanunnaturalwaysimplytosuitthe
calculations.

o Donotdevelopcomplexlogicjustbecausethedataisenteredinaparticularway.

Docalculationsinnaturalorunfactoredunitse.g.tonnes,dollarsetc(thisdoesnotaffect
calculationtimeorinternalprecisionoffloatingpointcalculations).

o Usegradesandrecoveriesasdecimalfractions(valuesbetween0and1),notas
percentages(valuesbetween0and100).Makeuseofthespreadsheetsnumber
formattingfeaturesandstylestodisplaypercentages.

o Avoidmultiplyinganddividingby1000,1000000etcinthebodyofthemodel.Thisis
errorproneandaddsunnecessarycomputations.Makeuseofthespreadsheets
numberformattingfeaturesandstylestoroundthedisplaytoshowthousands,
millions,etc.

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 o Preprocessrawdataoncebytheseunitand/orscalingconversionfactorsif
necessarybeforefurtheruseinthemodel.

Ifexportingresultstoanothermodel,createanexportworksheetintheformatrequiredby
thatmodel,anddoanyunitorscalingconversionsnecessary(topercentages,thousands,
millionsetc)whenpopulatingtheexportsheet.

2.4.5 DirectinvolvementofProjectTeammembers
KeyTeammembersmayassistwiththecreationofthemodelintheirareasofexpertise.

Theirenthusiasmforlotsofdetailtoreplicatetheintellectualchallengesoftheirspecial
areasshouldbetemperedbyandmatchedwiththerelativelevelofimportance.

Theyshouldaudittheirownpartofthemodelandsocoownthemodel.

2.4.6 HelicopterView
Eachteammemberneedstogainaworkinghelicopterviewofthemodelling.Focusisgiventothe
areasthatmatterthemost.Workonintellectuallystimulatingbutminorissuesshouldbeminimised.

Asummarysectionwithgraphsofkeyassumptionsandresultsshouldappearnearthefront
ofthemodeltogiveTeamMembersandManagementareadilyunderstoodoverview.

2.5 Transparent

2.5.1 Thecompleteevaluationflowslikeasimplestorybook
Bystartingatthetopofthefirstworksheetandreadingonscreenorprintingtotheendof
thelastworksheettheinexperienced,nonexpertshouldbeabletoreadilyfollowthelogic.

Nonexpertreadersshouldbeabletoreadilyunderstandhowthemodelworksandhowits
componentpartsfit.

Thearchitectureandadherencetogood/recommendedmodellingpracticesshouldmake
theevaluationtransparent.

Itshouldbeeasytovisuallydistinguishbetween:

1. Inputofrawdata

2. Referencingofdatafromotherworksheets

3. Computations

15

 4. Outputs

Everyworksheetandeverycellshouldhaveapurposeandgenesisthatisobviousonthe
screenandinprint.

2.5.2 Inputdataisexposed
Everypieceofinputdatashouldbeenteredinaprominentcolouredinputcellbeforeitis
usedinanalgorithm.

Noinputshouldbehiddeninanalgorithm,withthepossibleexceptionofeveryday
conversionssuchasdividingbythousandsorconvertingpoundstokilograms.However,itis
recommendedthatunitconversionfactorsalsobeenteredonce,andreferredtowhere
required.Thisavoidstypographicalerrorsorinconsistencies(e.g.thenumberofsignificant
figuresused)whenthesamefactorisenteredmultipletimesinmultiplelocations,and
potentiallyatdifferenttimesandbydifferentpeople.

Aspecificfontcolourshouldbeusedtoreadilyidentifydatainputs.Blueiscommonlyused.

AppropriateuseofControls(e.g.dropdownboxes,checkboxesetc)canshowtheranges
orspecificoptionsfordatavaluesandscenariosettingsthatmaybevalidlyusedinthe
model,andlimitentriestothese.

2.5.3 Dubiousdataishighlighted
Adistinctivecolourcodingshouldbeusedtohighlightinputdataorcomputationsthatare
dubiousorverypreliminary.Pinkmaybeused.

2.5.4 Sourceofdataisrecorded
Alldatasourcesshouldberecorded(seesection2.7).

anumberofcolumnswithhistoricaldatafrompreviousyearsmaybeusefulthiswillhelp
demonstratetheveracityofforecastdata.

2.5.5 Algorithmsflowvisually
Visuallythesequenceofcomputationsshouldflowlikeasimplestorybookdownand
acrossthespreadsheet.

Complexalgorithmsshouldbebrokenintoeasytofollowsteps.

Computationsshouldappearobviousandgenerallyshouldnotrequireinterrogationofcells.

16

 Anychangeorinconsistencyinasequenceofalgorithmsacrossarow(ordownacolumn)
shouldbehighlighted.

Linkstootherworkbookscanbedangerousbecausetheothermodelmaybealtered
withoutthechangebeingrecognised.Iflinkstootherworkbooksareused,thewhole
row/columnwithtitlesandlabelsshouldbereferencedacrosssothatcovertchangescanbe
seen.Thelinkedrowshouldbehighlightedincolour.

Macrosthatperformcalculationscannotbereadilyfollowedvisuallyorauditedand
generallyarenottrusted.

SomespreadsheetFunctionshaveahistoryofmisuseandcannotbeaudited,whereaslong
handcomputationscanbefollowedeasilyandvisually.

Multiplerecalculationsofthesamethingshouldbeavoided.

Ifcreatingnewlogicthatsupersedesexistinglogic,itisrecommendedthemodellereither:

o Labeltheoldlogicclearlyassuperseded,andpreferablymoveitawayfromthe
activelogic,e.g.tothebottomofthesheet,or

o Deletetheoldlogic,butlogthechange,identifyingthesupersededversionofthe
modelthatusedit.

2.5.6 Languageinfull
Unitsandtechnicalexpressionsshouldbeexpressedinfullatleastonceinamodel.
ConsiderusingalistofAbbreviationsoraGlossaryofTerms.Abbreviationssuchast,T,
mandMhavedifferentmeaningstodifferentpeoplesomeofwhicharenotconsistent
withinternationalstandards.ExamplesincludedrytonnesandwetshortTons.

Ifanalgorithmrequiresdatafromanotherworksheetthenthecompleterowisfirst
referencedacross,usuallyjustabovewhereitisneeded.

Everyrowthatisreferencedfromanotherworksheetisshowninadistinctivecolourcoding
andorfontstyle.

Thismeansthateveryalgorithmusesdataalreadyshowninitsownworksheet.Auditingan
algorithmwillnevershowdatathatisreferencedorlinkedfromanotherworksheet.

2.5.7 Referencingotherworkbooksisavoided.
Linkstoworksheetsinotherworkbooksshouldbetreatedwithextremecaution.Ifdoneit
shouldbeobvious,limitedtospecialsituations,anddonewithextremecare.Thewholerow
orcolumnorrectangularrangeshouldbelinkedacross.Adistinctivecellformatshould
highlightsuchimports.

17

 Ideallythisshouldonlybedoneforimportingdatathatwillchangeinfrequently(ornotat
all),oftenpreprocessedintosuitabletablestructuresorsummariesforuseinthemodel.
(ExamplesmightincludetablesofOreReservesgeneratedfromdataextractedfrom
geologicalblockmodelsandmineplanningsoftware,orfixedandvariableunitcostsderived
fromdetailedcostrecords.)

Informationfromotherworkbooksshouldalwaysbeimporteddirectlyintocellssimilarto
dataentrycellswithnootherprocessing,andthenusedincalculationselsewhere.Formulas
inacellshouldneverbothimportdatafromanotherworkbookandperformsome
calculationonorwiththatexternalinformation.

Separateexternaldatafilesshouldbemaintainedforeachversionofsuchdata,linksfrom
themainmodelshouldbecarefullycheckedregularly.

Informationidentifyingthedataversionshouldbeimportedfromthelinkedworkbookas
wellasthedataitself,sothatitcanbeeasilyseenwhatisbeingusedwithouthavingtoedit
thelinkages.

Calculationlogicthatflowsfromoneworkbooktoanotherandbacktothefirstshouldbe
avoided,aschangesmadeearlyinthelogicinthefirstworkbookwillnotflowcorrectlyto
laterstagesofthelogiciftheotherworkbookisnotopenorlinksbothwaysbetweenthe
twoworkbookshavenotbeencorrectlymaintained.Suchlinkscaneasilybebrokenifone
workbookissavedwithanewnamewhiletheotherisclosed.

2.6 Disciplined,RigorousandConsistent

2.6.1 Trustwhatisseen
Whatisseenonthescreenorinprintshouldrepresentwhatishappeningineachrow,
columnandcell.

Everycellshouldadhererigorouslytothemodellingpracticeswhichareshownatthestart
ofthemodel.

Everycellshouldbeabletobetrustedtobeconsistentwithitsneighboursofthesame
formatting.

Anyinconsistenciesinalgorithmsshouldbehighlighted.

Worksheets,columnsorrowsshouldnotbehidden.TheDataGroupfacilityisacceptable
becauseitmarksthecollapseddata.

18

2.6.2 DisciplineandRigour
Eitheruse100%modellingPracticesorzeroPractices.ModelsthatfollowthePracticesin
themainbutwhichcovertlyfalterinotherpartsarefarworsethanmodelsthathaveno
Practices.

Timeshouldbeallowedtousethemodellingpracticesandproperlyauditthemodelbefore
resultsareexpected.

2.6.3 AggregatesandTotals
Totalsandsubtotalsshouldbeobvious.Itisrecommendedthatacolumnontheleftsideof
thespreadsheetisused,whereitisusuallyvisible,ratherthanontheright.Totalrows
shouldbehighlightedwithboldfontorborders.

Eachsequenceofnumbersbeinginputted(rowand/orcolumns)shouldbeaggregatedand
thesetotalsmadeobvioussothattheycanbereadilyunderstoodandcanbechecked
againstsourcedata.

2.6.4 ColumnHeadings
Thesequenceofcolumnsacrosseveryworksheetinaworkbookshouldbeidenticalunless
clearlyidentified,especiallyforyear(orothertimeperiod)headings.

Onceasequenceofcolumnheadingsisestablishedinoneworksheetitshouldbe
maintainedinallotherworksheets.Forexampleiftheyear2018isinColumnKinone
worksheetthenitshouldbeincolumnKinallworksheets.Exceptionsshouldbeclearly
highlighted.

2.6.5 ReadymadeModelsandWorkedExamples
Modelswithblankinputfieldstobefilledforentryintoablackboxshouldbeusedwith
caution.Theymaybeusefulforsortingopportunities.

WorkedExamplesoftheseAusIMMModellingPracticescanbeusedasthestartingpoint
foranewmodelandadapted.

2.6.6 LogofChangesandModelVersions
Whereahistoryofchangestothemodellingneedstoberecorded:

o Versionnumbersshouldbegiventomodelsdistributed,and

19

 o Notedwithoutputsinreports,presentationsetc(i.e.includefilename,worksheet,
date,andrevisioninfooterorprintedcellforpublishedoutputs).

Themodeldistributedorusedforreporttablesandfiguresshouldbethelastwiththat
versionnumber.Anysubsequentworkdoneshouldbewiththenextversionnumber.

Anyoneeditingthemodelshouldlistallupdatesinalogofchangeswith:

o Dateandperson

o Adescriptionoftheupdate(withfiguresnoted),newNPVfigureetc,and

o Commentsdescribinganyreconciliation/explanationoftheeffect(ifrequired).

2.7 RecordingSourcesofAllData

2.7.1 Rownotesofthesourceofthedata
Anyonereadingthemodelshouldbeabletoimmediatelyidentifythesourceanddateofthe
data,andsoassesswhetheritisthemostrecentandappropriate.

Thisappliestoeveryrowofnumericalinputvaluesandtocomputationallogicthatis
unusual.

Thesourceofeachitemofinformationshouldberecordedwiththedate,personand/or
documentname.

Thisshouldshowasarowimmediatelyaboveorbelowtheinputteddataandalways
appearsinfullonthescreenorinprint.Itshouldnotbeinahidden,embeddedcellnote.

Someanalystsmaychoosetousenotesincellsaspersonalremindersofchangefor
recordingwhyalgorithmschangeand/orachronologicalrecordofallhistoricaldataused
andupdates.

Anysourcedatathatisknowntobedubiousortoneedcheckingshouldbeidentifiedina
specificfontcolour.Pinkormagentaisbeingwidelyused.

Atthebeginningofthemodelthenameofthepersonperformingthemodellingshouldbe
stated,withthecontacttelephoneand/oremailaddressandthestartdate.

Disciplineisrequiredtoupdatesourceinformationwhendataisupdated.Thereislittleor
nowaytocheckonthislaterifitisnotdoneatthetime.

Itmaybeusefultoretainpreviousdatasets,withcapabilityinthemodeltoswitchbetween
them.Inthiscasedatasourceinformationmightbeenteredinaparticularcolumnineach
datarow,anditwillbemoreevidentifsomedatasetshavethesameornosource
information.

20

2.8 RapidtoAudit

2.8.1 Speed
IfthePracticeshavebeenfollowedrigorouslythemodelshouldbeeasytofollowand
thereforequicktoaudit.Consequentlypeoplearelikelytobemorewillingtoauditothers
models.

2.8.2 ProcessofAudit
Threephasesofauditarerecommended:

Selfauditbythepersonwhodevelopedthemodel,

AuditsbyinternalmembersoftheTeamwhochecktheirownsections,and

Aformalauditoftheentiremodelbyanindependentperson(s)externaltothe
model.

