Discount rates and risk assessment in mineral project evaluations

CIM Bulletin, Vol. 88, No. 989, 1995

Lawrence Devon Smith Kilborn Inc., Toronto, Ontario

The concept of risk is well established in the mining industry. It is acknowledged when estimates of reserves are expressed as proven or probable, when mining and metallurgical recoveries are applied to the ore, and when contingencies are added to costs. However, it is difficult to provide a quantitative assessment of risk. The significant sources of risk in a mineral project and how these are addressed in project evaluations are discussed. The discount rate is examined as a fundamental means of reflecting risk in discounted cash flow evaluations. Current industry practice is discussed, and a methodology for the analysis of risk levels is proposed that assesses the constituent components of the discount rate: real interest, mineral project risks, and country risk.

Keywords: Capital asset pricing model, Corporate cost of capital, Country risk, Discounted cash flow, Discount rate, Evaluation, Net present value, Real discount rate, Risk, Risk assessment, Risk factors.