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UBC Theses and Dissertations

Canadian evaluation of a Mexican mining venture and the next investment step Bach, Geoffrey D., 1980

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A CANADIAN EVALUATION OF A MEXICAN MINING VENTURE AND THE NEXT INVESTMENT STEP by GEOFFREY D. BACH Chartered Accountant A THESIS SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF BUSINESS ADMINISTRATION m THE FACULTY OF GRADUATE STUDIES (Faculty of Commerce and Business Administration) We accept t h i s thesis as conforming to the required standard THE UNIVERSITY OF BRITISH COLUMBIA May 1980 (c) Geoffrey D. Bach, 1980 In presenting this thesis in partial fulfi lment of the requirements for an advanced degree at the University of Br it ish Columbia, I agree that the Library shall make i t freely available for reference and study. I further agree that permission for extensive copying of this thesis-for scholarly purposes may be granted by the Head of my Department or by his representatives. It is understood that copying or publication of this thesis for financial gain shall not be allowed without my written permission. GEOFFREY DAVID BENHAM BACH Faculty of Commerce and Business Administration The University of Br it ish Columbia 2075 Wesbrook Place Vancouver, Canada V6T 1W5 Date 25 March 1980 ABSTRACT This study evaluates a minority i n t e r e s t i n a s i l v e r orebody i n Zacatecas, Mexico, leading to a decision i n mid 1979 by a Canadian mining company, whether to s e l l , hold or develop the orebody into a s i l v e r mine on a j o i n t venture basis. The framework employed i n the evaluation emphasizes the importance to mining companies of exploration to i d e n t i f y mineral orebodies, and s t r i v e s to assess the Canadian miners' view of the p o l i t i c a l and economic circumstances i n Mexico as they may a f f e c t a long-term mine investment i n that country by a Canadian corporation. Alternative methods of evaluating an orebody are esta-blished and reviewed i n conjunction with the selection of what has value to whom, and what influences the value. Success of the Canadian mining investment i n Mexico depends on the relationships between the three j o i n t venture partners i n addition to the existence of an i d e n t i f i e d orebody ready for development. Before measure-ment of the value of the minority i n t e r e s t i n the orebody i s attempted, an examination i s made of the needs of partners, the selection of partners and the relationships between the partners to the j o i n t venture. Measurement of the value of the minority i n t e r e s t i s based on a f e a s i b i l i t y study prepared i n 1975 and up-dated by the writer to early 1979 conditions. Production data, revenue forecasts and mine costs of construction and subsequent I l l operations are presented and analysed to provide an over-view of the f i n a n c i a l aspects of the potential mine. Valuation of the minority inte r e s t i n the orebody i s achieved after determining mine cash flow forecasts, net earnings forecasts and forecast s o c i a l benefits and costs to Mexico. The conclusions of the study are that the Canadian's investment has a value i n the range US $3 100 000 to US $3 900 000 and that the orebody w i l l continue to be held u n t i l circumstances allow improved returns to the owners of the orebody. i v TABLE OF CONTENTS PAGE NUMBER ABSTRACT i i LIST OF TABLES v i i i CHAPTER INTRODUCTION 1. 1 Introduction 1 1. 2 The purpose of the study 2 1. 3 Limitations of the study 4 1. 4 Organization of the study 5 1. 5 Background of Placer Development Limited 9 1. 6 Placer's f i n a n c i a l p o sition 11 1. 7 Placer's propensity toward r i s k 14 1. 8 Placer's strengths and weaknesses 16 1. 9 Objectives of Placer 18 CHAPTER TWO EXPLORATION 2.1 Objective of exploration 21 2.2 Cost of exploration 22 2.3 Resource p o l i c y 28 2.4 Process of exploration 31 2.5 Path to a decision on the location of exploration e f f o r t 33 2.6 Exploration target nations for Placer 35 CHAPTER THREE A MINING VIEW OF MEXICO 3.1 An introduction to Mexico 4 3 3.2 Minerals 46 3.3 Mexican p o l i t i c s 47 3.4 Mexican economics 50 3.5 Government attitudes toward mining 5 3 3.6 Why invest i n Mexico? 54 CHAPTER FOUR TAXES 4.1 The tax comparison 58 4.2 Canadian taxes on mining business 59 4.3 Canada's federal income tax 60 4.4 B r i t i s h Columbia's taxes on income 61 4.5 Other taxes i n Canada 63 4.6 Mexican taxes on mining business 64 4.7 Mexico's production taxes 65 4.8 Mexico's taxes on income 67 4.9 Other taxes i n Mexico 68 V CHAPTER FIVE PAGE VALUATION METHODS FOR A POTENTIAL MINE NUMBER 5.1 What to value 72 5.2 Valuation methods 75 5.3 Investment and financing decisions 78 5.4 Cost of c a p i t a l 83 5.5 Risk 88 5.6 The cash flow method 92 5.7 The asset appraisal method 96 5.8 The earnings c a p i t a l i z a t i o n method 97 5.9 The s o c i a l cost/benefit method 101 5.10 Valuation method: a preference 105 CHAPTER SIX PARTNERS AND THE POTENTIAL MINE; IN MEXICO 6.1 The partners 111 6.2 Ownership i n the potential mine 116 6.3 Partnership p o l i c i e s 117 6.4 Negotiations 119 6.5 The poten t i a l mine i n Mexico 12 3 6.6 Metal revenue forecasts 128 6.7 Mine costs 137 6.8 F e a s i b i l i t y study 142 CHAPTER SEVEN PROJECT ECONOMIC RESULTS AND VALUATION 7.1 Cash flow forecasts 146 7.2 Earnings forecasts 150 7.3 A l l o c a t i o n of mine generated cash 152 7.4 S e n s i t i v i t i e s 159 7.5 Social benefits and costs 161 7.6 Valuation of the potential mine 174 7.7 Valuation of Placer's i n t e r e s t i n the mine 190 7.8 Placer's next step i n Mexico 197 CHAPTER EIGHT SUMMARY AND CONCLUSIONS 8.1 Summary 199 8.2 Conclusions 201 8.3 Concluding comments 202 BIBLIOGRAPHY 203 LIST OF APPENDICES v i VI APPENDICES APPENDIX PAGE NUMBER NUMBER 1 Placer Development Limited - Assumptions made i n pro forma Balance Sheets as at 31 December 1980 208 2 Metric symbols and imperial equivalents 210 3 Mexican Mining Company S.A. de C.V. -Investment decision case cash flow r e s u l t s 211 4 Mexican Mining Company S.A. de C.V. -Financing decision case cash flow re s u l t s 212 5 Mexican Mining Company S.A. de C.V. -Investment decision base case cash flow r e s u l t s and s e n s i t i v i t i e s 214 6 Mexican Mining Company S.A. de C.V. -Financing decision base case cash flow results and s e n s i t i v i t i e s 215 7 Placer Development Limited - Investment decision case cash flow re s u l t s to shareholder i n Mexican project 217 8 Placer Development Limited - Financing decision case cash flow r e s u l t s to shareholder i n Mexican project 218 9 Placer Development Limited - Investment decision base case cash flow re s u l t s to shareholder i n Mexican project and s e n s i t i v i t i e s 220 10 Placer Development Limited - Financing decision base case cash flow re s u l t s to shareholder i n Mexican project and s e n s i t i v i t i e s 221 11 Mexican Mining Company S.A. de C.V. -Investment decision cases: p r o b a b i l i t y of occurrence 223 12 Mexican Mining Company.S.A. de C.V. -Financing decision cases: p r o b a b i l i t y of occurrence 224 APPENDIX NUMBER 13 Mexican Mining Company S.A. de C.V. -Project cash flow: equity base case for investment decision 14 Mexican Mining Company S.A. de C.V. -Project cash flow: loan base case for financing decision 15 Placer Development Limited - Canadian cash flow: equity base case for investment decision 16 Placer Development Limited - Canadian cash flow: loan base case for financing decision 17 Social benefits and costs - Foreign currency inflow and outflow 18 Hurdle Rate v i i l LIST OF TABLES TABLE PAGE NUMBER NUMBER I Geographical d i s t r i b u t i o n of ownership in Placer 9 II Mines operated by Placer - past and present 1 0 III Placer Development Limited Extracts from consolidated balance sheet - 31 December 1978 Pro-forma balance sheets - 31 December 1980 1 2 IV Placer Development Limited - li n e s of business information 13 V Net cost to a B r i t i s h Columbian" company of $100 of exploration expenditure i n B r i t i s h Columbia 24 VI Net cost to a Canadian company of $100 of exploration expenditure i n Mexico through i t s wholly-owned Mexican 26 corporation VII Canadian federal and B r i t i s h Columbian e f f e c t i v e tax rates on mining income (current/deferred tax expense combined) 63 VIII Placer Development Limited - Cost of c a p i t a l calculated as at 31 December 1980 85 IX Pu b l i c l y owned production and service industries i n Mexico and Canada 115 X Mexican Mining Company S.A. de C.V. - Ore Reserves 124 XI Mexican Mining Company S.A. de C.V. - Mining and M i l l i n g Rates 125 XII Mexican Mining Company S.A. de C.V. - Concentrate Output 127 XIII Mexican Mining Company S.A. de C.V. - Metal Production i n Concentrates 128 ix TABLE NUMBER XIV Mexican Mining Company S.A. de C.V. - Forecast Product Prices and Terms of Sale XV Mexican Mining Company S.A. de C.V. - Mine Costs XVI Mexican Mining Company S.A. de C.V. - Capital Construction Expenditures XVII Mexican Mining Company S.A. de C.V. - Postproduction Capital Expenditures XVIII Mexican Mining Company S.A. de C.V. - Operating Costs XIX Mexican Mining Company S.A. de C.V. - Results of selected cash flows -the project XX Placer Development Limited - Results of selected cash flows - shareholder i n Mexican project XXI Mexican Mining Company S.A. de C.V. - Forecast earnings statement -production years 1 to 5 XXII Mexican Mining Company S.A. de C.V. - Forecast a l l o c a t i o n of mine generated cash - loan base case XXIII Mexican Mining Company S.A. de C.V. - E f f e c t i v e tax rates over the mine l i f e - loan base case XXIV Social benefits and costs - Tax revenue XXV Social benefits and costs - Foreign currency inflow and outflow XXVI Social benefits and costs - Infrastructure XXVII Social benefits and costs - Summary XXVIII S i l v e r - h i s t o r i c prices XXIX Mexican Mining Company S.A. de C.V. - Orebody valuations based on m u l t i p l i e r of net earnings PAGE NUMBER 133 138 139. 