Discounted Cash Flow Analysis Input Parameters and Sensitivity


Christopher R. Lattanzi

Discounted cash flow analysis provides a means of relating the magnitude of expected future cash profits to the magnitude of the initial cash investment required to purchase an asset or to develop it for commercial production. The objectives of discounted cash flow analysis are to determine: 1) The net present value of a stream of expected future cash revenues and expenditures; 2) The rate of return which the expected future cash flows will yield on a given level of initial cash investment.In the case of mineral properties, discounted cash flow analysis is generally accepted as the preferred method of valuation, whenever sufficient data are available to permit its reasoned application. Sufficient data are required to support estimation of all of the individual elements of cash revenue and cash expenditure which will be associated with the development and operation of the property, up to the end of its estimated life. It is the accuracy of these input estimates which determines the validity of the resulting determinations of profitability and rate of return on invested capital.In undertaking any discounted cash flow analysis, it is important to recognize certain fundamental attributes of the mining industry: 1) The basis of any mineral development is the existence of an ore reserve; 2) Costs are determined by the number of tonnes mined and processed, while revenues are determined by the number of pounds or ounces of metal produced. The two are related by the recovered grade of the ore; 3) Profit is typically more sensitive to changes in revenue than it is to changes in cost; 4) Commodity price is a principal determinant of revenue, but it is also the factor with which is associated the greatest level of financial risk.In the end, of all of the factors which must be considered in the discounted cash flow valuation of a mineral property, the most significant are the reliability of the reserve estimate, particularly with respect to recovered grade, the price at which the product is to be sold, and the risk of not maintaining the projected level of price.
Keywords: discounted cash flow analysis, cash flow valuation, mineral property, reserve estimate