ThestatusofeachofthesethreeauditsshouldbeclearlyvisbleontheIntroduction
worksheet.

2.8.3 AuditingReportsbasedontheEvaluation
Thepersonauditingthemodelusuallyshouldalsoaudittherelevantsectionsofanyreports
basedonthatmodel.

Theinterpretationofmodelresultsovertherangesofcasesneedstobeconfirmed.

2.8.4 AuditingMechanisms
Acommonapproachtoauditistoworkfromthekeyoutputs,suchasNPVorproduction,
backupthestreamsofcomputationstotheinputsforeach.

Createerrorcheckingformulaswithinamodel.Themoreoftheseformulasinamodel
themoreselfauditingitbecomes.

Thetotalforeachdatainputoverthelifeoftheevaluationshouldbecheckedagainstthe
sourcedata.Globaltotalsofkeyinputsandoutputsshouldbetested.

Wheretheevaluationispartofalargersizedresourceorbusinessitsvalidityandcontext
shouldbeinvestigated.

Useofspreadsheetauditing/checkingsoftwareshouldhighlightinconsistenciesandtheuse
ofdatavalueshardwiredintoformulas.

21

 Consistencyofalgorithmsacrossrowsanddowncolumnsmaybetestedbycopyingthe
algorithminthefirstrowacross/downallothers.Itisnotuncommonforthefirstcolumnto
bedifferent,thoughthatshouldbehighlighted.Copyingthesecondcolumnmaybebetter.

Auditdowncolumnsisbetterdoneinotherthanthefirstcolumnincasethefirstcolumn
wasalteredbutmistakenlynotcopiedacross,orisdifferentfromtherestforsomevalid
reason(inwhichcasethedifferenceshouldbehighlighted).

Whenauditing,itcanbeusefultocreateanewsheetatthefrontoftheworkbookwith:

o Allauditingnoteslisted,

o Aprioritisationcolourcodenotinghigh,mediumandlowrankeditems(usingred,
yellowandgreencellcolouring),and

o Linkstothesectionsofthemodelthattheauditingnotesapplyto.

22

3 GUIDELINESFORECONOMICEVALUATION

3.1 Purpose
TheGuidelinesforEconomicEvaluationdiscusskeyconceptsandmechanicsineconomicevaluations
andareindependentoftheGuidelinesforSpreadsheetModelling.Itisrecommendedthatthese
GuidelinesareappliedbyCompanies,Organisations,ConsultantsandIndividualsascurrentBest
PracticeGuidelineswhilstrecognisingthattheiradoptionisvoluntary.Workedexamplesthatserve
toillustratetheseprinciplesandthemechanics(alongwiththosefortheSpreadsheetModelling)are
providedinAppendixA.

3.2 Context

3.2.1 TheoryandComputationofNPV,IRRandRisk
RefertoFinancialTheory,RiskTheoryandrelateddocumentsforthecalculationofDiscountedCash
Flow(DCF),NetPresentValue(NPV),InternalRateofReturn(IRR),riskadjustmentandrelated
metrics.AppendixBprovidesabriefintroductiontodiscountratesfortheinformationoftechnical
analystswhodonothavefinancialtraining.

3.2.2 EconomicEvaluationandFinancialModelling
Preferablytheevaluationoftheeconomicsofaninvestmentiskeptseparatefromthemodellingof
itsfinancing.

Evaluatetheeconomicsoftheunderlyingcashflowswithoutfinancingasthefirststep.
Understandtheviabilityoftheunderlyinginvestment.Thisiseconomicevaluation.

Considerwaysoffinancingtheinvestment,infinancialmodelling,asthesecondstep.Thisis
financialmodelling

Iffinancingiscombinedwiththeeconomcevaluationthenthediscountratewillneedtobe
adjusted.

3.2.3 Modelling,ValuationandEvaluation
Evaluationisathreetierprocess.Modellingiscreatingtheworkingtoolatthebottom,
valuationsaretheoutcomesofusingthemodeltotestvariouspossibilitiesandscenarios,
whileevaluationisthehighestlevelprocessofunderstandingthebestoutcomeforthe
businessororganisation.Evaluationistheprocessofconsideringtheeconomicworthofan
activity.Itshouldinvestigateallinputs,computations,outputs,casesandalternatives.
23

 Valuationisanoutcomeoftheevaluationprocesswhereasinglevalueorarangeofvalues
is/areproducedunderset/setsofconditions.

Thenumerousassumptionsinvolvedcanleadtovaryingviewsastothevalueofaproject,
company,etcwhenapplyingtheDCFtechnique.Thistendstolendweighttoexperience
beingofparticularimportance.

Valuationexercisesaremoreaccuratewhenrankingprojects,etc,onarelativebasis.That
is,underacommonsetofassumptions,onecanidentifywhichproject,withinasuiteof
projects,willprovidethegreatestvalue.

Valuationsareundertakeninanabsolutesensewhenanabsolutevalueisattributedto
theproject,whichisnotrankedrelativetootheroptions.Valuesarealwaysbasedonfuture
estimatesandhencealevelofuncertaintyisinherent.

Whenundertakingvaluationsonanabsolutebasisarangeofoutcomesshouldbe
determined.

3.2.4 StandAloneorIncrementalValue
Theoverallapproachtoevaluationmaybeincrementalvalueorabsolutevalue.

Anexistingbusinessoractivityisusuallyvaluedinabsoluteterms.

Aninvestmentisusuallyvaluedasitsincrementaleconomicimpactthevalueof
proceedingminusthevalueofnotproceeding.

Incrementalevaluationsshouldincorporateallimpactsofachange.Itmaybebetterto
modelthewholebusiness,withandwithoutthechange,ratherthantryingtoisolatethe
incrementalimpactsonly.

Inallcasestheevaluationshouldconsiderwhethertherearealternativesi.e.stayingwith
thestatusquoorwhetheritmayimproveitsbaseactivitywithasmallerinvestment.

Synergiesbroughtbycombiningoperationswillusuallyrequireastandaloneevaluation.

3.2.5 StandAlone,Synergies,UsingTaxLosses
Normallytheassessmentistobeoftheentityonastandalonebasis.Ifthereisaspecialreasonfor
crosssubsidyorcrosspenaltythenitsquantum,importanceandlikelihoodmustbeclearly
described.

Typicalbenefits/penaltiesfromoutsidemayincludetherealisationofpreexistingtaxlosses,
(ifusable),synergiesfromcombiningactivities,andmarketposition.

24

 Thisshouldnotbeincludedifthebenefit/penaltyislikelytorealisedinthenormalcourseof
businesswithoutthisactivity/investment.

Thevaluationshouldclearlydifferentiatebetweenthevalueoftheentityonitsown("stand
alone")andthevalueofanyspecialbenefits/penaltiesfromoutside.

Theconditionsforreceivingbenefits/penaltiesfromoutsideshouldbeoutlined.Otherways
ofrealisingthesebenefits/penaltiesshouldbeoutlined.

3.2.6 Gearing(Debt)
Normallytheeconomicassessmentisoftheunderlyingeconomicsbeforetheintroductionofany
debt.Ifforsomereasondebtmustbeconsideredthediscountratemustbeadjustedandthe
quantum,risksandimportanceofthedebtdescribed.

Insomecases,cashflowanalysisisundertakeninnominaltermsandinclusiveofdebt.Thisis
commonlyreuiredbyfinancierstodetermineifinterestondebtcanbecoveredwithoutperiodsof
default,ifthedebtcanberepaid,andwhattheequityvalueisviathisparticularapproach.

Normallythecashflowsshouldbeunleveragedorungearedi.e.beforetheuseofany
debtand,hence,withoutinterestcostsondebtandtheirtaxdeductions.

AccordingtoFinancialTheorythediscountrateisadjustedifdebtisintroduced.

FaultyevaluationscanmakedebtappeartoimprovetheNPV.

3.2.7 ExpectedValuesandResults
Thereisanelementofsubjectivitywhenestimatingwhatisexpectedinthefutureevenif
basingestimatesonhistoricaldata,aspastoccurrenceswillnotnecessarilyrepresentwhat
willhappeninthefuture.

Certainvariableswillbemoresubjectivethanothers:futurecommoditypricesaregenerally
unknownandcanvarywidelyfromtheforecast,whereasfutureconcentratorrecoveryrates
foranoperatingplantmightchangebutaremorelikelytobeunderstoodverywell.

Theimpactofachangetoaparametershouldbeanticipatedandcheckedagainsttheresult
fromtheeconomicmodel.Unexpectedeffectsshouldbereconciled.

3.2.8 Alternatives
Theevaluationshouldconsiderallreasonablealternativeactivities/investmentsthatarepossible.

Althoughoneactivity/investmentisproposedtheremaybealternative
activities/investmentsthatachievethedesiredoutcome.
25

 Thedonothingcaseusuallyisanalternative,andmaybecalledthebasecase.Ifthe
investmentisnotmadehowwouldthisbasecasebeoptimised?

3.2.9 RangesandLikelihoods/SensitivityAnalysis
Withineachactivity/investmenttheevaluationshouldconsidertherangeofpossibleoccurrences
andevaluatethespreadandlikelihoods.

Unlessonlyoneresultispossibletheevaluationshouldconsiderthelikelyrangeofinputs,
computationsandresultsratherthanreportingasinglecase.

Therearevariousmethodsofconsideringrangesandlikelihoods.

Onemethodconsidersaseriesofdiscretefeasiblecasesfromlowtohighandprobability
weightsthem.

Anothermethodusessoftwaretogenerateadistributionofoutcomes.Ifthismethodis
used,theparametersincludedandexcludedshouldbedisclosed.

Keyinputsshouldbeprioritisedandvariedbytheamountsbywhichtheycanbeexpected
tovary.Usuallythesearedoneatreasonablehighsandlowsandagainatnearextreme
highsandlows.Sometimesthesearebesttestedinclustersofparametersbutusuallyitis
testingoneparameteratatime.Sensitivitytestingof+/10%and+/25%etcnowis
regardedashavinglowvalue.Itisimportanttorecognisethatthistypeofvaluation
typicallyassumesonlyonevariablechangesatatime,andthesameunderlyingphysical
mining,treatmentandsalesplanismaintainedforallvariationsconsidered.Itdoesnottake
anyaccountofhowdecisions,andhencetheplans,wouldchangeinresponsetoreal
changesintheinputsbeingflexedintheevaluation.Forexampleifthepriceisincreased
thentheminescheduleprobablyshouldbereoptimised.

3.2.10 InputDataQualityAssessment
Ifdistributionsorlikelyrangesarenotavailableforvariousinputdataitems,thefollowingranking
schemeisoneofmanythatmaybeuseful:

Aseparatecolumnbesidetheinputnumbersmaybepresentedtoindicatethereliabilityof
variousinputdataitems.Thescoreofinputdatawouldbeputasanumbere.g.from1to3.
Forexample,iftheinputisfromareliablesuppliersquoteitmayscore1,iffromopen
literatureandverified,2,andifaneducatedguesswithlargeuncertainty,score3.

Totalscoresmaybeaveraged.Thenuncertaintycanbelow,mediumorhighdependingon
theclassofscorethedatareceived.Iftheinputdataqualityscoredlessthan2,uncertainty
islow,ifabove2butbelow4,mediumandifabove4ishighetc.

Insomesituationsthedataqualitymayberequiredtoscorea1andinothersituations,
e.g.preliminarytechnicaleconomicevaluationorwheretheprocessisconceptual,ahigher
uncertaintyisacceptable.
26

 Othersmaychoosetodescribethelevelofaccuracyasconceptual(e.g.30%),pre
feasibility(e.g.20%)orfeasibility(e.g.10%)andreflectaccuracyincontextofsome
weightedaverage.

3.2.11 RealandNominal
ARealmodelexpressesatimeseriesofcashflowsinwhichtheeffectofinflationisexcluded.The
advantageofpresentingdatainrealtermsisthatevaluationsaremoreeasilyunderstoodand
audited.Economicmodelsofwholeoflifeprojectsandstrategicplansarenormallyexpressedin
realterms.

ANominalmodelexpressesatimeseriesofcashflowsintheactualdollarsoftheperiod:thatis
withinflationincluded.Budgets,shorttermforecastsandcommoditypriceforecastsareusually
expressedinNominaldollars.

Caremustbetakentoensurethattherealandnominalinformationisnotmixedandthateachis
clearlyidentifiedintheunitscolumn.Arealcurrencyunitshouldbelabelledwithitsyear.

Somepractitionersuseverticalfontforreattermsanditalicsfornominaltermsdata.

Ifapplyingthecorrectrealandnominaldiscountratestotherealandnominalcashflows,
theNPVandIRRwillbethesamebyeithermethod,andIRRsfromrealandnominalcash
flowswilldifferonlybytheinflationrate.Caremustbetakentoapplyanominaldiscount
ratetonominalcashflows,andarealdiscountratetorealcashflows.

ForRealTermsevaluationstheeffectofinflationovertheyearsisremoved.Pricesmay
increase/decreaseinrealtermsbecauseofproductionefficiencies,marketdemand/supply,
foreignexchangemovementsandothernoninflationimpacts.

Careneedstobetakenwithinputstodistinguishwhethertheyarespecifiedinrealor
nominalterms.

Ifworkinginrealterms,therearetwowaysofhandlingtaxdepreciationandotheritems
normallycalculatedinnominalterms.

o modeltheseitemsinnominaltermsandconvertbackintorealterms,or

o Modeltheseitemsinrealtermsanderodetheirvaluebyinflation

3.2.12 LifeoftheEvaluation
Normallyanevaluationisdoneforthefull,remainingeconomiclifefromthepresentdaytotheend
includingclosureandlegacies.Ifthereisaspecialsituationandonlypartoftheeconomiclifeis
consideredthepartsofthelifeexcludedandestimatesoftheirimpactonvalueshouldbeclearly
described.