140 141 147 149 151 153 157 164 166 169 173 181 185 X ACKNOWLEDGMENT The writer wishes to express his appreciation to the manage-ment of Placer Development Limited, Vancouver, for the i r w i l l i n g -ness to provide data concerning t h e i r i n t e r e s t i n g mining prospect i n the State of Zacatecas, Mexico. Thanks are due to Bernice Larade of Placer who kindly adapted an ex i s t i n g computer programme to s u i t Mexican tax laws as understood by the author and then input given data to provide the project's forecast cash flows. In addition, the considerable typing e f f o r t of Roberta Mah i s appreciated. CHAPTER ONE INTRODUCTION Introduction It's a ri s k y business. A lab e l given to the mining industry by mining executives i n a frustrated e f f o r t to describe complex exploration and mining problems, degrees of r i s k , luck and the vagaries of the metal markets. Experienced mining executives assess the magnitude of r i s k i n t u i t i v e l y i n many instances as under competi-t i v e circumstances and, frequently, time pressures they make substantial commitments out of limited exploration budgets. Many have become enthused over an in t e r e s t i n g mining prospect only to be disappointed as information about the anomaly i s pieced together to form a d i s -couraging picture.. The often repeated process of pros-pect evaluation beginning with the s i t e examination and acq u i s i t i o n of mining r i g h t s , through to the c o l l e c t i o n and review of data, and the i n i t i a l ore reserve calcu-l a t i o n s , provides the industry's leaders with a broad understanding of the economics and competitive nature of the industry over an extended period of time. There are no s t a t i s t i c s to substantiate the statement that for every one thousand prospects examined, just one prospect matures to an operating m i n e ; h o w e v e r , few in the industry w i l l dispute i t i s a small l i k e l i h o o d . 2 This paper assumes considerable progress has been made along the path to the conviction that an economic-a l l y viable orebody exists i n the state of Zacatecas, Mexico. A detailed and comprehensive study of the geological area of inte r e s t and an optimized feasible outcome from the operation of a mine at the s i t e has been made. Much information i s available to the potential investors but s t i l l questions of the utmost importance concerning the value of the property have to be answered. Is more information needed to reduce the r i s k of using poor data upon which to base an assessment of the value of the property? Is i t worthwhile spending more to r e t a i n the mining rights pending the a r r i v a l of improved industry conditions? Is s u f f i c i e n t r e l i a b l e information available to confirm that under the base case set of circumstances forecast i n the f e a s i b i l i t y study, an economically a t t r a c t i v e mining investment exists? What eff e c t s w i l l an investment i n the potential mine have on the i n d i v i d u a l investor's present and future business? 1.2 The purpose of the study Two s i g n i f i c a n t questions the paper w i l l proceed to answer concern Placer Development Limited as a Canadian 3 investor i n a proposed Mexican S i l v e r mine and are: What i s the value of Placer Development Limited's minority i n t e r e s t i n Mexican Mining Company S.A. de C.V. which holds the Zacatecas property, and should Placer invest additional funds and other resources i n Mexico to b u i l d and operate the proposed s i l v e r mine? Answers to these questions can be given i n a few words; so-many-dollars and either yes or no. However, the process of valuation and decision making can be a long and arduous one, p a r t i c u l a r l y i f a reasoned analysis i s undertaken. Both answers are affected by the purpose for asking and the circumstances surrounding and preceding the questions in the f i r s t place. A valuation and commitment decision required i n haste i n order to minimize a loss w i l l lead to one value and possibly a d i f f e r e n t decision on investment when com-pared with answers arrived at i n a more relaxed atmos-phere. In t h i s instance, the questions are posed by the owner of an i n t e r e s t i n mineral r i g h t s . A minority in t e r e s t complicated by the fact that i t i s a foreign asset held j o i n t l y with a foreign government agency and a foreign business i n the private sector. This paper assumes there are no special forces influencing the questions and answers other than 1979 mining industry general variables, such as forecast metal supply and demand, and a completed f e a s i b i l i t y study on the 4 Zacatecas property. 1.3 Limitations of the study At the best of times and after many man-years of e f f o r t , information concerning an orebody i s incom-plete and not e n t i r e l y accurate. This study has taken as i t s basic data costs determined i n a 1975 f e a s i b i l i t y study which themselves were dependent on metal market forecasts made at that time. The p a r t i c u l a r combination of metal prices, construction costs, operating costs and taxation p r e v a i l i n g i n 1975 and forecast for the future determined the then optimal mine production capacity. The mine capacity.and i t s costs established at that time have been used i n t h i s study to estimate produc-ti o n volumes, revenues and costs to forecast cash flows of both the Mexican corporate vehicle and the.Canadian investor. The four year intervening period to 1979 has brought considerable change to Mexico having an impor-tant e f f e c t on the estimate of costs, among other factors. The most s i g n i f i c a n t change may be the de-c l i n e i n value of the Mexican Peso which began i n 1976. A revised comprehensive cost estimation for the mine's construction and operation has not been made. The writer made enquiries of Placer employees most, fam i l i a r with p r e v a i l i n g Mexican conditions and re-ferred extensively to l i t e r a t u r e providing information on the current business environment i n that country to 5 a r r i v e at up-to-date estimated costs. The economic findings of t h i s study, p a r t i c u l a r l y the rates of return on investment, are subject to the l i m i t a t i o n s described above but the decision whether to go ahead with the project i s not expected to be affected. 1.4 Organization of the study Later i n t h i s chapter, a b r i e f history of Placer Development Limited i s given. Placer i s a Canadian mining company and i t i s evaluating a mine prospect i n Mexico from which i t i s hoped to achieve long-term benefits. The f i n a n c i a l p o sition of Placer i s reviewed, followed by an assessment of the company's propensity toward r i s k and a discussion on the corporate objectives of Placer. Chapter Two concerns exploration for minerals be-ginning with the objectives and cost and explains the need for constant exploration e f f o r t and the r i s k of loss attached to spending exploration funds. A b r i e f examination of governmental mineral resource policy provides an i n d i c a t i o n of the environment within which mining companies work. An outline of the exploration process through several stages i s given and t h i s i s followed by an eleven nation review of the reasons leading to decisions concerning the location of Placer's exploration e f f o r t . Chapter Three discusses a mining view of Mexico. 6 B r i e f reference i s made to Mexican s o c i o l o g i c a l , econo-mic and p o l i t i c a l problems exacerbated by stupendous population growth and the unequal d i s t r i b u t i o n of income. Any investor playing an active role i n Mexico has to come to terms with the customs and character of the people. Fundamentally, i t ' s a matter of choosing ones friends and s t i c k i n g with them; the working of the hi e r a r c h i c a l system must be understood by any Canadian investor i n Mexico. A short description of the mineral industry i s followed by a necessarily limited review of the p o l i t i c a l climate which deals with the need for good business advice from l o c a l nationals,.economic national-ism and mineral r i g h t s . Chapter Three also includes comments on the impact on the mining industry of poten-t i a l , o i l revenues for Mexico, a short discussion on the country's bout of i n f l a t i o n i n the l a t e 1970's and the nation's foreign exchange p o l i c i e s . Lastly, the chapter of f e r s a governmental perspective of the mining industry and suggests that the industry i s welcome to operate p r o f i t a b l y within the country but under government dictated conditions. Chapter Four o f f e r s a b r i e f insight to Canadian and Mexican taxes applicable to the value of mine production i n B r i t i s h Columbia and Mexico. The tax bite from the value of production i s an overt signal to the mining industry on the degree of acceptance i n a country. A Canadian mining company w i l l assess the welcome by Mexico to a large extent on the e f f e c t i v e rate of tax applied to earnings i n Mexico that can be repatriated compared with af t e r tax earnings from a