Authors: Chaesary H. Rekinagara & Defi Puspitasari
Mining and economics are closely related—almost like siblings—because every mining activity is inherently tied to economic feasibility. Therefore, economic knowledge is essential for stakeholders in the mining industry, both academics and practitioners. This article discusses valuation and evaluation in mining projects.
What are valuation and evaluation? Are they different?
Valuation is the process of assessing the value of an asset, business, or project in monetary terms, such as dollars or other currencies, including rupiah. Damodaran (2016) states that valuation does not always require complex mathematical formulas—there is even an element of art involved. Therefore, differences in valuation results and analyses are acceptable.
Evaluation is a technique used to assess or judge the performance of an activity or project. The term evaluation is not limited to the mining industry; it is also used in other disciplines such as environmental evaluation, disaster evaluation, and organizational evaluation within companies.
Essentially, evaluation can serve as one approach to valuing mining projects.
Why are mining projects different?
In mining, valuation techniques differ from those in industries like manufacturing or banking due to the following characteristics:
- The mining industry is cyclical, with unpredictable fluctuations, making commodity prices difficult to forecast.
- Mining assets are exhaustible (can be depleted).
- The industry is highly sensitive to external variables (commodity prices, political conditions, geological risks, etc.).
What approaches can be used to value mining projects?
Income Approach
This approach values a project based on its ability to generate cash flow. The most commonly used method is Discounted Cash Flow (DCF) to calculate Net Present Value (NPV).
Advantages:
- Straightforward technique
- Accounts for future risks
- Easy to understand, even for non-economists
Disadvantages:
- Static (does not capture internal dynamics)
- Potential for undervaluation
- Sensitive to assumptions
How to determine DCF?
There are three common methods:
- Summing risk-free interest rate (rf), mineral project risk (rmp), and country risk (rc) (Smith, 2002)
- Using WACC (Weighted Average Cost of Capital) and RADR (Risk Adjusted Discount Rate) (Kumral, 2020)
- Based on expert opinion, surveys, or publications by mining analysts
Another method under the income approach is Real Options.
Real Options is a relatively newer technique compared to DCF. It was developed by Black, Scholes, and Merton in the 1970s, known as the BSM model.
Advantages:
- Incorporates managerial flexibility in handling future risks
Disadvantages:
- Complex and difficult to understand mathematically
Market Approach
This approach is based on market prices. A commonly used technique is multiples, often applied in valuing publicly traded companies.
Advantages:
- Relatively simple
- Data is publicly accessible
Disadvantages:
- Difficult to find truly comparable projects (apple-to-apple comparison)
- Potential bias due to reliance on historical data
Cost Approach
This approach values a project based on the costs incurred to initiate it, typically during the exploration phase before production. One method used is Depreciated Replacement Cost (DRC).
Advantages:
- Relatively attractive to investors
Disadvantages:
- Requires agreement on the depreciation method used
Source: All About Mining Webinar #1: Valuation Techniques & Risk Analysis of Mining Projects
Speaker: Aldian Ardian, Ph.D. (cand.)