TheNetPresentValue(NPV)canbemathematicallycalculatedatanypointinthelifeofa
cashflow.Forpracticalpurposesaconvenientdateintherecentpastorthenearfuture(as
27

 aguide,withinsixmonths)isusedwithanysignificantcashflowsintheinterveningperiod
clearlynoted.Manycompaniesspecifyavaluationdatetobeappliedforconsistencyinall
evaluationsconducted.TheremainingNPVatvarioustimesinthefuture(i.e.theNPVthat
wouldbedeterminedbyanalystsatthattime,assumingtheprojectandtheworldeconomy
proceedaspredictednow)mayalsobeausefulmeasureforcomparingoptionsinalonglife
project.

Theenddateshouldbeasensibletimeinthefuturewhensignificantcashflowsand
liabilitiesareexpectedtofinish.

Estimatesofclosurecostsandlegaciessuchasongoingremediationmaybesubstantialand
canhaveasignificantimpactonNPV.Abroadassumptionthatsalvagewillpayforclosure
costsandlegaciesisnotusuallyvalid.

SunkcostsshouldbeexcludedfromanNPVcalculationastheydonotrepresentafuture
cashflow.However,thewrittendownvalue(fortaxpurposes)ofpreviouslypurchased
assetsisrelevanttofuturetaxcalculationsandmayberequired.

3.2.13 AfterTax
Normallyevaluationsareafteralltaxes.Iftherearespecialcircumstanceswherepretaxevaluation
isappropriatethecircumstancesshouldbeexplained.

Taxesotherthancompanyincometaxandinternationalwithholdingtaxesarenormally
includedinthecapitalcosts,operatingcostsandrevenue.

Normally,companyincometaxandmineralroyaltiesshouldbeincludedasadiscreteblock
ofcomputationsintheevaluation.

Normally,theevaluationisunleveragedandsocompanyincometaxisbeforethe
introductionofdebtrelatedcashflows.

Wherethevaluationisofanentityinanothercountrytheimpactofinternationaltaxes,such
aswithholdingtax,shouldbeestimated.

Whereinternationaltaxesarenotyetadequatelydefined,astatementdescribingtherange
ofpossibilities,alongwiththeimpactsonvalue,shouldbeincluded.

Evaluationsmaybeconductedatminesiteleveltoselectbetweenvariousoperating
strategies.Thesemightbeconductedonapretaxbasiswheretaxisthesameforalloris
relativelyunimportant.Thisisusuallysatisfactoryforoptionswithsimilarlevelsofcapital
intensity,butmaygivemisleadingresultsifcomparisonsarebetweenlowcapital/high
operatingcostandhighcapital/lowoperatingcostoptions.Itisadvisableforthetechnical
economicevaluatortoatleastincludeasimpletaxcalculationtoensurethepreandpost
taxevaluationsarenotsuggestingdifferentstrategies.

28

3.2.14 RiskandUncertainty
Theinclusionorexclusionofriskinanevaluationisofhighimportance.

Acompleteeconomicevaluationrequiresanunderstandingoftheimpactofriskand
uncertaintyonthefinaloutcome.Decisionsshouldtakeintoaccounttherobustnessinthe
expectedperformance.Therearemanywaysofmodellingriskanduncertaintyineconomic
evaluations:thesemethodsaretouchedonbutnotcomprehensivelycoveredinthis
document.Toadequatelyevaluateriskanduncertainty,economicevaluationsshould
includeoneormoreofthefollowingfeatures:

o SensitivityAnalysis:theimpactofchangingonevariableatatime.Theseresults
haveseverelimitationsbecausetheytypicallyneglecttheflowonimpactsofthat
changeontheplan.

o ScenarioAnalysis:thesearesuperiorbecausetheyconsiderthedynamicsof
interrelatedchanges

o MonteCarloSimulation:Independentorcorrelatedvariablesarechangedmultiple
timestoreflecttheprobabilitydistributionsoftheirvalues,producingaprobability
distributionoftheoutcomes.Theseshouldbeusedwithextremecautiontoensure
allkeyparametersarevarying,withmathematicalrelationshipsbetweenthemand
notjustwithselectedkeyparametersthatareconvenienttodefine,suchasprice,
capexandopex.

o Optionanalysis(seesection3.4.1)

o ValueatRisk(seesection3.4.2)

Theevaluationshouldclearlydescribeifriskwasexcludedanddescribetheriskcontext.

Theevaluationreportshouldclearlydescribetheprocessbywhichriskwasincludedandany
recogniseddeficiencies.

Therisksmaybeintroducedintothecomponentcashstreamsduringcomputations,orusing
expertknowledge,intothecaseasawholebywayofthediscountrate.

o Ifintroducedintothecomponentcashstreamsariskcanbereflectedbyadjusting
theinputrelatedtotheriske.g.metallurgicalrecoveryratelowerrecovery,lower
valuation.Caremustbeexercisedifworstcasevaluesareusedforanumberof
variables:theprobabilityofalltheworstcasescenariosoccurringconcurrentlyis
generallyverylow.Aprobabilisticanalysisispreferableifsuitabledistributionscan
bedevelopedforallkeyinputparameters.

o Ifintroducedbythediscountratethenariskpremiumcanbeaddedtoincreasethe
discountrateandgeneratealowervaluation.Thisneedexpertknowledgeandis
discussedfurtherinAppendixB

29

 Someprojectmanagerswillidentifyrisksthatareconsideredpartiallyortotallyavoidable.
Theassessorsofsuchtechnicalandnontechnicalriskswillrelyontheirprofessionalopinion
andprecedenttoweighupthevalidityofsuchassumptions.Thisdoesnotguaranteethe
riskswillbeaddressedasenvisagedandtheanalystinconjunctionwiththeproject
membersandleaderwillhavetodetermineiftheserisksshouldbeconsideredinthe
quantitativecomponentofevaluationviatheapproachesdescribedaboveorviaanexercise
inlikelihood/sensitivityanalysis.

Evaluationspecialistsshouldnotacceptamethodologyofincorporatingriskwithout
understandingandacceptingit.Specialistsshouldnotbebaffledbypersonswhoappearto
beexpertspersuadingthemtoadoptamethodwhichappearstoocomplextounderstand.
Ifrequiredtocompletetheexercisethenthespecialistshouldmakethesituationclearto
teamleadersanddecisionmakers.

3.2.15 Materiality
Theevaluationshouldmatchthequality(detail,precision,complexity)ofeachcomputationwithits
impactontheresult.

Theevaluationshouldgivemostattentiontotheinputsandcomputationsthathavethe
greatestimpactonvalue.Extracolumnstotallingcashflowandshowingthecontributionto
NPVmayhelpidentifymateriality.

Theevaluationshouldaimtoreducethecomplexityanddetailoflessimportant
computationswherethiswillnotsignificantlyreducethevalidity/precisionoftheresult.

Focusshouldbeonthekeydriversofvalue.Itavoidscomputationsthatareoverlydetailed
inareaswithminorimpactonthekeyresults.

Usually,thecomputationofRevenuehasthegreatestimpactonvalue,followedby
OperatingCostsand/orCapitalCosts,andtheleastimpactcomesfromTaxes.

Normallythegreatestfocusisonthegenerationofrevenuefromtheresourceintheground
throughproductiontosalesvolumesandproductquality,andtopriceandforeignexchange
rates.

Operatingcostsinpreliminaryevaluationsmaybesimplefixedandvariablecosts,whereas
inprecisionevaluationstheymaybedetailedfixedandvariablecosts.Thevariablecostsat
eachstageinaprocessflowsheetshouldrelatetothequantitiesbeingprocessedateach
stage.Theyshouldnotberelatedtothequantitiesoffinalproduct.Detailedvariablecosts
usuallyusePhysicalsxUnitCosts.

Capitalcostsinpreliminaryevaluationsmaybecoarseestimates,whereasinprecision
evaluationsmaybedetailedestimates.

Inmanyevaluationstaxesandworkingstockcalculationscanbegreatlysimplifiedwithout
significantlossofprecision.
30

3.2.16 EvaluationFramework
AneasytofollowframeworkistousethefourcashstreamsofProduction/Revenue,CapitalCosts,
OperatingCostsandTaxesleadingtoNetCashFlowandvaluemeasuressuchasNPV.

Reducingtheevaluationtofourcashstreamsmakescomputations,auditandunderstandingrapid.

Cashstream1=Revenue=SalesxPrice+/debtors

Cashstream2=Capital(cashspentnotcommitments)

Cashstream3OperatingCosts=ConsumptionsXCosts(includingrelatedtaxes)+/
WorkingCapital

Cashstream4=Taxes=CompanyIncomeTax+GovernmentRoyalties(ifnotinoperating
costs)+/adjustmentsforcashpaymentdates.Internationalbusinessesusuallyshouldbe
valuedatthreelevels:

1. Thestandaloneoperation/businessin100%termsregardlessofownershipto
determinethehealthoftheunderlyingbusiness.

2. Thevaluestothevariousownersoftheirsharesofthebusiness,incountrybutafter
specialdealsandtaxes.

3. Thevaluetothevariousownersoftheirsharesafterrepatriatingcashflowstotheir
homecountriesandpayingtopuptaxesthere.

31

3.3 Process

3.3.1 ProductPrices,TreatmentandRefiningCharges,andForeignExchangeForecasts
Usuallyforecastsofproductpricesandforeignexchange(forex)areamongstthemostimportant
assumptionsforcalculatinganNPV.Theynotonlypartiallydeterminerevenueeachyearbutthey
determinehowmuchofthemineraldepositiseconomic.Thefollowingactivitiesarerecommended:

Explainthesourcesofforecasts,andwhethertheyweremodified.

Graphthekeyprice(s)andforeignexchangeinhistoricaltermsandthelow,midandhigh
price(s)assumedintothefutureforthelifeofproject.

Usuallythecomputationsofrevenuehavegreatestimpactonvalue.Ironicallycomputations
ofrevenueinsomecommoditiesarerelativelysimpleonceproductionandsalesare
computed.

Wherethecomputationofpriceiscomplexsuchasthetreatmentterms,refiningcharges
andassociatedchargesformetalconcentratesatopdownapproachmaybeasuperior
method.

o ForexamplethehistoryofTreatmentCharges(TC)andRefiningCharges(RC)is
convertedintographsofhowthevalueofeachcontainedmetalintheconcentrate
hasbeensharedonapercentagebasis,e.g.67%tominesand33%tosmeltersand
thisisforecastratherthanusingTCsandRCs.Howeverthesplitmayvarywithprice
andamorecomplexpricingmodelmayberequired.

Therearenumerousapproachesusedfordealingwithcurrencymixesandrealandnominal
termswithintheeconomicevaluation.Oneapproachisdescribedinthesectionbelowon
OperatingCosts.

3.3.2 Sales:Volumes,qualities,workingstocks/capital
Togetherwithpriceandforeignexchangeforecaststhesalesvolumesareimportantassumptions.It
isrecommendedthatthemodel:

Outlinemarketvolumeandqualityassumptions.

Outlinetheforecastimpactofthesesalesonthemarket.

Outlineanyunusuallogistics.

32

 Workingcapitalindebtorscanbeapproximatede.g.4weeks/52weeksxSalesRevenuefor
debtors(Samewithcostsforcreditors).Revenuelagsforbasemetalsconcentratesmaybe
estimatedfromactualortypicalsalesterms.

Workingstocksofsalesproductshouldbeapproximatedinthesynthesisofproduction
wheretheyaresignificant.

Establishingworkingstocksmaybesignificantatprojectstartupandduringrampup.There
maybeasignificantlagbetweenproductionrampupandproductdespatchesuntilthe
businessplateaus.

MovementsinworkingcapitalshouldbeincludedinthecomputationofCashStream1:
Revenue.

Simplestockscalculationmethodscaninclude:

o Maintainingaspecifiedstockpilesizeattheendofeachtimeperiod,drawndownat
theendofthelife,or

o Applyingatimelagbetweenproductionandsalesdates.

3.3.3 Production:Volumes,headgrades,recoveries,productgrade,delivery.
Theeconomicevaluationmaysynthesisetheproductionprocessoruseoutputsfromdetailed
computationsandsyntheses.Itisrecommendedthatthemodel:

Outlinethemethodsusedtoestimateproduction,includinghowLifeofMine(LOM)figures
aredetermined,whichmayincludemineandplantavailabilities,miningvolumes,mining
recoveryanddilution,headgrade,processrecoveriesandproductspecificationsfor
economicmetalsandkeydeleteriousconstituents.

Describethemethodsbywhichtimeframeofthelifeoftheentitywasestimated,including
constructiontime,rampup,operationallifeandclosure.

Outlinethevariousbroadproductioncasesconsidered.

Disclosewhethertheresourceandreservefiguresusedinthemodelarereportedin
accordancewiththeAustralasianJointOreReservesCommitteeCode(JORC)i.e.ifthe
figuresareexistingResourcesandReserves,iftheevaluationwillbeusedtosupport
publicationofReserveCategories,oriftheyareestimatesthatarenotJORCcompliant(Note
thattheJORCCodeisforpublicreportingofResourcesandReserves.Internalevaluations
candowhateverisreasonableforthepurposesoftheevaluations,thoughJORCCode
categoriesofresourcesandreservesmaybeimportantinputinformationevenifresultsare
nottobemadepublic).