Canadian mine. Chapter Five begins with a discussion on what needs to be valued when examining a potential mine as value i s affected by the interested parties and the reasons for seeking a valuation. The valuation of the Zacatecas mineralized property i s being made to establish whether a mine should be b u i l t and operated, or what i s being c a l l e d the investment decision. The commitment of re-sources to a project follows an investment decision and the importance of the separation of the investment de-c i s i o n from the decision concerning how best to finance the project i s stressed. Two matters necessarily i n -volved i n any c a r e f u l l y considered valuation procedure are the cost of c a p i t a l and r i s k . The c a l c u l a t i o n of the cost of c a p i t a l of Placer Development Limited i s used by example to describe how the cost i s established for subsequent use i n the discounting of forecast cash flows. Risk i s assessed by the valuator i n any valua-t i o n of a potential mine. Some r i s k s are mentioned s p e c i f i c a l l y but the subjective nature of the o v e r a l l impact of r i s k on the valuation does not allow precise costs of r i s k to be determined owing to the often con-tested assumptions used. However, two of the four methods of valuation discussed o f f e r mechanisms which seek to allow for r i s k . The cash flow method and 8 earnings c a p i t a l i z a t i o n method use a discount rate and earnings m u l t i p l i e r respectively. Reference i s made to four valuation methods: the two that have already been mentioned together with the asset appraisal method and the s o c i a l cost/benefit method. Each i s reviewed and a preference for the cash flow method of valuing a potential mine i s stated. Chapter Six describes the formation of the partner-ship, the need for a common purpose and the attributes of the Mexican partner sought by Placer. Some problems experienced with the partnership i n 1976 are alluded to and the new partnership momentum i n 1979 i s mentioned. The form of ownership i n the mineralized property i s dealt with, followed by a discussion on partnership p o l i c i e s and the various rounds of negotiations re-quired to i n i t i a t e the partnership and carry the project through to successful operations and re p a t r i a t i o n of funds. Chapter Seven discusses selected cash flow r e s u l t s and provides pro forma earnings statements of Mexican Mining Company S.A. de C.V. using the loan base cash flows. Calculations of s o c i a l costs and benefits are included followed by comments on economic results of the project. Chapter Seven ends with valuations of the potential mine and Placer's i n t e r e s t i n Mexican Mining Company S.A. de C.V. 9 Chapter Eight summarizes the r e s u l t s of the study and draws conclusions on the value of the i n t e r e s t i n the orebody. 1.5 Background of Placer Development Limited Placer Development Limited i s incorporated i n B r i t i s h Columbia and registered on the American, Toronto, Montreal, Vancouver and Sydney stock exchanges. The company had 5088 shareholders at 31 December 1978, d i s -tributed per Table I, owning 12,104,000 issued shares. TABLE I Geographical D i s t r i b u t i o n of Ownership i n Placer Canada 78.6% Australasia 12.0% USA and other 9.4% 100.0% Source: Placer Annual Report 1978, page 30. The company, i t s subsidiaries and managed associates (2) employed 2389 persons at 31 December 1978 m nine countries but predominantly i n Canada, the Philippines and A u s t r a l i a . The majority of the company's income has to date been derived from mining. Placer i s Canada's largest producer of molybdic oxide (contains molybden-um) and major producers of copper concentrate are within the group. In addition, the Placer group pro-duces coal, mercury, gold, s i l v e r and magnetite. The 10 company also has interests i n the Canadian o i l and gas production industry and the Australian pastoral and manufacturing industries. Placer began i n 1926 with an exploration programme that concentrated on B r i t i s h Columbia, the USA (mostly Alaska) and Colombia. In 1928 and i n the few years thereafter, mines at Bulolo, New Guinea and Clutha, 13) A u s t r a l i a started the r e a l growth of the company so that by 1979, eighteen mines had been operated, eight of which are s t i l l l i v e today (Table I I ) . TABLE II Mines Operated by Placer - Past and Present Important Products  Mine Country Primary Secondary Operating 1. Endako Canada Molybdenum 2. Gibraltar Canada Copper Molybdenum 3. Craigmont Canada Copper Iron 4 . Equity (in 1980) Canada S i l v e r Copper,Gold 5. Marcopper Philippines Copper Silver,Gold 6. Cortez (mothballed) USA Gold 7. McDermitt USA Mercury 8. Placer Coal USA Coal Closed 9. Canex Canada Tungsten,.Lead Zinc 10. Bulolo New Guinea Gold 11. Pato Consolidated Colombia Gold 12. Nechi Consolidated Colombia Gold 13. Asnazu Colombia Gold 14. Iron Age USA Iron 15. Evans Jones USA Coal 16. Clutha A u s t r a l i a Coal 17. Rutherglen A u s t r a l i a Gold 18. Mitel Portugal Lead,Zinc S i l v 11 1.6 P l a c e r ' s f i n a n c i a l p o s i t i o n The c o n s o l i d a t e d Balance Sheet of P l a c e r a t 31 December 1978 (Table III) shows t o t a l a s s e t s of $377,300,000 are h e l d but a thorough understanding of the company r e v e a l s t h a t three of the e i g h t o p e r a t i n g mines' (Table II) a s s e t s are onl y p a r t i a l l y i n c l u d e d i n t h a t t o t a l . The three are not owned 100% by P l a c e r and two do not f a l l under the heading of c o n s o l i d a t e d s u b s i d i a r i e s . One o f the th r e e i s a j o i n t venture and only 51% of i t s a s s e t s are i n c l u d e d i n the t o t a l ; the othe r two are accounted f o r under the heading of "Investments and oth e r a s s e t s " as one l i n e c o n s o l i d a -t i o n s u s i n g the e q u i t y method of ac c o u n t i n g . A f t e r adjustment f o r the v a r i o u s accounting methods employed, i t i s found t h a t P l a c e r a d m i n i s t e r s almost $500 m i l l i o n worth of a s s e t s expressed i n h i s t o r i c value d o l l a r s i n v e s t e d over s e v e r a l y e a r s . S i m i l a r adjustments t o s a l e s i n 1978 i n c r e a s e d the c o n s o l i d a t e d s a l e s r e p o r t e d of $170,300,000 (Table IV) to $270 m i l l i o n . The company has r e c e n t l y committed i t s e l f to the c o n s t r u c t i o n o f a new c o p p e r / s i l v e r mine i n c e n t r a l B r i t i s h Columbia due f o r completion i n the summer o f 1980. Table I I I shows how the new mine c o s t w i l l a f f e c t the Balance Sheet of P l a c e r between 1 January 1979 and 31 December 1980. Based on assumptions l i s t e d i n Appendix 1, three s t a t i s t i c s deserve a t t e n t i o n . TABLE III PLACER DEVELOPMENT LIMITED (Millions Canadian Dollars) Extracts from Consolidated Balance Sheet Pro-Forma Balance Sheets 31 December 1978 31 December 1980 Including Equity Including Equity Sil v e r Mines Limited S i l v e r Mines and Mexican Mining Limited Co. S.A. de C.V. Current assets: Cash,deposits and marketable s e c u r i t i e s $ 56 .6 $ 93. 3 $ 81. 8 Receivables 35 .0 44. 0 44. 0 Inventories 33 .3 42. 3 42. 3 124 .9 179. 6 168. 1 Investments and other assets 73 .0 121. 8 133. 3 Property, plant and equipment: Buildings and equipment 82 .1 132. 6 132. 6 Properties and development 97 .3 130. 3 130. 3 179 .4 262. 9 262. 9 $37 7 .3 $564. 3 $564. 3 Current l i a b i l i t i e s : Accounts payable 52 .9 57. 9 57. 9 Long-term debt due within one year 11 .0 24. 7 24 . 7 63 .9 82. 6 82. 6 Long-term debt 46 .9 94. 8 94. 8 Deferred income and resource taxes 16 .9 18. 9 18. 9 Minority interests i n subsidiaries 17 .7 22. 7 22. 7 Shareholders' equity: Capital and contributed surplus 18 .3 18. 3 18. 3 Earnings reinvested i n the business 213 .6 327. 0 327 . 0 231 .9 345. 3 345. 3 $377 .3 $564. 3 $564. 3 S t a t i s t i c s Working c a p i t a l $ 61 .0 $ 97. 0 $ 85. 5 Working c a p i t a l r a t i o 2.0 :1 2.2: 1 2.0: 1 Debt/Equity r a t i o 1:4 .0 1:2. 9 1:2. 9 Assumptions are l i s t e d i n Appendix 1 13 TABLE IV PLACER DEVELOPMENT LIMITED Lines of Business Information (Millions Canadian Dollars) Industry Segments -Sales: Mining O i l and gas Manufacturing Other industries Operating Earnings:* Mining O i l and gas Manufacturing Other industries Total operating earnings General corporate expenses Interest and exchange loss Exploration expense Interest and other income Earnings before taxes and other items Geographic Area -Sales: Canadian operations Foreign operations Operating Earnings:* Canadian operations Foreign operations $ 48.7 Years ended December 31 1978 1977 $112.8 $119. 8 17.7 14. 4 27.6 33. 0 12.2 9. 9 $170.3 $177. 1 $ 37.5 $ 33. 6 8.9 6. 9 1.4 2. 3 0.9 0. 3 48.7 43. 1 (3.9) (4. 3) (7.9) (5. 8) (12.1) (9. 9) 8.8 7. 7 $ 33.6 $ 30. 8 $122.1 $132. 2 48.2 44. 9 $170.3 $177. 1 $ 46.4 $ 39. 8 2.3 3. 3 $ 43.1 *Represents sales less cost of sales, depreciation, depletion and allocated general and administrative expenses. Source: Placer Annual Report 1978, page 27. 