Chapter 6.

1 MINE VALUATION*
D ONALD W. G ENTRY
As noted in the introduction to this section, the term mine valuation implies the assigning of a dollar or other currency value to the worth of a mine or mining project and provides a measure of the desirability of ownership of that property. As such, several types of value may be encountered in performing a mine valuation study. These are 1. Market value. 2. Full cash value. 3. Salvage value. 4. Replacement value. 5. Capitalized value. 6. Book value. 7. Assessed value. 8. Insured value. Each of these has a specific meaning that can be applied to determine a monetary amount in a specific situation. Of interest in this chapter is the broader question of what is the value of the mine?, or what is the mine worth? In this context the value of interest is the market value of the property. Market value is the value (price) established in a public market by exchange between a willing buyer and a willing seller when neither is under duress to complete the transaction. Thus the term market suggests the idea of barter. The term market value is often used synonymously with the term fair market value. The courts have come to accept the legal definition of fair market value as the amount in cash, or in terms reasonably equivalent to cash, for which in all probability the property would be sold by a knowledgeable owner willing but not obligated to sell to a knowledgeable purchaser who desired but is not obligated to buy. Therefore, the determination of market value of a specific mining property can only be made by the market through an actual sales transaction, in accordance with the foregoing caveats pertaining to the absence of duress on the part of either the seller or the buyer. Typically, mineral economists, appraisers, and government tax officials, among others, are concerned with the estimation of market value for mineral properties. This estimated market value must be based on the time and conditions existing as of a specified date. Consequently, market value is a dynamic property that constantly changes as market conditions and expectations change. Following is a discussion of the approaches most often utilized to estimate the market value of mining properties. The specific recommended methodology for estimating the value of a mining project is provided in Chapter 6.2.
AND

T HOMAS J. ON EIL

approaches and its applicability to mining or mineral properties is provided in the following discussion.

6.1.1.1 Cost Approach

The cost approach to mine valuation attempts to determine the depreciated replacement cost for the asset in question. That is, what would it cost to reproduce an asset of identical quality and state of repair? The fundamental concept with this approach is that a purchaser would not be justified in paying more for a property than it would cost him to acquire land and construct improvements that had comparable utility with no undue delay. The cost approach is rarely applicable in mining because the correlation between construction costs and the value of the property is very imperfect. For example, if one were to build mines with production capacities of 100 tpd (90 t/day) each, one on a very rich ore deposit and one on an economically marginal deposit, construction costs might be very similar, but fair market values of the two mines would, clearly, be substantially different. Another problem arises when the cost approach is applied to newly discovered mineral properties that have no surface improvements or equipment of any kind. The very nature of mineral exploration and mining dictates that the discovery value of an ore deposit is generally greater than the cost incurred in making that discovery. If this were not true in the aggregate, investment could not be justified for exploration. Furthermore, the notion of estimating the cost of acquiring a comparable asset (ore body) is not very useful. This cost could, for example, be infinite if nature failed to provide a duplicate for explorationists to find. The cost approach is not only the least applicable method in the valuation of mining properties, but it generally is the least reliable also.

6.1.1.2 Market (Comparable Sales) Approach

This approach is considered by most appraisers and the courts to provide the best indicator of fair market value, since it reflects the balance of supply and demand in the marketplace. The market approach assumes that a purchaser would not be justified in paying more for a property than it would cost him to acquire an equally desirable substitute property. The concept of market value also presumes conditions of an open market, exposure for a reasonable time, knowledgeable buyers and sellers, absence of pressure on either the seller to sell or the buyer to buy, and a sufficient number of transactions to create a stable market. The market approach encounters serious practical problems when applied to mining transactions. This is mainly due to two facts: first, there are very few sales of mining properties, and therefore few comparative data are available; and, second, since each mineral deposit is unique in quality, size, geographical location, degree of development, and many other parameters, any market data are of modest value at best. To be applicable, the market data must not only relate to similar assets but must also be for a similar point in time.

6.1.1 APPROACHES TO MINE VALUATION

To estimate the market value of any asset, most appraisers initially consider three generally accepted approaches to value estimation. All three approaches are based on the very important appraisal principle of substitution. A closer look at each of these
* This chapter is compiled exclusively from materials contained in Chapters 1 and 2 of Mine Investment Analysis by D.W. Gentry and T.J. ONeil (1984) and from the article Minerals Project Evaluation An Overview by D.W. Gentry (1988).

390

MINE VALUATION
Experience in the area of mineral property transactions suggests that the open-market, unpressurized dealing and other assumptions previously mentioned in association with this approach are seldom reflected in reality. When such criteria and assumptions are met, it is often extremely difficult to ascertain the actual or true value of the sale because of stipulations pertaining to production commitments, deferred payments, exchanges of stock, production payments, and other subtle factors that can affect the value significantly.