33

3.3.4 CapitalCosts
Estimatesofcapitalcostscanvaryfromhighlevelestimatestocomprehensiveestimatesincluding
contingenciesandallowances.Itisrecommendedthatthemodel:

Outlinethemethodusedtoestimatecapitalcosts,includingindirectcosts,contingencies,
allowances,etc.Preferablytheseestimateswouldbebasedonstudiesthatemployan
industryacceptedmethodologyandsupportedbyappropriatedocumentation.Theaccuracy
andconfidenceintheestimateisexpectedtoincreaseastheprojectprogressesthroughthe
conceptual,scoping,prefeasibility,feasibilityanddetailedengineeringstudystages.

Outlinethemethod(suchasquotations,materialtakeoffs,factors,benchmarking,etc)used
toestimatecapitalcosts,includingindirectcosts,contingencies,allowances,construction
costs,EPCM,freightcosts,localduties,etc.

Outlinethekeyconstructioncostsandtimetocommissioningassumptions.

Itisnotimportantifaparticularitemisclassifiedasanoperatingcostorasacapitalcostin
theevaluationfordeterminingpretaxcashflows.Itisimportantthateachitemiscorrectly
treatedinthetaxandinanyaccountingcomputations.Correctclassificationisessentialfor
determiningdepreciationandprofitortaxableincomeforthemodellingofbothtaxation
andfinancialaccounting.Itshouldbenotedthatcertainitemsmaybecapitalisedforone
setofcalculationsandexpensedfortheother,orcapitalisedbutdepreciatedbydifferent
methodsand/orratesfortaxandfinancialaccountingcalculations.

Outlinetherangeofestimatesofcapitalcost.ThedifferencesinNPVresultacrosstherange
ofcapitalcostsshouldbecomputedandunderstoodbydecisionmakers.

Considerthetimingdifferencesbetweencapitalconstructionandpayment.

Outlinedetailsofanybond(egenvironmental)thatmayberequired,distinguishingbetween
noncashaccountingprovisionsandcashflows.

Ongoingorsustainingcapital,whichmaintainsthecapabilitiesacquiredbytheinitialproject,
shouldbecalculatedfromitsdrivers.Itmaybeaproportionoftheinitialcapital
expenditure,orbasedonhistoryinamorematureoperation.Althoughoftenexpressedas
anannualcost,itmaybemoreappropriatetoexpresssomecomponentsonapertonne
basisifchangesinproductionratesaretobemodelled.

WorkingCapitalmaysignificantlyimpactonearlycashflows.Keyitemsaretypically:

o Firstfillofconsumablesintheoperatione.g.grindingmedia,tyresetc

o Majorcriticalspareparts

o Initialstockingofotherwarehouseconsumables

o Operatingcostsincurredbeforeinitialrevenueisreceived.

34

3.3.5 OperatingCosts
Estimatesofoperatingcostscanvaryfrombroadapproximationstodetailedestimates.The
principlesdiscussedinthecapitalcostsectiononaccuracyanddatasourcesgenerallyapplyto
operatingcost.Itisrecommendedthatthemodel:

Outlinethemethod(suchasquotations,materialtakeoffs,factors,benchmarking,etc.)
usedtoestimateoperatingcosts,includingfixedandvariablecosts,socialand
environmentalcosts,contingencies,etc.

Categorisecostsbyfunctione.g.mining,milling,etc,orbycostelemente.g.labour,fuel,
consumables,power,maintenance,materials,etc.Coststructuresthatarebuiltupbyboth
functionandcostelementalongwithfixedandvariablecomponentsareconsideredto
representthehighestorderofdetail.Itshouldbenotedthatwhenaccessinghistorical
accounting,functionalandcostelementinformationisgenerallyavailablewhilsttheanalyst
willhavetoformaviewonwhatcostsarefixedandwhatcostsarevariableasaccounting
systemsmaynotcategoriseonthisbasis.

Asageneralprinciple,variablecostsshouldbeappliedtoeachphysicalactivitywhose
quantitieswillvaryrelativetothekeyactivityquantitiesasaresultofchangesininputsthat
maybeflexed,ornaturallyasaresultofchangesintheresourcebeingminedorthetonnage
treated.However,materialityeffectsandtherequiredlevelofaccuracyofthestudyshould
alsobetakenintoaccountchangesintheratiosofthephysicalquantitiesmaybesmall
enoughtoobviatetheneedforthemorecomplexcostmodel,andasimplefixedplus
variablepertonneoforemodelmaybeadequate.

Outlinethecommissioningandrampupassumptions.

WorkingstocksareincludedinthesynthesisofProductionandareapproximatedwhere
thereisinsignificantimpactonvalue.

Privateroyaltiesareincludedasanoperatingcostbutgovernmentroyaltiescanbeincluded
eitherasanOperatingCostorasaTaxdependingoncustom.However,theprocedure
adoptedintheevaluationshouldbedefined.

Forleasedequipment,noteiftheleaseisanoperatingleaseorafinancedlease.

Aspertheclassificationofcapitalcosts,itisnotimportantifaparticularitemisclassifiedas
anoperatingcostorasacapitalcostintheevaluationfordeterminingpretaxcashflows.
However,correctclassificationisessentialfordeterminingdepreciationandprofitortaxable
incomeforthemodellingofbothtaxationandfinancialaccounting.Itshouldbenotedthat
certainitemsmaybecapitalisedforonesetofcalculationsandexpensedfortheother,or
capitalisedbutdepreciatedbydifferentmethodsand/orratesfortaxandfinancial
accountingcalculations.

Theoperatingcostscomponentofworkingcapitalmaybesimplymodelledby:

35

 o Maintainingaspecifiedinventoryatthestartofeachtimeperiod,drawndownat
theendofthelife,butallowingforspoilageandobsolescence,or

o Applyingaleadtimebetweenproductionandspending.

Outlinetherangeofestimatesofoperatingcost.ThedifferencesinNPVresultacrossthe
rangeofoperatingcostsshouldbecomputedandunderstoodbydecisionmakers

Therearenumerousschoolsofthoughtwhendealingwithoperatingcostsinvarious
currenciesandamixtureofrealandnominaltermsoneapproachthatcanbeappliedto
overseasoperationsisasfollows:

1. Initiallymodelcostsinthecurrencyinwhichtheyareincurred.

a. Itmaybenecessarytoseparatedifferentcurrenciese.g.expatriateand
locallabourcosts,consumablessourcedfromvariouslocations,etc.

b. Identifythecostswhicharequotedinonecurrencybutareactuallyincurred
inanothere.g.petroleumproducts.

2. Deriveasreal(orperhapsmoreaccurately,"uninflated")costsinthecurrencyin
whichincurred,forthephysicalquantitiesscheduled.

a. Notetheageofvariousdataitemsandinflate/deflatetoacommonpointin
timeifappropriate.

3. Applyinflationfororiginalcurrency,appropriatetoeachcashflowitemproduces
nominalcashflowsinthosecurrencies.

4. Converttothecurrencyofthecountrytaxingtheoperatingentity(usuallythe
countrywheretheoperationislocated),usingnominalexchangerates.

5. Calculatedepreciationfortaxpurposes,andhencetaxableprofitandtax,andhence
netcashflowinthecurrencyofthetaxingcountry.

6. Converttothereportingcurrency,usingnominalexchangerates.(Additionaltaxes
mayneedtobecalculatedinthiscurrency.)

7. Deflatetorealmoneyamountsusingtheappropriatedeflatorforthereporting
currency.

8. Discountusingrealaftertaxdiscountrate.

3.3.6 ClosureCosts
Estimatesofclosurecostscanvaryfrombroadapproximationstodetailedestimates.Itisnot
adequatetoassumethatclosurecostswillbeoffsetbytheproceedsofsalvage.Itisrecommended
thatthemodel:

36

Outlinethemethodusedtoestimateclosurecostsandongoingactivities.Describeif
indirectcosts,contingencies,allowances,etcareincluded.

Iftheevaluationswillvaryparametersthatwillchangetheminelife,itmaybenecessaryto
expressrehabilitation,redundancycosts,salvageandscrapvaluesasfunctionsoftheclosure
date.

3.3.7 Taxes(directcompanyleveltaxes)
Inaneconomicevaluation,taxesarenotusuallycomputedtotheprecisionofofficialincometax
returns,butusuallyaremoresimplifiedsothattheresultsmatchtheprecisionandimpactofother
keycomputations.

Taxesincludecompanyincometax,specialcompanytaxes,capitalgains,carbontaxes,
withholdingtaxes,internationaltaxesandgovernmentroyalties.Indirecttaxesareusually
includedincapitalandoperatingcosts.

Outlinecompanyincometax,otherdirectcompanytaxes,governmentroyaltiesandany
internationaltaxes.Describeanyspecialtaxissuese.g.ifwithholdingtaxescanbecredited
inthetaxregimewhereprofitsarerepatriated.

Outlineanytaxbenefitsorpenaltiesthatarespecifictothisinvestment,suchaspreexisting
losses,orcrosssubsidyspecialgovernmenttaxationarrangements.Describethe
importancetovalue.

Incometaxmaybeapproximatedwheretheimpactisnotmaterial.Afewrowsof
algorithmsmaysubstituteformanyrowsoflonghanddepreciationorothercalculations.If
theevaluationmodelisconstructedtobeflexibletopermittheevaluationofalargenumber
ofoptionsandscenarios,itisessentialthattaxcalculationsarealsoflexiblewithinthemodel.
Itisnotthenappropriatetohavetaxescalculatedindetailbytaxaccountantsorforafew
casesenteredasdataformanydifferentcases.

Ifcapitalcostsarecomputedinrealtermsthenintheevaluationmodelthetaxdeductions
forcapital(andanyotherdeductionsspreadoveryears)shouldbeerodedbyinflation
unlesstheimpactofinflationisnotsignificant.Otherwisethetaxdepreciationiscomputed
innominaltermsandconvertedbackintorealterms.

AsdiscussedinthesectiononOperatingCosts,governmentroyaltiescanbeincludedin
OperatingCostsorinTax,dependingoncustom.

3.3.8 DiscountRateandNPV
Technicaleconomicanalystswillrarelyhavetoderivethediscountratetobeused.Doingthisisan
experttasknotnormallywithintheexpertiseofsuchanalysts.TheDiscountRateiscomputed
accordingtoFinancialTheoryandistypicallyspecifiedbythecompanycommissioningthe
evaluation.NotesonthederivationofdiscountratesareincludedinAppendixBasbackground

37

informationfortechnicalevaluatorswithoutfinancialtraining.Theimportantthingfortheanalystis
toensurethatthediscountrateusedandthecashflowstowhichitisappliedareconsistent.

HistoricallyintheMiningIndustrytherehavebeenvariousconflictingapproachesto
computingdiscountrate.Theseinclude:

1. IsthediscountratefortheCompanyorfortheindustrysectorbeingevaluated?

2. Howisdebtincluded?

3. Istheevaluationbeforeoraftertax?

InanevaluationmodelthenetcashflowcanbeconvertedtoanNPVusingseveralmethods.

o Onemethodistouseafewrowsofeasytofollowcomputations(longhand)rather
thanusingNPVFunctionsorsoftware.Longhandcomputationsaremorereadily
understoodandcheckedforbasedateanddiscountfactorforthefirstperiods.

o Theothermethodistousespreadsheetfunctions.Howevertheseareoftenused
incorrectly,andcareisrequiredwithregardtothetimingofcashflows.

Thediscountratemustmatchthecashflowi.e.realornominalterms,andbeforeorafter
tax.

Usingtheappropriatediscountratewithacashflow,whetherinrealornominalterms,
shouldgivethesameNPV.BeforetaxNPVandaftertaxNPVcandiffer.

Cashflowsfromoperationsoccurthroughanyyear,notnecessarilyatthestartorendofa
year.Toreflectthis,discountingfromthemidpointofeachperiodisrecommendedforan
absolutevaluation.Forcomparativevaluations,thisislessimportant,butconsistencyof
approachforallcasesisessential.

3.3.9 Auditing
Auditingisanessentialcomponentoftheevaluationprocess.Itbestoccursprogressivelyduringthe
evaluationprocess,andmustbeundertakenbeforeanyresultsarereleased.isthestatusofthe
auditshouldbeprogressivelyrecordedintheIntroductiontoeveryevaluationmodel.

Step1:Periodicselfauditsoftheevaluationmodelasitisdeveloped.

Step2:Auditsofthepartsoftheevaluationbytheexpertsineachoftheparts.

Step3:Athoroughauditofthefinalevaluationmodelbypartiesexternaltotheevaluation
project.Onepartymayauditthemechanicsofcomputationswhileotherspecialists
auditthevalidityofinputsandoutputs.

Additionaltipsonauditing:

o Checkthegraphsforanomalies,inconsistenciesandtrendsthatlookincorrect.

38

 o Usesoftwarethatanalysesspreadsheetstofinderrors.

o Includeselfchecksfortotalsandsubtotalsthroughoutthemodel.Dothesetotals
matchtheinputdataandexternaldocuments?

o StartingattheNPVworkbackupeachofthecashstreamstotheinputs.

o Checkacolumnawayfromthefirstcolumnofcomputationsincaseachangehas
beenmadebutaccidentlynotcopiedacrosstherows.

o Copythealgorithminthefirstcolumnofcomputationsacrosstotheendoflifeand
seeiftheresultschange(butbeawareofrowswherethefirstcolumnmay
legitimatelybedifferentfromtheothers).

o Checktheoutputsoflargeevaluationsbycreatingastandalonesummarymodel
ofonlyafewrows.

o Whenauditing,itcanbeusefultocreateanewsheetatthefrontoftheworkbook
with:

Allauditingnoteslisted,

Alistofitemstobecheckedorcorrectedusingaprioritycolourcodenoting
high,mediumandlowrankeditems(usingred,yellowandgreencell
colouring),and

Linkstothesectionsofthemodeltowhichthattheauditingnotesapply.