14 The f i r s t i s that cash i s forecast to increase from $56,600,000 to $93,300,000. The second i s that the working c a p i t a l r a t i o i s steady i n the region of 2 to 1 and the t h i r d s t a t i s t i c i s that, even immediate-l y a f t e r building a new mine at a construction cost of $80 m i l l i o n , the debt to equity r a t i o f a l l s to only 1:2.9. Clearly, the company has the f i n a n c i a l strength to undertake a mine construction programme i n Mexico i n association with two f i n a n c i a l l y p a r t i c i p a t i n g Mexican e n t i t i e s concurrently with i t s commitment to bui l d the Equity Mine. The pro-forma consolidated Balance Sheet at 31 December 1980 including both the Equity and Mexican proposed mine (Table III) confirms that view. 1.7 Placer's propensity toward r i s k Placer's history has demonstrated the company's willingness to change i t s business as p r e v a i l i n g conditions appear to di c t a t e . Examination of mine openings by Placer show how the company plunged into New Guinea's i n t e r i o r to produce gold from a large dredging operation. The r i s k s involved i n New Guinea were substantial as there was no infr a s t r u c t u r e , not even a road near the property, and the i s o l a t i o n i n -tense. The company was a pioneer i n the use of a i r -c r a f t i n the mining industry when i n the early 1930's i t transported mine equipment to the construction s i t e at Bulolo. The company's in t e r e s t i n gold production directed i t s resources to Colombia and A u s t r a l i a soon aft e r Bulolo. Both entries were bold steps i n the depression of the 1930's and the reward was commensurate with the r i s k s accepted. For example, i n 1935 Placer's net (5) earnings rose f i f t e e n - f o l d to $1.5 m i l l i o n . The second world war years presented special problems to the company as the Bulolo operation was l o s t to the Japanese. Also, the passage of time and the fixed value for an ounce of gold was rendering many gold mines uneconomic. Placer recognized the time for a change of emphasis and redirected i t s e f f o r t to o i l and gas pro-duction i n Texas, tungsten mining i n B r i t i s h Columbia and coal mining i n Alaska. These ventures, p a r t i c u l a r l y the tungsten mine, represented large f i n a n c i a l r i s k s for the company mainly through s i z e . Just as important was the metalurgical problem at the Canex tungsten property which was known to e x i s t at the time the f i n a n c i a l commitment was made. The survival of the company was threatened but dedicated e f f o r t won the day and Placer operated the mine which provided the base for the post war rebuilding of i t s mining expertise and f i n a n c i a l strength. Todays decision makers i n the company were clo s e l y involved with the Canex operation. In the late 1960's and early 1970's substantial r i s k s were taken; f i r s t l y i n the decision to produce 16 molybdenum i n such large quantities at Endako, second-l y to enter the Philippines i n a high volume low grade copper operation u t i l i z i n g new technology i n the capacity of available equipment and, t h i r d l y , to b u i l d the Gibraltar mine with i t s very low copper content i n ore. Since 1926, the company has b u i l t mines, not acquired them. It i s true today that the policy i s to b u i l d mines and r e s i s t the takeover of e x i s t i n g mining operations. An exception occurred i n early 1978 and by December 1978 the f i n a n c i a l b u l l e t was b i t t e n . Losses were incurred by Placer Coal and an extraordinary item was written o f f representing close to half the i n i t i a l investment. The outcome of the p o l i c y i s the strength of i t s Balance Sheet but small size when compared to a company such as i t s major shareholder, Noranda, which began i t s l i f e i n the same era as Placer. Given that a proposed investment concerns d i r e c t involvement i n the construction of a mine, Placer displays a strong propensity toward r i s k . 1.8 Placer's strengths and weaknesses The discussion on Placer's strengths and weak-nesses i s r e s t r i c t e d to those of i n t e r e s t to i t s business partners i n Mexico as they have a bearing on the Mexican government 1s attitude toward the company i n i t s project negotiations. 17 ; P l a c e r . 1 s.' .mo.sfe. important. /• strength, i s l i k e l y to ..be, the company's proven a b i l i t y to b u i l d and operate successful mines on time, within budget and t e c h n i c a l l y up-to-date. The company's willingness to operate outside Canada es p e c i a l l y i n previous decades i s well known and a good reputation has been maintained with foreign governments i n a l l i t s dealings. Mining expertise i s available within the company although many of those associated with the late 1960's and early 1970's construction a c t i v i t y are approaching retirement age. The six year dry s p e l l of construction a c t i v i t y , McDermitt Mine excepted, when mining world-wide went through a down cycle after the 1974 boom has probably done no more harm to Placer than to i t s competitors. Perhaps the experience gained by the company and i t s personnel as they design and b u i l d the Equity mine w i l l be fresh i n the minds of those assigned to Mexico i n 1980 following a go-ahead decision. The f i n a n c i a l s t a b i l i t y of the company described e a r l i e r i s important to i t s partners.. S t a b i l i t y , together with r e l i a b i l i t y i n cost of mine performance, allows managements of the partners to make decisions with confidence i n data provided by the f e a s i b i l i t y study. They w i l l . a l s o f e e l that the cost of the proposed Mexican mine at $80 m i l l i o n i s of s u f f i c i e n t size to ensure that Placer w i l l take no chances i n jeopardizing i t s e f f i c i e n t construction and operation. 18 An intangible strength l i e s i n the fact that Placer i s a r e l a t i v e l y small Canadian and not a large American multinational. Mexico i s anxious to d i v e r s i f y i t s foreign investment sources to reduce the dominant posi-t i o n of the United States i n that f i e l d . Weaknesses are not believed to be important at t h i s stage but could become so i n the event three mines are b u i l t by Placer at approximately the same time. The company has already acquired a known molybdenum orebody i n northern B r i t i s h Columbia. The market for molybdenum i s very strong and the company w i l l be tempted to go-ahead with that project at an early date i n the event i t i s economically f e a s i b l e . The company has the option to use consultants i n i t s design and construction and given i t s preference to do the work i t s e l f , the Mexicans w i l l watch the s i t u a t i o n care-f u l l y . 1.9 Objectives of Placer Survival i s most l i k e l y the key objective of the company. As a mining company, the continued existence of economic operations depends on obtaining new ore-bodies to replace those phased out through exhaustion of reserves. Any company has the option open to d i v e r s i f y i t s e f f o r t s by entering new f i e l d s and, indeed, Placer has gone that route as recently as 1977 when i t acquired a p u b l i c l y traded Calgary o i l company 19 for approximately $50 m i l l i o n . However, for purposes of t h i s paper, only those objectives t i e d to mining are important. The need to explore i s fundamental to the industry as a whole but i n d i v i d u a l mining companies can avoid actual exploration by acquiring proven ore-bodies d i r e c t l y or v i a a c q u i s i t i o n of owners of the orebodies. The investment decision process and the valuation of the company's in t e r e s t i n the Zacatecas property assumes that Placer's objective i s wealth maximization. If the objective were to be simply su r v i v a l then p r o f i t would not be required except to finance the e f f e c t s of i n f l a t i o n and to allow for the p o s s i b i l i t y of new mines coming on stream at costs greater than the one being phased out. 20 CHAPTER ONE  REFERENCES 1. L. Adie of Placer Development Limited, Western Construction and Industry, December 1977 2. Placer Development Limited Annual Report 19 78, page 30 3. " F i f t y years ahead" Western Miner, August 1976, page 20 4. IBID, Page 21 5. IBID, Page 21 21 CHAPTER TWO  EXPLORATION 2 .1 Objective of exploration Exploration i s the name of an a c t i v i t y directed toward the i d e n t i f i c a t i o n of an economically feasible orebody which has not previously been recognized. Exploration by the mineral industry involves a great deal of time, money and e f f o r t and every l e v e l of a c t i v i t y i s important to the process. The one man prospector can contribute valuable information i n general just as the major participants can provide im-portant voluminous data on a s p e c i f i c property. The objective of exploration i s the replenishment of the stock of economically fea s i b l e orebodies s u f f i c i e n t to allow a l e v e l of mineral production which s a t i s f i e s p r e v a i l i n g and forecast demand. At the corporate l e v e l , exploration i s more cl o s e l y concerned with acquiring the mineral ownership r i g h t s . It i s obvious that simply i d e n t i f y i n g an economically feasible orebody does not necessarily lead to recovery of exploration costs. The fear of imminent loss of non-renewable resources has been upon us for years. For example, the English economist Stanley Jevons, warned of the approaching exhaustion of coal i n 1 8 6 0 . ^ In the 1 9 7 0 ' s , the Club of Rome's publication "Limits to Growth" continues to have a profound impact on public p o l i c y . However, as Professor Adelman of MIT observed "....the fear of 22 imminent raw material exhaustion has for i t s basis a (2) complete disregard of theory, s t a t i s t i c s and hi s t o r y " . The world i s i n the Best shape ever i n terms of known re-serves, which have been growing faster than consumption and s u f f i c i e n t for hundreds of years for such products as i r o n , n i c k e l , aluminum, manganese and potash. It i s important to remember that many minerals are not con-sumed, but merely transformed, and can be endlessly i , (3) recycled. 