The Miners introduction to Valuation

The Basic principles

From financial perspective, the valuation of any company or a mine is not different from any other financial asset. It is essentially the sum of all the Cashflows (Money) that is expected to be received over a period of time.

Time Value of Money – Putting it simply, Money today is more valuable than money in the future. Eg. Hundred Rupees today is equivalent to 110 Rs one year later. (10% interest rate assumed)

This principle relies on the opportunity cost (also known as Cost of Capital or Cost of Carry) of returns to be generated from Cash in hand over the period of time.

Valuation (NPV) = Sum of all the cashflows weighted by a factor for time value of the money (aka Discount factor)

Where Wi = 1/(1+r)ⁱ

Theoretically, the Discount factor is a rate (similar to Interest Rate) which is a function of the risk of a project (Expected Rate of Return). For eg A low risk project will carry a discount rate of say 10% while a high risk project will carry a discount rate of 15%.

Practically the estimate of Discount Rate (expected rate of return) is drawn on the basis of Weighted Average Cost of Capital (WACC). WACC is simply weighted average cost of Debt and Equity

• Cost of Debt is rate of interest on loans of the company
• Cost of Equity is the rate of return expected by the shareholders of the company
• To sum it up simply, the determining the valuation or the Net Present Value(NPV) is only a matter of forecasting the cashflows from the Mine and then discounting it with the WACC of the company.
  
  
  Formula Refresher
  Selling Price x Production = Revenue
  COP x Production = Cost
  Revenue – Cost = EBITDA
  EBITDA – Depreciation = PBT
  PBT – Tax (33.99%) = PAT
  PAT + Depreciation = Cash Profit
  Cash profit less Capex less Increase in Net Working Capital = Net Free Cash Flow
  Net Free Cash Flow when Discounted at Discount Rate (say 14%) = NPV
  NPV should be +ve so that the project is viable
  IRR should be at least  equal to WACC for the project to be viable
  NPV and IRR are related- IRR is that discount rate at which NPV becomes Zero
  Discount rate is determined as a WACC - weighted average of cost of Debt (interest cost) and Cost of Equity (Expected rate of return of the shareholders).
  NPV of a company is same as Enterprise Value (EV) of that company
  NPV + cash – Debt = Market Cap = No. of shares x value of each share