3.3.10 Graphs
Graphsarerecommendedas:

1. Aquickcheckforerrorsininputdata,computationsandoutputs,and

2. Afastwayforotherstounderstandtheevaluation.

Adequatetimeshouldbeallowedfortheevaluationmodeltographallkeyinputsandkey
outputsaschecksonerrorsandforrapidunderstandingoftheentity.Theseshouldinclude
cashflows,NPV,prices,salesvolumes,production,grades,saleableproduct,revenue,
capitalcosts(constructionandongoing),operatingcosts,taxes.

3.3.11 HelicopterView
Theevaluationprocessshouldbeconductedwithregularpausestounderstandhowtheentitylooks
fromahelicopterview.

39

 Resultsandgraphsshouldbeviewedanddiscussedafterimportantstagesinthe
developmentoftheevaluation.

3.3.12 Avoid
Overcomplexity

blackboxspreadsheetfunctions.

Blackboxmodelsandstandardtemplatemodelswhichclaimtocoverallevaluations.

Linkstootherworkbooks:thesearedangerousbecausetheothermodelmaybealtered
withoutthechangebeingrecognised.Ifusedthewholerow/columnwithtitlesandlabelsis
referencedacrosssocovertchangescanbeseen.

Macrosthatperformcalculations:thesecannotbereadilyfollowedvisuallynorauditedand
generallyarenottrusted.

Hiddenrows,columnsorworksheets:theDataGroupfacilityissatisfactorybecauseit
marksthecollapseddata.

Spreadsheetfunctionsthathaveahistoryofmisuse:thesearedifficulttoaudit,whereas
longhandcomputationscanbefollowedeasilyandvisually.

40

3.4 AlternativeEvaluationandAssessmentMethodologies

AlthoughtheDCFapproachisthepreferredmethodologyusedintheminingindustry,numerous
othermethodologiesareavailableandareincreasinglybeingusedonamoreregularbasis.During
thecourseofdevelopingtheAusIMMGuidelinesforModellingandEvaluationthetopicof
alternativemethodologieswasraisedanddiscussed.Itwasdeemedprudenttohighlightthe
existenceandcontinuingemergenceofthesealternatemethodologiesandtodiscussacouplein
brief,namelyRealOptionsValuation(ROV)andValueatRisk(VaR).TheAusIMMdoesnotinany
waysuggestthatthesemethodologiesbeusedinassessingmineralprojects,butratherthat
memberskeepinmindthatalternativetoolsareavailableandarebeingincreasinglyacceptedin
conjunctionwiththetraditionalDCFapproach.

3.4.1 RealOptionsValuation(ROV)

WhatisRealOptionsValuation?

TheRealOptionsValuation(ROV)techniquewasderivedfromtheBlackandScholesfinancial
optionpricingmodeldevelopedin1973.Thesequenceandtimingofdecisionscanbemodelled
usingROVthusprovidingamethodwhichvaluesprojectflexibility.

WhenROVshouldbeapplied?

RealOptionsValuationissuitedtoprojectswithinherentfutureuncertainties.Foraprojectwith
littleornouncertainty,ROVcanbeused;howeveritwillyieldthesameresultasatraditionalDCF
valuation.

ROVshouldbeusedwhendifferingbusinessstrategiesexisttodeterminethevalueofeachstrategy.
Additionally,itcandetermineatwhichtimeastrategyshouldbeactedupon.

Benefitsanddrawbacksofthemethod

ROVcanaccuratelyvaluedecisionsunderanuncertainfuture.However,theaccuracyofthe
valuationdependssignificantlyontheassumptionsusedtocarryoutthevaluation.

Computingtimeisdependentofthenumberofuncertainparametersincorporatedintothe
valuation,thusasROVcomplexityincreasessotoodoescomputingtime.Tominimisecomputation
timekeyparameters(i.e.commodityprice,recoveryandminingrate)needonlybeincluded.
Computerprograms,suchasDPL(DecisionProgrammingLanguage),allowaROVtobecomputedin
underaminutewithasmanyastenuncertaininputparameters.

41

Oneofthegreatestbenefitsofusingarealoptionsprocessisthatitcanchangeadecisionmakers
wayofthinking.Therealoptionwayofthinkingmayseetheearlyabandonmentofanuneconomic
projectasasuccess.Itplacesimportanceontheabilitytomodifyaplanratherthantoadheretoit
anditfavoursinvestmentsthatarerobusttouncertaintyratherthandependentonit.

3.4.2 ValueatRisk(VaR)

WhatisValueatRisk?

VaRisusedinfinanceformeasuringandmanagingrisk.Whenusedinportfoliomanagementitis
commonlyexpressedasaprobabilityofmakingalossorreturnbelowacertaindollarvalueovera
specifictimeperiode.g.anassetportfoliowithaoneweek5%VaRof$10mhasa5%chanceof
decreasinginvaluebymorethan$10movertheweek.

WhenVaRshouldbeapplied?

TheVaRmethodprovidesanestimateddistributionofoutcomes.Italsoallowsthemanagementof
riskbyprovidingafeelforexposureonthedownsideandhenceprovidesanopportunitytotailor
riskexposure.

Benefitsanddrawbacksofthemethod

ApplicationofVaRintheminingindustryinvolvestheidentificationofrisksandtheir
interdependenciesatalllevels.Thisinvolvesacomprehensivestageofquantifyingandconsidering
alltherisksreducingthechanceofoversightsthatmayoccurwhenusingalternativemethods.

Theidentificationofrisksthatarematerial,understandingtheirinterdependencies,alongwiththe
quantificationandmodellingofprobabilitycurvesisaninvolvedprocessthatrequiresgatheringa
considerableamountofinformation.

Theconceptthatastatisticalapproachcanbeappliedforunderstandingthedistributionofvalue
outcomesandthatthenstrikingaVaRisapplicabletonumerousmarketsholdstrue.Infinancial
markets,themethodisusedtomakedecisionsforinvestinginvariousmarketseachwiththeir
respectivelevelsofrisk,liquidityandvolatility.Miningassetsdemonstratetheirownpeculiar
characteristicsaroundliquidityandvolatility,suggestingthatconceptsinherentinVaRwillbeused
formakinglongertermdecisionsconcerningexistingandproposedprojectsratherthan,asitis
currentlyusedinfinancialmarkets,forshortertermportfoliomanagement.

42

APPENDIXAWORKEDEXAMPLE
Thefollowingexampleisillustrative,andisnotintendedtobedefinitive,ofhowtostructurea
model.Theanalystshouldalwaysconsiderwhenstructuringamodelandsummarypage,itis
importanttoconsiderthelevelofdetailatwhichtheexerciseistobeundertaken,theaudienceitis
intendedfor,andtheinformationnormallyexpectedtobeconveyed.

ThefollowingworkedexamplewasmadeavailableasanExcelWorkbooktoAusIMMMembersand
participantsattheAusIMMMetPlant2011inPerthinAugust2011.ItisshownbelowinPDF.

Worked Example - MetPlant 2011

Contact
Peter Card 04 07 508 924
Purpose
This 'Worked Example' illustrates the economic evaluation modelling practices recommended by AusIMM
It compares a gold mine using existing common technology with a new technology - at concept level
Warnings
This example is an illustration. It has not been audited and should be checked before being us
Audits
Self audit P Card Yet to be completed
existing case D Martin Yet to be completed
new tech case G Darwin Yet to be completed
taxes G Wise Yet to be completed
external peer C Casey Yet to be completed

Simplifiedtofourcashstreams
Eachevaluationissimplifiedintofourstreams:Revenue, Operating Costs, Capital Costs and Taxes. Accounting can be derived from these.

Understandingthecolourcoding
13Aug2011BWhite,"SalesPlanforOperationsto2025"
67.4 Everyitemofinputdataisexposedinacellusingbluefontonabluebackground
Ithasitssource,dateandpersoninbluefontintherowimmediatelyabove.(Notasahiddencellnote)
67.4 202.2 Anyitemthatisdubiousorneedingverificationisinpinkfont
Everyitemwhichisreferencedacrossfromanotherworksheetisingreenfontongreenbackground.
recovery %silver 36% 36% ThecompleterowisreferencedacrossincludingitstitleincolumnAasacheckthatthecorrectdataisbeingreferenced.
IfareferencedcellisinColumnBinthesourceworksheetthenitappearsinthesamecolumn(B)inthisworksheet.(thisgreatlyreduceserrors)
Thereforeif2013isincolumnKinoneworksheetthenitisincolumnKineveryotherworksheet
134.8 Everyalgorithmmustusecellsonlyfromthisworksheet.(Itdoesnotreferencedatainanotherworksheet,norcontainhiddenfreshdata)
134.8 Computationalalgorithmsshouldnotchangeacrossarow.Ifthereisanexceptionitshouldbehighlightedwithadarkborder

67.4 Somepeopleuseitalicsfornominaltermsdataandverticalfontforrealtermsdata

43

WorkedExampleMetPlant2011

Summary
Existingcase
existingtechnology
NPVExistingCase A$ 2,007,342
IRRExistingCase 9.1%

AlternativeA
carboninpulptechnology
NPVAlternativeA A$ 37,833,798
IRRAlternativeA 9.4%
40
50

30
ExistingCase FourCashStreams 40
AlternativeA FourCashStreams
30
20
20
10
10

0
0
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
A$M

A$M
10 10

20
20
30
30
40
Cashstream2:Capital
40 Costs Existing Case CashflowDeficit
Cashstream2:Capital
50 Costs AlternativeA CashflowDeficit

Cashstream3:OperatingCosts Existing Case Cashflowifpositive

Cashstream3:OperatingCosts AlternativeA Cashflowifpositive

Cashstream4:Taxes ExistingCase Cashstream4:Taxes AlternativeA

ExistingCase NPV AlternativeA NPV

30 20
20 10
10 0
0 10 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
A$M

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 20
A$M

10
20 30
40
30
50
40
60
50
70
60
80
DiscountedCashflow ExistingCase CumulativeNPV ExistingCase DiscountedCashflow AlternativeA CumulativeNPV AlternativeA

ExistingCase Mining AlternativeA Mining

TonnesOreorOuncesGold

6
TonnesOreorOuncesGold

600,000 1,200,000 6
500,000 5 1,000,000 5
AuGrams/Tonne

AuGrams/Tonne
400,000 4 800,000 4
300,000 3 600,000 3
200,000 2 400,000 2
100,000 1 200,000 1
0 0 0 0
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Ore Production Head grade Ore Production Head grade

60 ExistingCase Sales,Price,Margin 1,200 60 ExistingCase Sales,Price,Margin 1,200

GoldOunces(000's)

GoldOunces(000's)

1,000 1,000
40 800 40 800
$/ounce

$/ounce

600 600
20 400 20 400
200 200
0 0 0 0
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Goldsold GoldpriceForecast Pretaxmargin/oz Goldsold GoldpriceForecast Pretaxmargin/oz

ExistingCase Opex AlternativeA Opex

20,000,000 30,000,000
25,000,000
15,000,000
20,000,000
10,000,000 15,000,000
10,000,000
5,000,000
5,000,000
A$

A$

0 0
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
miningcost processingcost fixedcosts miningcost processingcost fixedcosts

ExistingCase Capex AlternativeA Capex

35,000,000 50,000,000
30,000,000
40,000,000
25,000,000
20,000,000 30,000,000
15,000,000 20,000,000
10,000,000
10,000,000
5,000,000
A$

A$

0 0
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
InitialCapitalCosts OngoingCapitalCosts InitialCapitalCosts OngoingCapitalCosts

44

WorkedExampleMetPlant2011
This example is an illustration. It has not been audited and should be checked before being used.