2.2 Costs of exploration There i s seemingly an unlimited number of factors bearing on the cost of exploration but perhaps they can best be categorized as those r e l a t i n g to: the location of the exploration a c t i v i t y , and the type of material being examined or sought. The cost of exploration i n a r c t i c regions with s p e c i a l expenses a t t r i b u t a b l e to remoteness and cold conditions i s easy to recognize as r e l a t i v e l y high. The s i t u a t i o n of the explorer's head o f f i c e or exploration base versus the exploration s i t e i s another important factor. An exploration force operating from Vancouver is-most l i k e l y to perform more work per exploration d o l l a r expended i n southern B r i t i s h Columbia than can be done i n Southern Peru for a l i k e amount. These factors are quite obvious but the f i n a n c i a l constraints usually re-quire research, i f unnecessary costs are to be avoided. 23 Such costs are varied but the s i g n i f i c a n t factor i s generally taxation. Every j u r i s d i c t i o n o f f e r s i t s own slant on tax law, taxable income and deductible expenses i n a r r i v i n g at i t s own impact on the results of explora-t i o n . The sheer size of the world-wide tax policy sub-je c t , even when i t i s narrowed to the treatment of exploration expenditure, dictates that just two j u r i s -d i c t i ons be discussed here and then only b r i e f l y ; namely, Canada with emphasis on B r i t i s h Columbia and Mexico. Exploration expenditure on B r i t i s h Columbian mineral properties i s treated favourably i n tax law providing the e n t i t y incurring these costs has other taxable i n -come from which to deduct the expenditure. Table V shows that exploration e f f o r t i n B r i t i s h Columbia costs twelve cents on the d o l l a r after taxes with the proviso already mentioned. Similar calculations for a B r i t i s h Columbian company exploring elsewhere i n Canada deter-mine that exploration costs thirty-two cents on the do l l a r and a f u l l d o l l a r a f t e r taxes when exploration outside the country i s conducted through another (usually foreign) corporate vehicle. Foreign explora-tion does rank for a deduction against taxable income i n Canada but only a f t e r the foreign corporate vehicle has been abandoned and the Canadian company has no other presence i n that foreign country. In practice, t h i s means v i r t u a l l y no tax deductible costs of exploration 24 TABLE V Net Cost to a B r i t i s h Columbian Mining Company of $100 of Exploration Expenditure i n B r i t i s h Columbia B r i t i s h Columbia Exploration Expenditure $0 $100 Assume taxable income before exploration Exploration Resource p r o f i t s Federal income tax 36% of resource p r o f i t s less resource allowance of $250 (25% of $1000) and earned depletion of $33 (1/3 of $100 exploration expenditure) Pr o v i n c i a l income tax 15% of resource p r o f i t s less earned depletion of $33 (1/3 of $100 exploration expenditure) Mineral resource tax 17.5% of 85% of resource p r o f i t s less earned depletion of $33 (1/3 of $100 exploration expenditure) Total taxes Net earnings $1000 0 1000 $1000 100 900 $270 150 $222 130 149 129 569 $ 431 481 $ 419 Net cost to a B r i t i s h Columbian mining company of $100 of exploration expenditure i n B r i t i s h Columbia i s ($4 31 minus $419) $ 12 Note: Any benefits of the exploration are ignored. 2 5' through a foreign vehicle and, when i t does occur, i t i s treated as a c a p i t a l loss with the resultant res-t r i c t i o n s on amounts and timing of deductible costs. In the event the foreign corporate vehicle has taxable income of i t s own, the afte r tax cost to the Canadian company i s reduced. To simplify the demon-st r a t i o n , a 100% owned Mexican subsidiary of a Canadian company i s chosen and Table VI shows that foreign exploration under those circumstances i s t h i r t y -eight cents on the d o l l a r . In r e a l i t y , the government's p o l i c i e s on ownership of Mexican resources r e s t r i c t s ownership to 49% or 34% depending on certa i n conditions but as the Canadian i s often obliged to finance the exploration e f f o r t the afte r tax cost can be higher. A choice available to the Canadian i s to conduct explora-t i o n through a branch o f f i c e and thereby obtain a deduction against Canadian taxable income of 10% of the declining balance of such exploration costs. However, other business factors such as the need for limited l i a b i l i t y i n foreign countries usually influence the decision when r e l a t i v e l y large amounts are forecast to be spent i n a country and the company i s resolved to stay i n on a long-term exploration programme. Taxation effects on exploration p o l i c i e s of a Canadian company are considerable and form a major part of the decision process on the choice of locations to invest a company's resources. That i s not to say that 1 26 TABLE VI Net Cost to a Canadian Company of $100 of Exploration Expenditure i n Mexico through i t s wholly owned Mexican Corporation Outlay for exploration $100 Taxes no longer payable as taxable income reduced Income tax 4 2 Employee tax 8 Production tax abated: between 0% and 2% of production value depending on c a p i t a l expenditure and exploration l e v e l s . Assume _2 52 Reduction i n cash available for d i s t r i b u t i o n 48 Withholding tax (21%) no longer payable as d i s t r i b u t i o n to Canada reduced 10 Net cost of $100 exploration i n Mexico (see note) $ 38 Note: It i s assumed for t h i s purpose that the Canadian company never abandons a l l exploration e f f o r t and i t s presence i n Mexico. It i s also assumed that the Mexican corporation otherwise pays s u f f i c i e n t tax to o f f s e t the above taxes saved. Any benefits of the exploration are ignored. 27 i f the after tax cost of exploration i s minimal a company w i l l d i r e c t i t s attention to the j u r i s d i c t i o n with low costs for that reason. The l i k e l i h o o d of successful exploration e f f o r t coupled with the potential rewards i s uppermost i n the minds of an exploration manager. Target minerals' c h a r a c t e r i s t i c s and t h e i r abundance or r a r i t y of natural occurrence sought through exploration are bound to have a bearing on exploration costs. A forecast demand excess over supply of a p a r t i -cular mineral and taking into consideration prices and anticipated costs of finding and getting the product i n saleable form to market, i s an important factor which encourages exploration e f f o r t . An example of problems facing an exploration manager relates to uranium. A substantial increase i n demand for uranium has been forecast throughout the 1970's and the lead-time to bring a uranium mine on stream has lengthened owing to environmental concerns. The cost of obtaining permits to construct and operate uranium mines has grown exponentially in,recent years and the demand surge i s now expected to be delayed. As the cost of bringing the product to a saleable form r i s e s and the forecast demand f a l l s so the exploration manager i s obliged to consider the r e d i r e c t i o n of his exploration e f f o r t away from uranium. Accordingly, the cost of exploration combined with the l i k e l i h o o d of, and the amount and timing of expected rewards for successful exploration 28 e f f o r t , are paramount c r i t e r i a , to be s a t i s f i e d i n the path toward the f u l f i l l m e n t of the exploration objective. Tax considerations can reduce the impact of explora-ti o n expenditure but the exploration manager has to be prepared to incur about $27 m i l l i o n (1977 Canadian dollars) per economic mine discovery t y p i c a l i n the f i r s t half of the 1970*s i n Canada. ( 4 ) 2.3 Resource policy A nation's natural resource p o l i c i e s must be viewed in the context of the global market for resources. There are two stages to consider; before and after production i s achieved. I n i t i a l l y , questions on mineral resource p o l i c i e s focus on where to permit exploration and who may obtain rights to explore. After production i s achieved the questions concern who i s allowed to share i n the net benefits of mine projects and the a l l o -cation of the cash flows from projects. The exploration d o l l a r i s spent under world market conditions. The degree of welcome and the f i n a n c i a l treatment afforded explorers influences the flow of exploration funds to a nation and therefore i t s resource p o l i c i e s are examined c a r e f u l l y by an exploration manager before deciding on the a l l o c a t i o n of exploration e f f o r t . There i s a world-wide shortage of high r i s k venture c a p i t a l and there i s intense competition between and within nations to 29 a t t r a c t exploration funds and expertise. B r i t i s h Columbia offers a good example of t h i s competition. As mentioned e a r l i e r , exploration by a tax paying B r i t i s h Columbian company i n the province has an af t e r tax cost of 12% of the exploration expense but 32% i f the exploration i s conducted outside the province. Resource p o l i c i e s which govern where to permit exploration include r e s t r i c t i o n s on a c t i v i t y i n areas set aside as parks, on a g r i c u l t u r a l lands and other areas of p a