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Conference Proceedings

Mineral Valuation Methodologies Conference - VALMIN 94

Conference Proceedings

Mineral Valuation Methodologies Conference - VALMIN 94

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Discounted Cash Flow Methods and the Capital Asset Pricing Model

Mineral valuation may appear to be a special field
of financial valuation when in fact it is a subset of
general investment decision theory. The only significant
difference in mineral valuation is that in the case of
valuing an on-going mineral asset, ie a mine, often there
is no initial capital outlay involved. One is required to
determine what the mineral asset as it stands is worth.
But this is the same problem as determining the
maximum one could pay today and not incur a loss over
the life of the asset. In other words one needs to
determine the Net Present Value (NPV) of the asset. The two most widely used discounted cash flow
methods, NPV and Internal Rate of Return (IRR) came
of age with the rapid adoption of the personal computer
and spreadsheet programs. The two methods are directly
related as the IRR is a special case of NPV. NPV
measures the absolute increase in real wealth that can be expected from a certain investment, which makes it
particularly suitable for mineral asset valuation, but
ignores the efficiency of the investment. In contrast,
IRR gives the expected efficiency of the investment but
ignores the increase in wealth aspect. IRR has two
serious theoretical weaknesses; multiple IRR's and a
very rigid assumption about the rate of return of
reinvested proceeds, plus if no initial equity expenditure
is involved there is no IRR. The choice of the ""hurdle""
rate can also be a problem and in certain circumstances
one can obtain different rankings of mutually exclusive
projects using IRR and NPV. Although NPV and IRR supposedly measure
financial risk, in fact they only address a very narrow
area of risk, namely the time value of money given the
real discount rate. They side step the issue of what the
real discount rate should be and varying degrees of
risk. The classical way to establish the real discount
rate is to use the weighted average cost of capital.
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  • Published: 1993
  • PDF Size: 1.003 Mb.
  • Unique ID: P199410012

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