Existingcase
ExistingTechnology
NPVExistingCase A$ 2,007,342
IRRExistingCase 9.1%
40
ExistingCase FourCashStreams ExistingCase NPV
30
30
20
20 10

10 0
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

A$M
A$M

0 10

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 20
10
30
20
40
30
50
Cashstream2:CapitalCosts
40 ExistingCase CashflowDeficit 60

Cashstream3:OperatingCosts ExistingCase Cashflowifpositive DiscountedCashflow ExistingCase CumulativeNPV ExistingCase

Cashstream4:Taxes ExistingCase

ExistingCase Mining 60
ExistingCase Sales,Price,Margin
TonnesOreorOuncesGold

600,000 6 1,200

GoldOunces(000's)
500,000 5 1,000

AuGrams/Tonne
400,000 4 40 800

$/ounce
300,000 3 600

200,000 2 20 400
200
100,000 1
0 0 0 0
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

OreProduction Headgrade Goldsold GoldpriceForecast Pretaxmargin/oz

18,000,000
ExistingCase Opex 35,000,000
ExistingCase Capex
16,000,000 30,000,000
14,000,000
25,000,000
12,000,000
10,000,000 20,000,000
8,000,000 15,000,000
6,000,000 10,000,000
4,000,000
2,000,000 5,000,000
A$
A$

0 0
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

miningcost processingcost fixedcosts InitialCapitalCosts OngoingCapitalCosts

LifeofMine units Total 2011 2012 2013 2014 2015 2016 2017 2018 2019

Cashstream1:ProductionandRevenue
Production
10Aug11TBensonmineschedule"MinePlan12June11"
OreProduction tonnes 2,150,000 300,000 500,000 500,000 500,000 350,000
Headgrade grams/tonne 3.1 2.5 3.1 3.8 2.9 2.8
Containedgoldmined ounces 213,183 0 0 0 24,116 49,839 61,093 46,624 31,511 0
ProcessingRecovery %ofcontainedgold 78% 83% 83% 83% 83%
Goldproduced ounces 175,736 0 0 0 18,810 41,367 50,707 38,698 26,154 0

Sales
23Aug11JGomachie:"SalesPlan:July2011"
Goldincircuit weeks 3 3 3 3 3 3 3 3 3
Goldincircuit ounces 0 0 0 1,085 2,387 2,925 2,233 1,509 0
Goldsold ounces 175,736 0 0 17,725 40,065 50,169 39,391 26,878 1,509

Revenue
23Aug10ABCCompanyForecastofgoldprice
GoldpriceForecast A$/ounceReal 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000
GoldRevenue A$Real 175,736,334 0 0 0 17,725,080 40,065,236 50,168,501 39,390,613 26,877,999 1,508,904

23Aug11JGomachie:"SalesPlan:July2011"
Debtors days 30 30 30 30 30 30 30 30
DebtorsClosing A$Real 0 0 1,456,856 3,293,033 4,123,438 3,237,585 2,209,151 0

Cashstream1:RevenueExistiA$Real 175,736,334 0 0 16,268,224 38,229,059 49,338,096 40,276,467 27,906,433 3,718,055

Cashstream2:CapitalCosts
10Aug10GDawson"CapitalCostEstimate:IndicativeEstimatesVersionG"
InitialCapitalCosts A$Real 58,000,000 3,000,000 30,000,000 25,000,000
OngoingCapitalCosts A$Real 10,000,000 3,000,000 4,000,000 2,000,000 1,000,000
Cashstream2:CapitalCostsEA$Real 68,000,000 3,000,000 30,000,000 25,000,000 3,000,000 4,000,000 2,000,000 1,000,000 0 0

TaxdeductionsforCapitalExpenditure
3May11EHermiAssumeallcapitalisdeductedinproportiontothegoldsoldoverthelifeofmine.
TaxDeductionforCapitalExpenditure %ofcontainedgold 10% 23% 29% 22% 15% 1%
Taxdeductionforcapitalexpenditure 68,000,000 6,858,601 15,502,975 19,412,366 15,241,935 10,400,262 583,860

Cashstream3:OperatingCosts
5May11GDawson"OperatingCostEstimate:IndicativeEstimates."Thereisnowastetobemined.
miningcostpertonne A$Real/tonneor 31 5 5 6 7 8
miningcost A$Real 13,300,000 1,500,000 2,500,000 3,000,000 3,500,000 2,800,000 0
processingcostpertonne A$Real/tonneor 100 20 20 20 20 20
processingcost A$Real 43,000,000 6,000,000 10,000,000 10,000,000 10,000,000 7,000,000 0
fixedcosts A$Real 15,000,000 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000
Cashstream3:OperatingCostsA$Real 71,300,000 0 0 0 10,500,000 15,500,000 16,000,000 16,500,000 12,800,000 0
costperounce A$/ounceReal 558 375 316 426 489 0

Cashstream4:Taxes
GovernmentRoyaties
2June11RTorply:SAStateRoyaltyis1%ofrevenuepaidmonthly
StateRoyalty %ofrevenue 1% 1% 1% 1% 1% 1% 1% 1% 1%
StateRoyalty A$Real 1,757,363 0 0 0 177,251 400,652 501,685 393,906 268,780 15,089

CompanyIncomeTax
2June11RTorply:CompanyIncometaxrateis30%.Thecashpaymentaveragesmidyear.Assumeoperatingcostcashstreamapproximatesthecostofgoodssold.
GoldRevenue 175,736,334 0 0 0 17,725,080 40,065,236 50,168,501 39,390,613 26,877,999 1,508,904
less
Cashstream3:OperatingCostsExistingCase 71,300,000 0 0 0 10,500,000 15,500,000 16,000,000 16,500,000 12,800,000 0
Taxdeductionforcapitalexpenditure 68,000,000 0 0 0 6,858,601 15,502,975 19,412,366 15,241,935 10,400,262 583,860
StateRoyalty 1,757,363 0 0 0 177,251 400,652 501,685 393,906 268,780 15,089
AssessableIncome 34,678,971 0 0 0 189,228 8,661,608 14,254,450 7,254,773 3,408,957 909,955

CompanyIncomeTaxRate %ofassessableincome 30% 30% 30% 30% 30% 30% 30% 30% 30%
IncomeTax 10,403,691 0 0 0 56,768 2,598,483 4,276,335 2,176,432 1,022,687 272,986
Incometaxpayment 10,403,691 0 0 0 56,768 2,598,483 4,276,335 2,176,432 1,022,687 272,986

Cashstream4:TaxesExistingA$Real 12,161,055 0 0 0 234,019 2,999,135 4,778,020 2,570,338 1,291,467 288,075

CashflowandNPV
Cashlows
Cashstream1:RevenueExistingCase A$Real 175,736,334 0 0 0 16,268,224 38,229,059 49,338,096 40,276,467 27,906,433 3,718,055
Cashstream2:CapitalCostsExistingCase A$Real 68,000,000 3,000,000 30,000,000 25,000,000 3,000,000 4,000,000 2,000,000 1,000,000 0 0
Cashstream3:OperatingCostsExistingCase A$Real 71,300,000 0 0 0 10,500,000 15,500,000 16,000,000 16,500,000 12,800,000 0
Cashstream4:TaxesExistingCase A$Real 12,161,055 0 0 0 234,019 2,999,135 4,778,020 2,570,338 1,291,467 288,075
CashflowExistingCase A$Real 24,275,280 3,000,000 30,000,000 25,000,000 2,534,205 15,729,924 26,560,076 20,206,129 13,814,966 3,429,979

IRRExistingCase 9.1%

Discounting
17July11FGreenemail:discountrateforinvestmentingoldis8%Real.Thebasedateis1July2011
DiscountRate %Real 8% 8% 8% 8% 8% 8% 8% 8% 8%
DiscountFactor 0.96 0.89 0.82 0.76 0.71 0.65 0.61 0.56 0.52

DiscountedCashflowExistingA$Real 2,007,342 2,886,751 26,729,179 20,624,367 1,935,792 11,125,505 17,393,968 12,252,613 7,756,605 1,783,157
CumulativeNPVExistingCase A$ 2,886,751 29,615,930 50,240,297 48,304,505 37,179,000 19,785,033 7,532,420 224,185 2,007,342

NPVExistingCase A$ 2,007,342 45

WorkedExampleMetPlant2011
This example is an illustration. It has not been audited and should be checked before being used.

AlternativeA
carboninpulptechnology
NPVAlternative A$ 37,833,798
IRRAlternativeA 9.4%
20

60
AlternativeA FourCashStreams AlternativeA NPV
0
40 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

20
20
A$M

A$M
0
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
20 40

40
Cashflowifpositive 60
60
CashflowDeficit
Cashstream2:CapitalCosts AlternativeA 80

Cashstream3:OperatingCosts AlternativeA DiscountedCashflow AlternativeA

Cashstream4:Taxes AlternativeA CumulativeNPV AlternativeA
AlternativeA Mining 50 AlternativeA Sales,Price,Margin 1,200
TonnesOreorOuncesGold

1,200,000 6 45

GoldOunces(000's)
1,000
40
1,000,000 5
AuGrams/Tonne
35 800
800,000 4 30

$/ounce
25 600
600,000 3 20
400
15
400,000 2 10 200
200,000 1 5
0 0
0 0 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

OreProduction Headgrade Goldsold GoldpriceForecast Pretaxmargin/oz

AlternativeA Opex 45,000,000

AlternativeA Capex
30,000,000 40,000,000
35,000,000
25,000,000
30,000,000
20,000,000 25,000,000

15,000,000 20,000,000
15,000,000
10,000,000
10,000,000
5,000,000
5,000,000
A$

A$

0 0
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

miningcost processingcost fixedcosts InitialCapitalCosts OngoingCapitalCosts

LifeofMine units Total 2011 2012 2013 2014 2015 2016 2017 2018 2019

Cashstream1:ProductionandRevenue
Production
13Aug11TBensonmineschedule"MinePlanfornewtechnology12Aug11"
OreProduction tonnes 4,300,000 600,000 1,000,000 1,000,000 1,000,000 700,000
Headgrade grams/tonne 1.5 1.3 1.5 1.6 1.7 1.1
Containedgoldmined ounces 204,180 0 0 0 25,080 48,232 51,447 54,662 24,759 0
ProcessingRecovery %ofcontainedgold 75% 80% 80% 80% 80%
Goldproduced ounces 162,090 0 0 0 18,810 38,585 41,158 43,730 19,807 0

Sales
23Aug11JGomachie:"SalesPlan:July2011"
Goldincircuit weeks 0 3 3 3 3 3 3 3 3 3
Goldincircuit ounces 0 0 0 1,085 2,226 2,374 2,523 1,143 0
Goldsold ounces 162,090 0 0 17,725 37,444 41,009 43,581 21,187 1,143

Revenue
23Aug10ABCCompanyForecastofgoldprice
GoldpriceForecast A$/ounceReal 1000 1000 1000 1000 1000 1000 1000 1000 1000 1000
GoldRevenue A$Real 162,090,032 0 0 0 17,725,080 37,444,348 41,009,152 43,581,499 21,187,237 1,142,716

23Aug11JGomachie:"SalesPlan:July2011"
Debtors days 0 0 30 30 30 30 30 30 30 30
DebtorsClosing A$Real 0 0 1,456,856 3,077,618 3,370,615 3,582,041 1,741,417 0

Cashstream1:RevenueA A$Real 162,090,032 0 0 16,268,224 35,823,587 40,716,154 43,370,073 23,027,861 2,884,133

Cashstream2:CapitalCosts
10Aug11GDawsonemail"CapitalCostEstimate:IndicativeEstimatesforNewTechnologyroute"
InitialCapitalCosts A$Real 83,000,000 3,000,000 40,000,000 40,000,000
OngoingCapitalCosts A$Real 15,000,000 6,000,000 6,000,000 2,000,000 1,000,000
Cashstream2:CapitalCostsA$Real 98,000,000 3,000,000 40,000,000 40,000,000 6,000,000 6,000,000 2,000,000 1,000,000 0 0

TaxdeductionsforCapitalExpenditure
3May11EHermiAssumeallcapitalisdeductedinproportiontothegoldsoldoverthelifeofmine.
TaxDeductionforCapitalExpenditure %ofcontainedgold 11% 23% 25% 27% 13% 1%
Taxdeductionforcapitalexpenditure 98,000,000 10,716,624 22,638,938 24,794,226 26,349,473 12,809,852 690,889

Cashstream3:OperatingCosts
25May11GDawsonemail"OperatingCostEstimate:IndicativeEstimatesfornewtechnology."Thereisnowastetobemined.
miningcostpertonne A$Real/tonneore 25 4 4 5 6 6
miningcost A$Real 21,600,000 2,400,000 4,000,000 5,000,000 6,000,000 4,200,000 0
processingcostpertonne A$Real/tonneore 75 15 15 15 15 15
processingcost A$Real 64,500,000 9,000,000 15,000,000 15,000,000 15,000,000 10,500,000 0
fixedcosts A$Real 17,500,000 3,500,000 3,500,000 3,500,000 3,500,000 3,500,000
Cashstream3:OperatingCoA$Real 103,600,000 0 0 0 14,900,000 22,500,000 23,500,000 24,500,000 18,200,000 0
costperounce A$/ounceReal 792 583 571 560 919 0

Cashstream4:Taxes
GovernmentRoyaties
2June11RTorply:SAStateRoyaltyis1%ofrevenuepaidmonthly
StateRoyalty %ofrevenue 0.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0%
StateRoyalty A$Real 1,620,900 0 0 0 177,251 374,443 410,092 435,815 211,872 11,427

CompanyIncomeTax
2June10RTorply:CompanyIncometaxrateis30%.Thecashpaymentaveragesmidyear.Assumeoperatingcostcashstreamapproximatesthecostofgoodssold.
GoldRevenue 162,090,032 0 0 0 17,725,080 37,444,348 41,009,152 43,581,499 21,187,237 1,142,716
less
Cashstream3:OperatingCostsAlternativeA 103,600,000 0 0 0 14,900,000 22,500,000 23,500,000 24,500,000 18,200,000 0
Taxdeductionforcapitalexpenditure 98,000,000 0 0 0 10,716,624 22,638,938 24,794,226 26,349,473 12,809,852 690,889
StateRoyalty 1,620,900 0 0 0 177,251 374,443 410,092 435,815 211,872 11,427
AssessableIncome 41,130,868 0 0 0 8,068,794 8,069,033 7,695,166 7,703,789 10,034,487 440,400

CompanyIncomeTaxRate %ofassessableinco 0.0% 30.0% 30.0% 30.0% 30.0% 30.0% 30.0% 30.0% 30.0% 30.0%
IncomeTax 12,339,260 0 0 0 2,420,638 2,420,710 2,308,550 2,311,137 3,010,346 132,120
Incometaxpayment 12,339,260 0 0 0 2,420,638 2,420,710 2,308,550 2,311,137 3,010,346 132,120