r t i c u l a r environmental concern. Often, the r e s t r i c t i o n s applicable today were enacted i n the past without consideration or even knowledge of the e f f e c t s on mining. P r o v i n c i a l and national parks are examples which have either increased the cost of exploration and subsequent mining operations - or banned the a c t i v i t y altogether. The p r o l i f e r a t i o n of the bureaucracy i n many countries apparently by design has served to increase the adverse impact of resource p o l i c i e s on the mining industry. It has become more fashionable i n t e r n a t i o n a l l y to regard foreign investors with suspicion e s p e c i a l l y those i n the mining industry who are thought to extract high p r o f i t s , contribute l i t t l e i n taxes and then leave problems behind as they move to the next victim. Limits to foreign ownership i n companies allowed to conduct the business of mining are often set by law and i n some countries i s not permitted at a l l . Even when permitted there can be blocks to the 3 0 rapid granting of permits and removal of other barriers before work can begin. The potential rewards from successful exploration are generally highly v i s i b l e as new mining for geological reasons Is frequently close to e x i s t i n g mines. L i t t l e thought appears to be given by the bureaucracy to the degrees of r i s k Involved i n reaching the production stage as i s evidenced by the usually higher e f f e c t i v e rates of tax on income from mining versus income from manufacturing a c t i v i t i e s i n the same country. Changing perceptions of the importance of non-renewable resources i n the 1970's stemming from the 1973 OPEC c r i s i s and dire predictions of resource shortages by the Club of Rome have served to penalize the mining industry. The s t a b i l i t y offered by business contract law i s no longer available i n dealings with government. Tax laws change a l l too often.Environ-mental laws are introduced regularly, sometimes with onerous retroactive e f f e c t . The combined impact of re-source p o l i c i e s which a f f e c t the a l l o c a t i o n of the cash inflow from a project therefore also have to be c a r e f u l l y researched by the exploration manager before a decision i s made on where to place the exploration e f f o r t . I t i s economics that ultimately determines the v i a b i l i t y of an orebody and governmental resource p o l i c i e s can render worthless what would otherwise be an economically feasible orebody. Regardless of who owns the rights to explore and develop mining properties, i d e n t i f i c a t i o n of economically 31 feasible orebodies must be achieved before a property may be regarded as a national asset. The combined weight of resource p o l i c i e s should always be set with the fundamental objective of exploration i n mind: to locate those assets. 2.4 Process of exploration As soon as an i n t e r e s t i n undertaking exploration i s kindled a decision on where and when to look and for what has to be made. Financial and personnel l i m i t a -tions dictate that the area to be explored has to be narrowed to s p e c i f i c countries and the timing of entry considered. The i n i t i a l step i s to l i s t countries thought to be of greatest i n t e r e s t and then document the re s u l t s of a study into the resource p o l i c i e s , business and p o l i t i c a l environments and the exploration p o s s i b i l i t i e s of each country. Once a target country has been selected more information i s gathered to supplement the i n i t i a l data on resource p o l i c i e s and p r e v a i l i n g business conditions. If a l o c a l national i s sought as an exploration partner, p a r t i c u l a r l y i f foreign ownership r e s t r i c t i o n s apply, i t i s advisable to f i n d the partner and formally agree to the terms of partnership before exploration f i e l d work begins. Negotiation d i f f i c u l t i e s can be avoided i f settlement of the business arrangements can be made before an i n t e r e s t i n g mineral prospect i s located. A v i t a l step enroute to a producing mine i s the a c q u i s i t i o n of exploration and mining r i g h t s . These rights are supplemented at a l a t e r stage with rights of access, water r i g h t s , environmental permits and a host of other documents which i n t o t a l allow the opera-ti o n of a mine. A l l these permits are needed but owner-ship of mineral rights at the beginning of exploration work i s e s s e n t i a l . After early data i s c o l l e c t e d about a property some i n i t i a l indications of i t s mine poten-t i a l can be established. The pot e n t i a l tonnage of the deposit and average grades evident so far combined with se l e c t i v e mining and cutoff control p o s s i b i l i t i e s , estimates of construction and operating costs and s t a t i s t i c s , enable the exploration manager to judge the l i k e l i h o o d of bringing the exploration programme to a successful conclusion. S e n s i t i v i t y analysis of the available information can be used to prepare a reference scale of tonnage and grades needed at various metal prices against which re s u l t s can be compared as explora-(5) t i o n work progresses. These early economic studies are very useful i n the ranking of targets to be explored when budget r e s t r a i n t s require elimination of prospects. There comes a time when s i g n i f i c a n t resources have to be committed to the exploration target i f work i s to continue. A preliminary economic study i s prepared i n order to ensure the next major expense, that of compiling a comprehensive f e a s i b i l i t y study, i s worthwhile. The 33 decision may be to hold or drop the prospect and, i f held, to proceed with or delay the implementation of a f e a s i b i l i t y study. The f e a s i b i l i t y study deals with a l l aspects of the mine's construction and operations and includes l i s t i n g s of important assumptions and fore-casts. The objective of preparing a f e a s i b i l i t y study i s to predict the economic outcome a r i s i n g from minerals produced i n saleable form from a property with s u f f i c i e n t supportive information to permit management to make the important decision whether to construct and operate the mine. 2.5 Path to a decision on the location of exploration e f f o r t Placer Development Limited and i t s subsidiary and associated companies do now, or have i n the past, operated mines i n seven countries (Table I I ) ; a c r e d i t -able record for a company the size of Placer. In the l a s t two years, Placer's exploration d o l l a r s have been committed to B r i t i s h Columbia and Canada i n increasing proportions according to Mr. Duthie, President of Placer, at the Company's annual general meeting i n May 1979. At that meeting, he went on to say "the s h i f t i n g of exploration and development expenditures w i l l no doubt continue as p o l i t i c a l p o l i c i e s i n world areas are revealed and put into practice. The most favourable areas receive the greatest attention". The policy statement puts Placer with the majority of members i n the mining industry. For years, the industry has con-centrated i t s exploration e f f o r t i n i n d u s t r i a l i z e d countries out of a l l proportion to favourable geology due to an uncertain investment climate i n the t h i r d world. During the 1960's, for example, 80% of private exploration expenditures were in developed countries with 70% i n only four - A u s t r a l i a , Canada, South A f r i c a and the United S t a t e s . ^ The time horizon of the exploration sector i n mining i s , of necessity, quite d i f f e r e n t to the operations sector. The operator has to plan c a r e f u l l y with broad parameters for perhaps f i v e years and i n d e t a i l for at l e a s t two years. The exploration sector i s l i k e l y to work i n terms of a decade for a general target area and at least two years i n detailed exploratory work. That i s not to say that set exploration budgets are an obstacle to i n t e r e s t i n g new prospects noticed from time to time, but i t would appear that the majority of explora t i o n funds are spent i n countries included i n the explora t i o n budget. The lead-time from i n i t i a l i n t e r e s t i n a target area, usually a nation, to the decision to b u i l d a mine i s considerable. Placer, for example, added Mexico as an exploration target area i n 1969 and by May 1979 had not earned anything there. Even with an immediate favourable decision on a potential mine, i t i s l i k e l y to be another ten years before the necessary investment i s repaid and 3 5 the i n i t i a l p r o f i t s r e a l i z e d . The decision to construct a mine i s based on the expectation of an acceptable pro-f i t and that may take up to twenty years from commence-ment of production. Placer's example i n Mexico w i l l span t h i r t y years. In these dynamic times, the c o n f i -dence expressed i n Mexico by Placer i s great. Lead-time then, plays an important role i n the selection of target nations for exploration e f f o r t . Management's perception of a nations long-term business environment governs the decision to invest time, e f f o r t and resources to an area. 2.6 Exploration target nations for Placer The four most popular nations as far as exploration e f f o r t by the private sector i s concerned have attracted Placer's attention i n the 1970's. However, South A f r i c a i s no longer the object of grass roots explora-t i o n and i t i s probably safe to say that the t h i r t y year business environment outlook for that country i s , at best, considered l i k e l y to deteriorate for reasons well understood. The major portion of Placer's exploration push has been directed to Canada, the United States and Au s t r a l i a . Among the i n d u s t r i a l i z e d western nations, geology favours those three countries and the s i m i l a r i -t i e s of language, business and p o l i t i c s a l l combine to at t r a c t a s i g n i f i c a n t share of Placer's exploration budget. 