Mine Economics
Project Overview
A large mining company is planning a major new development. To provide funds and to permit management to concentrate on the new development, the company would like to sell an operating underground copper mine with remaining reserves capable of supporting only four years production. They are prepared to sell the mine for A$25million.Omega Mining is considering purchase of the mine.
They have carried out a due diligence investigationof the property and have decided that the following data arereliable within acceptable limits.Reserves, 8 million tonnes to be mined and milled at the rate of 2 million tonnes per year.The accepted mining schedule indicates that reserves grade will reduce over the 4 years, averaging 3.2% copper in year 1, 3.1% copper in year 2 and 3.0% copper in year 3 and year 4.Metallurgical recovery will average 94% throughout.
Underground mining costs will average A$32/tonne in year 1 and will increase with expected inflation of 2.5%, year on year, for years 2, 3 and 4.Milling and site administration costs will average A$18/tonne in year 1 and will increase with inflation as do mining costs.Corporate overhead costs, including copper price hedging costs, willamount to A$2 million in year 1 and to A$500,000 in years 2, 3 and 4. These corporate overhead costs have been estimated in dollars of the year in which they are incurred.Close down, rehabilitation and redundancy costs, net of salvage value, will be incurred in the year after mining ceases.
These costs are estimated to amount to A$18 million in dollars of the year in which they occur.The existing concentrate sales agreements can be continued and forward sales can be arranged to guarantee an average price of US$4000/tonne of refined copper in year 1 and US$3000/tonneof refined copper in year 2 and a price of US$2400/tonne of refined copper in years 3 and 4.
Refined copper prices are in dollars of the year in which they are received. Realisation costs reduce mine revenue to 55% of the refined copper price per tonne of recovered copperin concentrates.Government royalties amount to 2.5% of mine revenue.The A$/US$ exchange rate is expected to average A$1 = US$0.78 in year 1, A$1 = US$0.74in year2 and A$1 = US$0.70 in years 3 and 4, reflecting an expected drop in commodity prices during that period. The mine would be acquired as an operating mine, complete with existing equipment, stores and consumables. However, the new owners would have to fund the operation for about 3 months before their first sales revenues would be received, amounting to about A$25million of working capital includingA$1 million of hedging and corporate costs. The funding required for the purchase would thus amount toA$50 million.
No sustaining capital would be required over the 4 years life of mining. Omega operates on a 40:60 debt:equity ratio. It can fund A$30 million from its own resources and can borrow A$20 million at an interest rate of 10%. The A$20 million of debt will be repaid in equal payments in years 1 and 2 of mine life. Omega believes its cost of equity capital is 15% and will use the weighted average cost of capital, rounded up to the next whole number, as the discount rate to evaluate the purchase.The purchase price can be depreciated on a straight line basis over the 4 years. The company income tax rate is assumed to be 30% over the life of the operation.
Your Task
Write a technique report to the board, including the following points.
1.State the objective and scope of your study.
2.Carry out discounted cash flow evaluation and determine the NPV and IRR of the value of the purchase and make recommendation.
3. Use the financial model to carry out sensitivity analysis of the project to identify and rank the critical parameter.4. Conclude your analysis and state recommendations if there is any. AimThe aim of the project is for students to experience the step by step development of a financial/technical modeling in project evaluation for a mining project. Learning OutcomesIt is intended that by the end of this project, students will be able to:
Understand the structure of project evaluation,
Create realistic, properly integrated financial/technical discounted cash flow models of a mining project, based on defensible cost and revenue assumptions, and permitting sensitivity analysis to identify the critical assumptions and rank them in terms of their impacts on project outcomes,
Demonstrate an appreciation of the time value of money, discount rates, commodity markets, and the impact of the economic environment on mining operations and planning,
Think and work individually
Demonstrate basic business and management skills
Report
Results should be presented in a proper technical report with a cover letter and summary.
The report should contain appropriate tables, contour plots and appendices.
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