Risk-adjusted discount rate and its components in evaluating hard coal projects at the feasibility stage

• Published in: Gospodarka surowcami mineralnymi 2019-01, Vol.35 (3), p.63
• Main Author: Saługa, Piotr W
• Format: Article
• Language: English
• Subjects: Discount rates; Discounted cash flow; Feasibility studies; Interest rates; Mineral deposits; Mining industry; Operating costs; Project evaluation; Project feasibility; Sensitivity analysis; Taxation; Uncertainty
• ISSN: 0860-0953; 2299-2324
• DOI: 10.24425/gsm.2019.128530

Because of the value of time, investors are interested in obtaining economic benefits rather early and at a highest return. But some investing opportunities, e.g. mineral projects, require from an investor to freeze their capital for several years. In exchange for this, they expect adequate remuneration for waiting, uncertainty and possible opportunities lost. This compensation is reflected in the level of interest rate they demand. Commonly used approach of project evaluation – the discounted cash flow analysis – uses this interest rate to determine present value of future cash flows. Mining investors should worry about project’s cash flows with greater assiduousness – especially about those arising in first years of the project lifetime. Having regard to the mining industry, this technique views a mineral deposit as complete production project where the base sources of uncertainty are future levels of economic-financial and technical parameters. Some of them are more risky than others – this paper tries to split apart and weigh their importance by the example of Polish hard coal projects at the feasibility study. The work has been performed with the sensitivity analysis of the internal rate of return. Calculations were made using the ‘bare bones’ assumption (on all the equity basis, constant money, after tax, flat price and constant operating costs), which creates a good reference and starting point for comparing other investment alternatives and for future investigations. The first part introduces with the discounting issue; in the following sections the paper presents data and methods used for spinning off risk components from the feasibility-stage discount rate and, in the end, some recommendations are presented.