36 Placer manages an operating mine i n the Philippines owning approximately 40% of the equity. I n i t i a l l y 65% of the mine was held by Placer but P h i l i p p i n e law subse-quently forced the sale of 25% to P h i l i p p i n e nationals. Local law, the a v a i l a b i l i t y of expert personnel and the necessary equipment at the minesite has led to an exploration programme i n the Philippines conducted by the Philippine associated company. Placer's i n t e r e s t i n the Philippines as an exploration target i s therefore s a t i s f i e d . Other countries which Placer has more than a passing i n t e r e s t i n are mostly i n Latin America. True; Greece, France, Thailand, New Zealand and F i j i are included i n a long l i s t of ventures, but these have come to naught. Three of ten mines now closed which were previously operated by Placer were i n Colombia (Table I I ) . A l l were gold mines and Placer's main int e r e s t i n Colombia s t i l l centres on gold. Continuous e f f o r t s have been directed toward renewing Placer's mining a c t i v i t i e s there and recent lack of success i s attributed to d i f f i c u l t i e s i n coping with the country's foreign investment and capital/earnings r e p a t r i a t i o n laws. Placer has an a f f i n i t y with Colombia born of the 1930's and 1940's. Members of senior management s t i l l r e c a l l how i t s Colombian mines kept the company a l i v e through the war years when i t s other investments were seized by the Japanese. A permanent representative i n Colombia brings mining prospects to the attention of Head Off i c e but a sense of f r u s t r a t i o n with Colombian mineral p o l i c i e s Is bui l d i n g . High uncertainty remains i n two important areas. F i r s t l y , the new administra-tion's (August 1978) handling of the i n f l a t i o n plagued economy and tax laws revamped by the predecessor Lopez Government. Secondly, the annual remittance of p r o f i t s which are limited to 20% of the Investment, but which (7) sometimes can be higher. Less and less e f f o r t and resources are being channeled to Colombia by Placer even though major investment potential l i e s i n the country's mineral sector. B r a z i l i s on the side l i n e s of Placer's exploration thrust but a watchful eye i s maintained over mining prospects. Other major companies' decisions to put resource sector projects on ice for various reasons draw attention to d i f f i c u l t i e s i n set t i n g up a large foreign managed investment i n B r a z i l . U.S. Steel pulled out of a large iron-ore venture p a r t l y because of d i s -(8) agreement over who should control the project. In-f l a t i o n poses a severe business problem and the cost of c r e d i t i s high. There follow correspondingly high expectations of p r o f i t from high r i s k investments such as surround mining. The business environment i n B r a z i l i s not stable enough at present to provide Placer with the confidence to devote worthwhile amounts of i t s exploration and 38 other resources. F i f t e e n years down the exploration and investment road i n B r a z i l u n t i l a project cash flow turns p o s i t i v e , assuming a l l the r i g h t decisions were made, i s further than Placer i s presently w i l l i n g to look. The four major copper exporters are Chile along with Zambia, Peru and Zaire. Placer has not looked upon A f r i c a as a favourable area of investment i n the past and shows no sign of changing i t s outlook. T r a d i t i o n -a l l y , the company has leaned toward the Americas and Australasia and Zambia's and Zaire's post-war history does l i t t l e to encourage otherwise. Peru i s an area where grass roots exploration i s considered unnecessary by Placer as known undeveloped orebodies e x i s t for which the government seeks foreign investment. Placer has expressed i n t e r e s t but by May 1979 no commitments have been made. The Chilean mining investment picture i s quite d i f f e r -ent from Peru. The Peruvian government maintains s t r i c t controls over i t s mining and the terms of business, where-as the Chilean government does not. Chile's economic pol i c y since 1973 encourages private enterprise to thrive and the chance of finding and developing a high grade copper mine o f f e r i n g quick investment payback i s r e l a -(9) t i v e l y high for the mining industry. The mineral wealth, primarily copper and nit r a t e s but also by-product molybdenum, gold and s i l v e r , i s a t t r a c t i v e to Placer and the major multinational energy and mining companies. Internal security and consequently the safety of i t s non-Chilean nationals i s good and s t a f f i n g a future mine i n Chile i s not regarded as a problem. Placer has found a suitable partner i n Chile and a good rapport has been established at the senior manage-ment l e v e l . Resident representatives of Placer's exploration department have been a c t i v e l y examining mining properties since 1977 and Placer's commitment to a long-term stay i n the country i s c l e a r . Their budget does not approach the magnitude of that a l l o t t e d to the i n d u s t r i a l countries but, i f and when a p a r t i c u l a r l y promising prospect i s located, i t i s evident the company i s prepared to increase i t s exploration commitment there. Argentina, l i k e Chile, i s r i c h l y endowed with the kinds of raw materials that Placer i s interested i n . Placer has p o t e n t i a l partners i n Argentina and, as i n Peru, known orebodies wait on an improved business environment for development. The p r i n c i p a l conditions which have s t a l l e d the exploration and investment pro-cess i n the country are the p o l i t i c a l turmoil and the persistent t e r r o r i s t problem that has threatened l i f e and property. One orebody l i e s adjacent to the Chilean border far from the A t l a n t i c Ocean ports and smelters. Its location offers an obvious economic solution. Mine and m i l l i n Argentina: transport, the concentrate the 4 0 150 km v i a a nearby e x i s t i n g highway to a Chilean smelter, and export. This seemingly l o g i c a l answer i s frustrated by inter-governmental attitudes stemming from long-term t e r r i t o r i a l disputes. Placer's Argentine exploration programme cannot get started despite latent enthusiasm i n Vancouver. In the late 1960's, Placer went through an expansion-ary period which included the successful Philippine copper mine. It was a time when proof was fresh i n management's mind that foreign exploration outside the i n d u s t r i a l i z e d nations could indeed turn up a winner and in t e r e s t was kindled. Mexico, an h i s t o r i c a l l y famous mining area lay just to the south of an area already t r a v e l l e d by Placer's exploration people. It offered a natural, extension i n a favourable explora-tion/investment climate i n 1969. Placer's foreign exploration programme has not u n t i l recent years included a detailed study of pre-v a i l i n g business conditions. In the past there was less need to do so as entry to countries for explora-t i o n purposes was easier than today. Nationalism had not manifested i t s e l f i n r e s t r i c t i v e foreign investment laws and the tax burden was easier to carry. Complete ownership of a foreign project was the norm and the rewards great for a company w i l l i n g to devote consider-able attention to i t s foreign operations. Todays need for l o c a l nationals as participants i n foreign mining ventures, rapid changes i n taxes as well as other business conditions means that more preliminary work i s needed before an exploration target nation i s selected. After the selection, a routine monitoring system has to be maintained to ensure the company's continued presence i n that country i s warranted. 