extractive industries - methods of valuation


As the mine/quarry involves a complex cash flow over a short period the best method of valuation is discounted cash flow (DCF). The example below is for a potential dolomite quarry:

VALUATION EXAMPLE - POTENTIAL DOLOMITE QUARRY


Area of site: 2 hectares
Area suitable for quarrying: after allowing for a support margin around the perimeter. 1.8 ha
Average depth of rock: 18 m
Therefore, "in situ" rock: 324 000 m3
Growth factor: (the difference in volume "in situ" and after crushing) 50%
Therefore, the expected volume crushed: 486 000

EXPECTED INCOME TO OWNER:


Dead rent: $10 000 pa
Term: 5 years
Royalty to owner on crushed rock: $1/m3

Expected annual extraction rate:

Year 1 80 000 m3
Year 2 145 000 m3
Year 3 200 000 m3
Year 4 50 000 m3
Year 5 11 000 m3

OUTGOINGS:

Royalty to Crown: 25c/ m3
The lessee pays all other outgoings including establishment costs.

Under the council and departmental approvals the site must be restored to its original condition upon the exhaustion of the quarry. This is expected to cost 100 000 /ha and the expected value on restoration as industrial land is 500 000/ ha.

The required internal rate of return (IRR) for the mine/quarry operations is 20%pa.

The value is determined using DCF. The use of DCF is justified in the case of mines and quarries because of their short life and the uneven and complex nature of the future income, returns and costs. The residual value is the NPV and equal to the land value. The DCF for the above example is shown below:

DISCOUNTED CASH FLOW VALUATION - DOLOMITE QUARRY

$' 000
YEAR: 0 1 2 3 4 5
Legal/stamp duty: (5)




Royalties to crown:
(20) (36.25) (50) (12.5) (2.75)
Cost of renovation:




(180)
Dead rent:
10 10 10 10 10
Royalties to owner:
80 145 200 50 11
End market value:




1000
Legal/commission on sale:




(40)
TOTALS: (5) 70.00 118.75 160.00 47.50 798.25
Discount factors @ 20%:
1.0000
0.8333
0.6944
0.5787
0.4823
0.4019
NPVs:
(5)
58.33
82.46
92.59
22.91
320.82
NPV:
572.11






MARKET VALUE: say 572 000



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