391

6.1.1.3 Income (Earnings) Approach

With the income approach, the value of an asset or investment-type property is estimated by calculating future annual net earnings generated from the producing property or asset and then discounting this earnings stream to the present time by the use of an appropriate discount rate. The approach assumes that a purchaser would not be justified in paying more to acquire income-producing property than the present value of the income stream to be derived from the property. Because of the calculation procedure utilized, many analysts refer to this as the capitalized income approach. In essence, the income approach is one step removed from the market (comparable sales) approach. If comparable sales data are unavailable or if one is estimating the value of a mineral commodity in situ, it is possible to arrive at a value estimate by combining the selling price of the commodity produced with the associated costs of producing it from the property in question. By proper incorporation of these data into a discounted cash flow analysis, it is possible to arrive at an estimate of property value even in the absence of actual production. It is important to remember, however, that the estimate thus obtained is not a direct estimate of the market value of a commodity in place, but rather an estimate of potential income generated from mining and selling the commodity. Capitalized future income is a unit valuation method. That is, a single value is assigned to the ore deposit, to surface and subsurface improvements, and to all real and personal property used in the production process. To a considerable degree, real property at mines has value only because of the presence of ore, and unit valuation is therefore appropriate. Because mines have limited operating horizons, and because there are well-established markets for most mineral commodities, the income approach is widely used in valuing mineral properties. The approach is commonly used by the mining industry in the assessment of investment rates of return and to determine appropriate purchase prices for mines or mineral prospects. From a practical standpoint, the income approach has the added capability of incorporating more obtainable, realistic data for analysis and therefore is the preferred approach to mine valuation. In addition, the income approach is consistent with the generally accepted definition of the value of a mineral property. That is, the value of a mining or mineral property at a specific point of time is simply the present value of all the future net annual proceeds that are expected to accrue from ownership. The basic element in the income approach to mine valuation is the pro forma income statement, which is discussed in more detail in Chapter 6.2.

Salvage Value: Salvage is the net sum, over and above the cost of removal and sale, realized for a property or asset when it is retired from service. Salvage value and scrap value are synonymous when the property or asset retired from service is scrapped for the value of its materials. Replacement Value: Replacement value refers to the existing value of a property or asset as determined on the basis of what it would cost to replace the property or its service with at least equally satisfactory and comparable property and service. The concept of replacement value is fundamental to the cost approach utilized by appraisers. Book Value: Book value is the original investment in the property or asset as carried on the organizations books less any cumulative allowance for depreciation or amortization entered on the books. Assessed Value: The assessed value of a property is the value entered on the official assessors records as the value of the property applicable in determining the amount of ad valorem taxes to be paid by the property owner. Insured Value: The insured value of a property refers to that value at which the property has been insured against loss or disaster. This value is generally associated with replacement value for tangible assets and earning capacity for property such as mines (ore deposits). Capitalized Value: The capitalized value of a property is the sum of discounted future annual net earnings generated by the property. The capitalized value concept is synonymous with the income approach to value estimation for mining properties.

6.1.2 PURPOSE OF MINE VALUATION STUDIES

There are many reasons for conducting studies on estimating the value of a mining property. Regardless of the specific purpose for estimating the value of a mining property, the ultimate objective of the study is to arrive at a monetary value or worth for the property in question. A specific value, or range in values, for a specific property is often required for one or more of the following purposes.

6.1.2.1 Acquisition
The acquisition of mineral properties may transpire at any point in time between a raw prospect and an actual operating mine. Obviously, the actual amount of data available on a property will depend upon where it lies within this spectrum. Depending upon the state of development of the property, the purchaser is acquiring assets with varying levels of risk. As such, the estimated value of the property must reflect not only the potential of the mineral deposit but also the relative risks associated with these assets. Certainly the distribution of value estimates for an existing operating mine would be expected to have a rather low variance as contrasted to that for a raw prospect.

6.1.2.2 Taxation
Mineral properties must also be valued for taxation purposes. Perhaps the classic example here is with ad valorem property taxes, levied by most state and local governments. The difficulty with value estimation of a mineral property for taxation purposes is that a single value is required for property worth. Most states have enacted tax provisions that attempt to approximate the value of a mineral property through a formula or other mechanism that rarely serves as an adequate measure of property value for an actual sale. These mechanisms are seldom

6.1.1.4 Other Types of Value

As mentioned at the beginning of this chapter, there are several types of value that may be encountered when performing mine evaluation studies. Following are brief descriptions of some of them.

392

MINING ENGINEERING HANDBOOK 6.1.2.4 Regulatory Requirements

Even the federal government has found it necessary to wrestle with the problems associated with estimating the value of federally controlled mineral lands. This results from the fact that the leasing of federal lands for some mineral commodities is through the competitive bidding process, and the government is obligated by law to accept no bid that is less than the fair market value of the mineral occurrence. As a result, the federal government is often required to estimate the value of certain leases prior to competitive bidding in order to assure that bonus bids and royalty provisions represent fair market value and are therefore acceptable. The federal government is faced with a similar valuation problem when determining or negotiating royalty provisions on other leased minerals.

based on strong economic foundations and only serve as a convenient proxy for mineral property values. As a result, significant discrepancies can occur between the appraised value of a property for tax purposes and the value as perceived in the marketplace.

6.1.2.3 Financing
The mode, mechanism, and magnitude of financing new mining properties or ventures are functions of the estimated property or project value. Certainly, the risk of default must also be considered in mining and must be assessed in regard to the perceived intrinsic value of the property. This aspect is becoming increasingly important in view of the popularity of international joint ventures as a means of dispersing project risks. The fundamental concern of lending institutions is not whether a specific rate of return is achieved by the project owner, but rather that the project will generate adequate cash flows to service the acquired debt. Thus lenders approach mine valuation studies from a different perspective.

Gentry, D.W., 1988, Minerals Project EvaluationAn Overview. Transactions, Institution of Mining and Metallurgy, Vol. 97, pp. A25-A35 Gentry, D. W., and ONeil, T.J., 1984, Mining Investment Analysis, SMEAIME, New York, pp. 1-34.