Cashstream4:TaxesAlterA$Real 10,718,360 0 0 0 2,243,387 2,046,266 1,898,458 1,875,322 2,798,474 143,547

CashflowandNPV
Cashlows
Cashstream1:RevenueAlternativeA A$Real 162,090,032 0 0 0 16,268,224 35,823,587 40,716,154 43,370,073 23,027,861 2,884,133
Cashstream2:CapitalCostsAlternativeAA$Real 98,000,000 3,000,000 40,000,000 40,000,000 6,000,000 6,000,000 2,000,000 1,000,000 0 0
Cashstream3:OperatingCostsAlternati A$Real 103,600,000 0 0 0 14,900,000 22,500,000 23,500,000 24,500,000 18,200,000 0
Cashstream4:TaxesAlternativeA A$Real 10,718,360 0 0 0 2,243,387 2,046,266 1,898,458 1,875,322 2,798,474 143,547
CashflowAlternativeA A$Real 28,791,608 3,000,000 40,000,000 40,000,000 2,388,388 9,369,853 17,114,612 19,745,395 7,626,335 2,740,585

IRRAlternativeA 9.4%
Discounting
17July10FGreenemail:discountrateforinvestmentingoldis8%Real.Thebasedateis1July2011
DiscountRate %Real 8% 8% 8% 8% 8% 8% 8% 8% 8%
DiscountFactor 0.96 0.89 0.82 0.76 0.71 0.65 0.61 0.56 0.52

DiscountedCashflowAlte A$Real 37,833,798 2,886,751 35,638,906 32,998,987 1,824,407 6,627,136 11,208,214 11,973,232 4,281,912 1,424,759
CumulativeNPVAlternativeA A$ 2,886,751 38,525,657 71,524,643 73,349,051 66,721,915 55,513,701 43,540,468 39,258,557 37,833,798

NPVAlternativeA A$ 37,833,798 46

FinancialAnalysis
Whyandwhenweshouldconsiderfinancialanalysiswitheconomicanalysis

DCFanalysisconcernsitselfwithcashinandcashout,thetimingofthesecashflows,andwhatthe
netvalueisinpresenttermsunderthedesiredrateofreturnsetbytheinvestorsthatprovideequity
andthelendersthatprovidedebt.Thepartiesprovidingequityanddebtfinancingwillrequirea
returnthatiscommensuratewithofthelevelofrisk(perceivedorreal)andtheseratesdetermine
thediscountrateusedinDCFanalysis.

AlthoughDCFanalysiswillidentifytheexpectedcashflowsattheoperationallevelitwillnot
necessarilyidentifythetimingandquantityofreturnsthatthepartiesprovidingtheequityanddebt
fundingwillreceive.Thisisofobviousimportancewhenconsideringthatthepartiesproviding
financewillwanttoknowwhentheirpaybackwillbereceived.Debtholderswillrequireassurance
that,underarangeofpossiblescenarios,interestontheloanfacilitycanbecoveredandthatthe
debtwillbepaidback.Equityholderswillwanttounderstandwhenpaybackintheformof
dividendswillcommenceandwhatthereturnwillbeoverthelifeofaproject.Giventhatdividends
arepaidfromretainedearningsanddebtrepaymenthasseniorityoverequitypayouts,the
operationneedstobemodelledfinancially.Ultimatelyitcomesdowntohowprovidersofcapital
receivereturnsbasedonwheretheysit,e.g.geographically,inwhichcurrency,basedontaxregimes
thatapply,howandwhentheycanaccesscashreturnsorearnings,etc.

Publicallylistedcorporationsaroundtheworldhaveastatutoryrequirementtoreporttheirresults
undertherespectiveaccountingstandards.Hencefinancialperformanceisassessedunderthese
accountingmeasures.Itisimportanttounderstandthat:

DCFprovidesameasureofvalueunderaneconomicapproachandtestsifthecostofdebt
andequityissatisfied(etc)overtheperiodofthecashflows,andthat

Financialanalysisisanecessarystepwhengravitatingtowardsthecorporateandfinancial
environmentsandwilltest,amongotherthings,forthesameovermorediscretetime
periods(e.g.ifinterestpaymentscanbecoveredeachyear).

47

APPENDIXBINTRODUCTIONTODISCOUNTRATES
Thisappendixisintendedtobeabriefintroductiontothetheoryunderlyingthespecificationof
discountrates.Itisassumedthatthereaderunderstandsthebasicprinciplesofthetimevalueof
moneyandthemechanicsofconductingadiscountedcashflow(DCF)analysistoderiveaNet
PresentValue(NPV):thesearenotdiscussedhere.Rather,thepurposeistoprovidebackground
informationtothetechnicaleconomicanalystwhomaynothaveformaltraininginthefield,sothat
he/sheunderstandswhatthediscountrateisintendedtodo,howitislikelytohavebeenderived,
andmostimportantlytoensurethatthediscountrateusedandthecashflowstowhichitisapplied
areconsistent.

ItshouldbenotedthatthediscussionisfortypicalDCFevaluations.However,manyoftheprinciples
apply,withvariations,toalternativevaluationmethodologiessuchasRealOptionsValuation(ROV).
Thediscussionisunderseveralsubheadings,asfollows:

WeightedAverageCostofCapital(WACC):Thediscountratetypicallyusedinmany
companies.

TheCapitalAssetPricingModel(CAPM):Typicallyusedtodeterminetherateofreturn
requiredbyshareholders(orequityholders)inacompany.

CashflowsRealorNominal,BeforeorAfterTax:Anyofthefourcombinationsofthese
parameterscouldbederived,anddifferentdiscountrateswillberequiredineachcase.
CashflowscanalsobeexpressedasbeforeandafterDebt,i.e.excludingorincluding
interestcoststhatwillapply.Cashflowsthatareafterthedeductionofinterestcostsare
typicallyreferredtoasgeared.Inourcoverageofdiscountratewewill,asistypicalinthe
resourcesindustry,refertoanalysisonanungearedbasis,beforeconsideringthefinancing
cashflows,hencethefourpossiblediscountratesratherthantheeightthatarepossible
ifalsoconsideringgearedcashflowanalysis.

AdditionstotheWeightedAverageCostofCapital:Therearetwogenerallyaccepted
approachesforreflectingriskinDCFvaluationsviathecashflowsorviathediscountrate.
Thatis,eitherthecashflowisreducedorthediscountisincreasedandthisresultsinalower
valuation.Ineffect,thehighertherisk,thenthegreaterthereturnsought.Many
companiesaddriskpremiumstotheWeightedAverageCostofCapitaltoaccountforrisks
ofdealingwithdifferentcommoditiesordifferentcountries.

WeightedAverageCostofCapital
Tospecifyadiscountrate,itisessentialtoaskwhatitisintendedtoachieve.Clearlythiswillbethe
sameaswhatitisintendedthattheprojectshouldachieve.Theunderlyingpurposeofanyproject
willtypicallybeatleasttoreturntotheinvestorstheircapitalplusarequiredrateofreturn.The
mechanicsofatypicalDCFcalculationaresuchthat,ifwediscountacompanyscashflowatthe
companysWeightedAverageCostofCapital(WACC)andgetanNPVofzero,wehaverepaidthe
capitalanddeliveredtherequiredreturn.AnypositiveNPVistheValueAddedbytheprojectover
andabovetherepaymentofcapitalanddeliveryoftherequiredreturn.

48

Anyventurewillbefundedbydebt,equity,oramixofthetwo.TheWeightedAverageCostof
Capitalisthecosttothecompanyofitstotaldebtandequityfunding.Itisderivedfromthe
followingformula:

WACC=rE.E/V+rD.(1t).D/V

where rE=returnrequiredonequity,orcostofequity

rD=returnrequiredondebt,orcostofdebt

E=marketvalueofequity

D=marketvalueofdebt

V=E+D

t=taxrate

WhendiscountingacashflowtocalculateanNPVitisimportanttouseadiscountratethatisinthe
sametermsasthecashflow.TheWACCisappliedtoungearedaftertaxcashflowsandsohasa
componentofcostofdebt(orinterest)andcostofequitytosuitthefactthatthecashflowis
availableforservicingdebtandequity.Thecostofdebtispaidbeforetax.Hence,itsaftertaxcost
isrD.(1t).The1tfactorisoftenreferredtoasthetaxshield.Equityholdersarepaidfrom
retainedearningsandthephysicalcashpaymentfromcashflowsaftertax.Hence,thecostofequity
isalreadyposttaxanddoesnotneedtobeadjustedforthetaxshielditdoesnotapply.

ThevariablesEandDaresometimesdeterminedfromthecompanyspubliclyreportedBalance
Sheet.Thebalancesheetfiguremaybeagoodrepresentationofthemarketvaluefordebtwhilst
themarketvalueofequityforpublicallylistedentitiesisbetterrepresentedbythemarket
capitalisationofthefirm.

Thecostofdebt,rD,istypicallyrelativelyeasytodeterminefromthedollaramountandinterestrate
ofeachsourceofdebtfunding,typicallydescribedindetailinthenotestotheannualaccountsin
thecompanysannualreport.Oneshouldalsoremembertocheckforanyneworretireddebt
facilitiesreportedbythecompanysincethelastreportedbalancesheet.

Therequiredreturnonequitycapital,rE,canbederivedbyvariousmethods:thisdiscussionwill
covertheCapitalAssetPricingModel(CAPM)approach.

TheCapitalAssetPricingModel(derivingtheCostofEquity)
Shareholdersreceivereturnsbytwomeans,DividendsandCapitalGains.Therateofreturn
requiredbyshareholdersdependsontheriskinessoftheinvestment:ifhighrisk,highexpected
returnsarerequired;iflowrisk,lowexpectedreturns.

Whileacceptingthatinrealitythereisalwayssomerisk,thereareinvestmentsthatareconsidered
riskfreee.g.governmentbonds.TheseprovidetheRiskfreeReturn,rF,andthe10year
governmentbondrateismostoftenused.

49

Investmentsspreadoverthetotalmarketwouldfacethemarketrisk,andwouldbeexpectedto
providetheMarketReturn,rM.

Investmentportfolioscanbebuiltwithalowerriskthanthemarket,andtheseareexpectedto
providereturnsbetweentheriskfreeandmarketreturns(i.e.greaterthanrFandlessthanrM).
Similarly,investmentportfolioscanbebuiltwithahigherriskthanthemarket,andtheseare
expectedtoprovidereturnsgreaterthanrM.Notethatreturnsforinvestmentsinnonriskfree
assetsareaverageexpectationsinthelongterm,butarenotguaranteedinanytimeframe,and
certainlynotintheshortterm.

TheCapitalAssetPricingModel(CAPM)relatesshareholdersexpectedreturn(rE)toriskbyalinear
functionwithagradientof,knownasthebetafactorofsimply,thebeta.

rE=rF+(rMrF)

whereistheratioofVolatilityofCompanyReturnstoVolatilityofMarketReturns

ThebetacanbeestimatedastheChangeinSharePrice(AdjustedforDividends)dividedbythe
ChangeintheMarketAccumulationIndexforthesametimeperiod.Todetermineacompanysbeta,
aseriesofsuchdatapointsisplottedovertime,andthegradientcalculated.Onecouldtrackshare
pricesandmarketmovementsoneself,orbuyinformationfromspecialistmarketresearchfirms.In
amathematicalsense,betarepresentsameasureofsystematic(ornondiversifiablerisk)ina
portfolioofassetsandismeasuredasthecovarianceofanassetsperformancerelativetothe
marketdividedbythevarianceinperformanceofthemarket.

Companybetasarequotedonvariousmarketwebpages,suchasthemajorbankssharetrading
websites,andalsopublishedbytheAustralianGraduateSchoolofManagement.Itisalsoimportant
torememberthatbetascanbecalculatedovervariousperiods(e.g.over18months,fouryears,etc)
andthereismorethanoneapproachavailable(butoftentheOrdinalLeastSquaremethodisused).
Acompanysbetacanalsochangeovertimemorethanonefigurecanbequotedovertime.

Bydefinition,themarket=1(if<1,theriskislowerthanthemarket,andif>1,higher),and
(rMrF)isdefinedtobethemarketriskpremiumabovetheriskfreealternative.Thefigurebelow
showstheserelationshipsgraphically:isthegradientofthereturnvsriskline.

50

Whenidentifyingthebeta,itisalsoofsomeimportancetonotethestatisticalcorrelation
coefficientfortherelationshipidentified:althoughabetavaluemaybedetermined,itmaynotbe
statisticallysignificant.Itshouldalsobenotedthatsomecompaniesarecountercyclicalandhave
negativebetas:theirreturnsmoveintheoppositedirectiontotheoverallmarket.

AccountingforInflation
Interestrateschargedbyfinanceproviders,andquotedinthecompanysannualreport,areusedto
specifynumericallythedollarvaluesoftherepaymentsthatwillbemadeinthefuture,inthemoney
ofthetimethatthepaymentsaremadethesearethereforenominalrates.Similarly,therates
ofreturngeneratedtoderiverEaretypicallybasedonreportedpricesovertime,withoutany
adjustmentfortheeffectsofinflationthesearealsothereforenominalratesofreturn.The
discountrateformulasquotedabovearethereforeNominalDiscountRates,whichcanonlybe
correctlyappliedtoNominalCashFlows.

Inflationerodesthepurchasingpoweroftheinterestandcapitalrepaidovertime.Therealreturn
isthatwhichisoverandabovetheinflationrate.

If rN= thenominalrateofreturn,and
ri= theinflationrate,

therealrateofreturnrRisNOTgivenby
(rNri),
butratherbytherelationship(knownastheFisherequation)
1+rR=(1+rN)/(1+ri)

i.e. rR=[(1+rN)/(1+ri)]1

DiscountRatesandNPVsRealandNominal,BeforeandAfterTax
Combiningtheabove,fourpossiblediscountratescanbederivedandapplied.Theappropriateone
tousewilldependonwhatthecashflowstobediscountedare:

Nominal,BeforeTax rNBT=WACC/(1t)=rE.E/V/(1t)+rD.D/V

Nominal,AfterTax rNAT=rE.E/V+rD.(1t).D/V

Real,BeforeTax rRBT=[(1+rE.E/V/(1t)+rD.D/V)/(1+ri)]1

Real,AfterTax rRAT=[(1+rE.E/V+rD.(1t).D/V)/(1+ri)]1

Thecostofequity,rE,isanaftertaxcostandsothebeforetaxdiscountrateshaverEgrosseduptoa
pretaxbasisofrE/(1t).

BeforeandaftertaxNPVscanbedifferent:

Theaftertaxdiscountratewillbelowerthanthebeforetaxdiscountrate.

51

 Thepointsintimesatwhichcapitalexpenditureisincurredandwhentaxdepreciationis
realisedaredifferent.

Anaftertaxevaluationmayincludetaxlossescarriedforwardatthestartoftheproject,itis
quitepossiblefortheaftertaxNPVtobegreaterthanthebeforetaxNPV(ifavalueisnot
attributedtothetaxlossesinthebeforetaxNPVcalculation).

NPVscalculatedfromrealandnominalcashflowsshouldbethesameifthecorrectdiscountrates
areused.Mathematically,deflatingnominalcashflowstorealandapplyingtherealdiscountrate
doesintwocalculationstepswhatisdoneinonestepbyapplyingthenominaldiscountrateto
nominalcashflows.Nominaltermcalculationsmayusedifferentinflatorsforvariousdriversand
componentsofthecashflow.Theeffectofthesewillnotnecessarilyaverageouttothegeneral
inflationratethatmaybequoted,butiftheoveralldeflationrateusedintheanalysisisalsousedin
theFisherequationforarrivingattherealandnominaltermdiscountrates,thereshouldbeno
differenceinNPVs.

AdditionstoDiscountRates
ThediscountratesasdefinedabovebytheWACCtakeaccountofinvestorsrequiredreturnsonly,
andthesystematicormarketrisk.Theydonottakeaccountofthebusinessriskofdealing
withcertaincommoditiesorincertainpartsoftheworld.

ManycompaniesaddariskpremiumtotheWACCtoaccountforthesefactorstypicallyupto
severalpercentagepointsforsomecommodities,andforvariouscountriesorregions.

Riskpremiumsarerulesofthumbthatappeartohaveacquiredlegitimacybyconsensusandlong
use.Thecommitteedevelopingtheseguidelinesisnotawareofanytheoreticalorevidentiary
supportfortheprocessitself,norforthevaluesusedfortheriskpremiums.Thecommitteenotes
that,whileusingdiscountratesthatincluderiskpremiumsmaybesatisfactoryforcomparing
alternativeswithinaparticularproject,givenitslocationandcommodity,thereareconceptual
difficultieswithcomparingsimpleNPVsderivedatdifferentdiscountratesforprojectswithdifferent
commoditiesand/orindifferentcountries.Itisalsoperhapsworthnotingthatthecompanysbeta
alreadyaccountsforitscurrentmixofcommoditiesandcountrieswhereitisoperating.

MonteCarlosimulationmaybeamorerigorouswaytoaccountforbusinessrisk,butonlyifreliable
probabilitydistributionsforvariousdataitemsareavailable.Allkeyparametersincluding
productionrateandmineableresourceneedtobeincluded:notjusttheeasiertoquantify
parametersofoperatingcosts,capitalcosts,gradesandrecoveries,etc.Itissuggestedwithout
proofthattheloweringoftheNPVresultingfromusingadiscountrateelevatedbytheuseofarisk
premiumisperhapsasurrogateforidentifyinganNPVthathasahigherprobability(perhaps90%)of
beingbetteredthantheexpectedvaluethatwouldbederivedwithnosimulationofbusinessrisks
anddiscountingattheWACC,whichwouldtypicallyhaveperhapsa50%probabilityofbeing
achieved.

Proponentsofothervaluationmethodologieswouldalsosuggestthattheuseofthesewould
precludetheneedtoapplysuchriskpremiums.ThisisdiscussedbrieflyinthesectionDiscount
RatesinOtherValuationMethodologiesbelowinthisappendix.
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FinancingCashFlows
Thefinancingcashflowscapitalrepayments,interest,dividends,andthetaxeffectsofinterest
paymentsareaccountedforinthediscountrates.Theyarethereforenotincludedinthecash
flowsforeconomicevaluationsdeterminingprojectNPVetcforatypicalungearedtechnical
economicevaluation.

Thefinancingcashflowsmayhoweverneedtobecalculatedoutsidetheeconomicevaluationto
confirmtheabilityoftheoperationtorepayloansandmeetdebtcoveragerequirements,asmaybe
requiredbyfinanciers.

CalculationofanEquityNPVcalculationmayberequested,assumingspecifieddebtfundingfor
theproject,todeterminethereturntoshareholders.Debtdrawdowns,andrepaymentsofcapital
andinterestwillthencomeintothecashflowanalysis,andthediscountratetobeusedwillbethe
requiredreturnonequity.Thisisgenerallynotrecommendedforthetechnicaleconomicevaluation:
theprojectshouldstandonitsownmerits,andnotdependonthefinancingarrangementsforits
viability.

Onecouldalsoevaluateaprojectattheequitydiscountratewithzerodebtfundingtoassessstand
aloneviabilityofproject.Thiswouldtypicallybeamoreconservativeapproach,astherequired
equityrateofreturnwouldusuallybegreaterthantherateofreturnfordebt.

DiscountRatesinOtherValuationMethodologies
Asnotedintheintroductiontothisappendix,theprecedingdiscussionisfortypicalanalysesoftotal
netprojectcashflowwithdiscountingatthecompanysWACC,whichinessencetreatsthenetcash
flowbyreferencetothecompanysoverallriskinessasperceivedbythemarket.Riskpremiumsare
usedbysomecompaniestoaccountfortheadditionalperceivedrisksofdealingwithcertain
commoditiesand/orincertaincountries.

Othervaluationmethodologies,suchasModernAssetPricing(MAP),ArbitragePricingTheory(APT),
andRealOptionsValuation(ROV)approachthevaluationproblemfromthepointofviewof
identifyinganddealingwithvariousrisksindividually.Someofthesemethodologiesaredescribedin
moredetailinothersectionsoftheseguidelines,butforthesakeofcompletenessinthisdiscussion
ofdiscountrates,certainaspectsaredescribedhere.

Someofthesetechniquesaccountfortheriskassociatedwithindividualcomponentsofthecash
flow.Individualbetasarederivedfor(forexample)metalpricesandvariouscostcategories,suchas
labour,consumables,energy,andsoon.Thetechniquesusedtoderivethesebetaswillbesimilarto
thosedescribedabovefordeterminingtheshareholdersrequiredrateofreturn.Thebetasthus
derivedareappliedtothemarketpremium(iethedifferencebetweenthemarketandriskfree
ratesofreturn)toderivediscountratesrelatingonlytothesystematicormarketriskofeachcash
flowitem.

Eachcashflowitemisthendiscountedatitsappropriatediscountrate,theresultingcashflowsthen
summedtoobtainatotal,whichisthenaccountingforallrisks.Theonlyotheritemtothenbe

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accountedforisthetimevalueofmoney.Thetotalriskdiscountedcashflowisthereforethen
discountedattheriskfreerateofreturntoaccountfortheeffectsoftimingonly.

Thebetasderivedforeachcashflowitemwillautomaticallyaccountfortherisksassociatedwiththe
commoditiesandcountriesinvolvedintherevenueandcoststructureofthecompanyand/or
project.Theresultwillbeadollardenominatedvalue,butsincethediscountratesusedhaveno
referencetothecostsofdebtandequity,thereisnoguaranteethatapositivevalueimpliesthat
debtprovidersandequityholderscanberepaidtheirinvestmentsandpaidtheirrequiredratesof
return.

ConcludingComments
Itisrarelythetaskoftheengineerortechnicalanalysttoderivediscountrates.Theyareusually
specifiedbythecorporatefinancedepartment.

Technicaleconomicanalystsshouldhoweverbefamiliarwiththeassumptionsunderlyingtheir
derivation,andensurethattheappropriaterateisapplieddependingonthecashflowsgenerated:
realornominal,beforeoraftertax.

Inparticularitshouldbenotedthat,whilegeneratingapositiveNPVusingtheWACCasthediscount
rateimpliesthatallprovidersoffundinghavereceivedtherepaymentoftheirinvestmentsplustheir
requiredratesofreturn,thisdoesnot,asnotedinthebodyoftheseguidelines,implythatany
particularpatternoffinancerepaymentscanbemade.

Differentprojects,companiesandindustrieshavedifferentWACCs.Therearenumerousviewson
whattheapplicableWACCiswhenvaluinganinvestment.Theauthorsmakenorecommendations
regardingthesesometimesopposingviewsexcepttomakereadersawaretheyexist.However,itis
recommendedthatsomethoughtisgiventosuchmattersas:fromwhatperspectivethevaluationis
beingundertaken,thesizeoftheinvestmentrelativetothecompany,whetheritisinanindustry
withdifferentrisksandtypicalWACCsfromthecompanysinvestorsperceptions,howitwillalter
thecostofcapitalifthetransactionproceeds,andhavingawellconsideredandjustifiableposition.
Someofthe(conflicting)viewsthatmaybeencounteredare:

Whenvaluinganinvestment,themarginalcostofcapitalisconsideredrelevant.Butthe
WACCcanbeusedifweightedwiththeadditionalmarginalcost.Thisignoresissuessuchas
themarginalcapitalrequirementsbeingfullyfundedusingdebtandanyeffectsoncredit
ratingsandapossibleincreaseincostofdebt.Manybelieve,iffullyfundedbydebt,then
usetheexistingWACCatmargin.Overtime,companiesrefinanceandthemarginalcostof
capitalwillceasehencethislendssupporttousingthecurrentproportionofdebtand
equityatexpectedcostsofdebtandequity.

Whenvaluinganothercompanyforacquisition,useyourcompanyWACCasthatiswhatthe
acquiredcompanyscashflowswillbevaluedatwhenconsolidated.

Whenvaluinganothercompanyforacquisition,usethatcompanysWACC.

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 Dobothoftheabovetoidentifywhetheryouandtheothercompanyvalueitdifferently,
withpotentialimpactsonacquisitioncosts.

Whenvaluingacompanyinthesameindustry,usetheindustryWACCthismaybebased
ontheviewthatanoptimalcapitalstructureisobtainableand,giventheoptimalmixis
difficulttoobserve,oneusestheindustryaveragecostofcapitalinstead.

Whenvaluingacompanyinadifferentindustry,usetheindustryWACCwithanadjustment
foryourdebtposition.

BusinessUnitswithinacompanyeachhavetheirownsetofrisks,henceitisappropriateto
useadifferentcostofcapitalwhenrankingopportunities.

55

APPENDIXCRECOMMENDEDREADINGLIST

DiscountRates

Smith,L,1990.Inflationinprojectevaluation,CIMBulletin,83(935):129133.

Smith,L,1995.Discountratesandriskassessmentinmineralprojectevaluations,CIMBulletin,
88(989):3443.

Smith,L,2002.Discountedcashflowanalysis,CIMBulletin,95(1062):101108.

ValueatRisk

Lai,F.J.andStange,W.UsingValueatRiskforIntegratedProjectRiskEvaluation.AusIMMProject
EvaluationConference2009,2122April2009.

Stange,W.andCooper,B.ValueOptions,RiskandFlexibilityinPlantDesignandOperations.
AusIMMMetallurgicalPlantDesignandOperatingStrategies(MetPlant2008),1819August2008
Perth,WA.

Whittle,G.,StangeW.andHansonN.OptimisingProjectValueandRobustness.AusIMMProject
EvaluationConferenceMelbourne,Vic,1920June2007.

RealOptions

Howell,S,Stark,A,NewtonDP,Paxson,D.,Cavus,M.,AzevedoPereira,J,Patel,K.,2001,Real
Options:EvaluatingCorporateInvestmentOpportunitiesinaDynamicWorld,(FinancialTimes:
PrenticeHall).

Copeland,TEandAntikarov,V,c2001,RealOptions:APractitionersGuide,(Texere:NewYork).

Schwartz,ESandTrigeorgis,L,RealOptionsandInvestmentUnderUncertainty:Classicalreadings
andrecentcontributions,c2001,(MITPress:Cambridge,Massachusetts).

Clemen,RT,c1996,Makingharddecisions:Anintroductiontodecisionanalysis,(DuxburyPress:
Belmont,California)

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APPENDIXDTECHNICALECONOMICEVALUATIONGUIDELINES
COMMITTEEMEMBERS
ConvenorandChairman DrBrianWhite

SubCommitteeMembers SimonAllard

PeterCard

MichaelConanDavies

TimDaffern

BrianHall

RichardHorton

AlisonMorley

DrNawshadHaque

DrAndrewNewell

TimPeters

MonikaSarder

StellaSearston

DrBillShaw

DrWayneStange

AlexTrevisin

MikeWarren

GrahamWood

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