42 CHAPTER TWO REFERENCES 1. A. Powis, "Public Policy and the Mineral Industry" 2nd McParland Lecture Mining Association of Canada, 1976, page 10 2. IBID, page 10 3. IBID, page 10 4. "Exploration: changing benefits" Mining Magazine, May 1979, page 387 5. H.K. Taylor, "Mine Valuation and F e a s i b i l i t y Studies" Mineral Industry Costs, Northwest Mining Association, Spokane, 1977, Chapter 1, page 5 6. A. Powis, "Public Policy and the Mineral Industry" 2nd McParland Lecture, Mining Association of Canada, 1976, page 3 7. "Colombia's new administration w i l l i n h e r i t healthy economy" Commerce America, 10 A p r i l 1978, page 15 8. "The B r a z i l i a n gamble" Business Week, 5 December 1977, page 81 9. "Chile: the move to a market economy" Euromoney, July 19 7 8 supplement, pp 1-37 43 CHAPTER THREE  A MINING VIEW OF MEXICO 3.1 An introduction to Mexico The Canadian mining decision maker contemplating a mining venture i n Mexico needs answers to fundamental questions as a f i r s t step i n his appraisal of the ven-ture. Does Mexico's geology and mining history encourage the view that an i n t e l l i g e n t l y planned and implemented exploration programme have an acceptable chance of success? Can non-Mexican business interests obtain and hold rights to explore for, develop and successfully operate mines i n Mexico? Do business environmental conditions allow a Canadian to own and operate a mine i n Mexico and to recoup the o r i g i n a l c a p i t a l invested, make a p r o f i t and send both amounts back to Canada? The f i r s t of these questions i s answered i n the posit i v e i n section 3.2 below as Mexico i s r i c h i n mining history and remains one of the world's greatest mining nations. The ownership and operation of mining properties i n Mexico by non-nationals i s ine x t r i c a b l y woven i n Mexican p o l i t i c s . Discussion of t h i s l i n k be-tween p o l i t i c s and mine ownership i n section 3.3 below indicates that non-Mexicans can own and operate mines but that p o l i t i c a l assistance to achieve that position i s important. Mexican economics and the Mexican government's attitude toward mining are described i n sections 3.4 and 3.5 below. The writer believes the Mexican business environment w i l l allow a good mine project to earn p r o f i t s which can be sent to owners i n Canada. The p r i n c i p a l ingredients for a successful mining investment i n Mexico are present i f an a t t r a c -t i v e orebody i s i d e n t i f i e d . Some background information concerning Mexico i s needed to underscore i t s d i f f e r e n t s o c i a l environment compared with Canada. Of Mexico's population of 65 m i l l i o n , about 30 m i l l i o n are under 14 years o l d ^ a n d the b i r t h rate (2) i s high. Mexico i s the world's fourteenth, largest country In area with i t s population concentrated on 15% of i t s t e r r i t o r y , yet having 40% l i v i n g i n widely d i s -(3) persed communities of about 2500 people. It i s one of the most unequal countries i n the world i n terms of the d i s t r i b u t i o n of national Income where the top 20% of households i n 1969 received 64% of family income and i t (4) i s s t i l l getting worse. Zacatecas i s one of the smaller of thirty-one states i n Mexico having a 1976 estimated population of (5) 1 097 0.00. It has three operating mines; a l l under-ground. The F r e s n i l l o mine produces lead, zinc, s i l v e r and copper and has an ore production capacity In the range 500 000 to 1 000 000 tonnes a year. The other two are smaller mines i n the ore production annual capacity range of 150 000 to 300 000 tonnes. f 6 ) 45 Canadian mining industry managements have to appre-c i a t e the differences i n outlook of a Mexican as compared with the better understood attitudes of Canadians. Today i n Mexico "machismo" i s one of the e s s e n t i a l character-i s t i c s of any authority r e l a t i o n s h i p which af f e c t s other t r a d i t i o n a l values of family, paternalism, hierarchy, order and p o l i t i c s . The violence, g u i l t , excessive competitiveness and consequent d i s t r u s t of others which form the essence of machismo aggravate c o n f l i c t on a l l levels from childhood on. The "mana" of an i n d i v i d u a l demonstrates d i s t r u s t and suspicion of another's inten-tions. It i s the a b i l i t y to formulate stratagems not e a s i l y discerned by others, to fathom another's motives and plans, which are always presumed h o s t i l e and which must be thwarted before they reach f r u i t i o n ; i t i s to (7) be sly and to be good at d u p l i c i t y . Machismo and mana together prevent an open rela t i o n s h i p f a m i l i a r to Canadians and interpersonal c o n f l i c t can e a s i l y escalate to group c o n f l i c t , and vice versa. The prevalence of machismo and the emphasis on mana i n turn has created a personal security system grounded i n the values of family, paternalism and hierarchy. The strongest t i e s are to members of the immediate family, then down to uncles, aunts, cousins and godparents. Mexicans have a ferocious pride i n t h e i r country but they also have deep cynicism about i t s a b i l i t y to pro-(8) gress. Corruption i s endemic i n Mexico and the people 46 demand a r i s e i n standard of l i v i n g as rapid as that of p o l i t i c i a n s and bosses. However, apathy rather than d i s -(9) a f f e c t i o n i s the p r e v a i l i n g mood in Mexico. 3.2 Minerals Mineral resources are abundant and varied i n nearly a l l parts of the country. The Yucatan Peninsula i s the exception. Gold and s i l v e r dominated e a r l i e r but over the l a s t f o r t y - f i f t y years non-precious metals became the largest part of the Mexican mining industry. A Guanajuato mine developed i n the early 19 70's was the f i r s t new s i l v e r property opened i n more than f i f t y years. Even so, Mexico i s s t i l l the world's largest primary producer of s i l v e r . Lead and zinc production puts Mexico amongst the world leaders and the world's largest fluorspar mine operates with Canadian expertise and ownership i n San Luis Potosi State. Mexico i s the world's second largest producer of sulphur, the country's most important non-metallic m i n e r a l . T h e l i s t of minerals available i s long but some are of p a r t i c u l a r i n t e r e s t to Placer owing to i t s mining history. They are gold found mainly i n the Sierra Madre Occidental; low grade copper widely d i s t r i b u t e d including Zacatecas; tungsten and molybdenum i n Sonora; mercury i n the Sierra Madre del Sur and lead and zinc already mentioned. Many undeveloped deposits are known but t h e i r i s o l a t i o n and consequently high infrastructure costs required to 47 bring them on stream render them uneconomic at present. Southern Zacatecas has the advantage of a d i r e c t r a i l l i n k to the port of Tampico on the Gulf of Mexico and, i n the other d i r e c t i o n v i a Aquascalientes, a l i n k with Torreon, the s t r a t e g i c a l l y located r a i l centre and shipping point for the mining and smelting industry. 3.3 Mexican p o l i t i c s The power centre i n Mexico rests i n Mexico City and in p a r t i c u l a r with the President. There i s a one party system with a president who may be elected for only one term of o f f i c e l a s t i n g s i x years. The l a s t few p r e s i -dents have been p o l i t i c a l l y l e f t and r i g h t a l t e r n a t e l y . The incumbent i s regarded as r i g h t leaning compared with his predecessor. The p o l i t i c a l s i t u a t i o n has been stable for f i f t y years, a record almost unequalled i n Latin America and often c i t e d as the chief reason behind the country's headway in developing i t s economy and a t t r a c t i n g foreign investment. Mexico's administrators are usually e f f i c i e n t although they are not above feigning delays to make t h e i r intentions more f o r c e f u l . A l l le v e l s of public administration can be tolerant of c o n f l i c t s of i n t e r e s t and acceptance of payment for favouritism, despite continuing high-level e f f o r t s to eliminate (11) corruption. 0 P o l i t i c a l power in Mexico i s not to be underestimated. A foreign investor cannot go alone into Mexico and expect 48 to obtain a l l the incentives available to the investor and avoid innumerable delays i n accomplishing his aims. It i s v i t a l to use Mexican legal and f i n a n c i a l advice, for example, and i t i s important to understand the sys-tem of "camarillas". Camarillas are quasi-permanent, h i e r a r c h i c a l , cooperative structures composed of a group of close collaborators around a "chief" with some posi-t i o n i n the governing hierarchy. The more power he has, the more rewards come to his collaborators. Each hopes to get i t s chief locked into a camarilla with a higher niche i n the hierarchy. Economic nationalism has become a permanent f i x t u r e of Mexican p o l i t i c s and the country has witnessed many controls such as foreign equity ownership and technology transfer r e s t r i c t i o n s , i n recent years. Mexico wants foreign investment on a minority basis that w i l l comple-(13) ment, rather than displace, l o c a l investment. It i s appropriate to mention here that Indianism i s one impor-tant thread of the n a t i o n a l i s t t r a d i t i o n . Indianism i s regarded as the antithesis of the Spanish heritage. The Indian i s conceptualized as the basis of the t r u l y national t r a d i t i o n and the Spaniard as the epitome of a n t i - n a t i o n a l i s t , c o l o n i a l i s t forces working against Mexican self-determination and the progress of Mexicans (14) as a national group. The dangers posed to a Canadian mining company seeking to invest i n Mexico are' c l e a r . Even i f he i s welcome today, the climate can change and the investment placed i n jeopardy. Nationalization p o l i c i e s are regulated by the constitution and a 1936 law which require court approval and adequate compen-sation for takeovers for reasons of public convenience. Rights of appeal and "adequate compensation" are taken seriously by Mexico as the country's dependence on foreign loans requires that i t maintain a good international 4- 4.- (15) reputation. Another area i n the p o l i t i c a l sphere of significance to the mining industry i s that of access to mining pro-perty. Two types of land tenure are r e s t r i c t i v e to the industry; national lands and ejidos. Both are prevalent throughout the country and both are obstacles to ob-taining mineral r i g h t s . National lands are controlled by the central government i n Mexico City and any mining a c t i v i t y including the use of national lands cannot be carr i e d out by an entity more than 34% owned by foreign-ers. Ejidos are a form of tenure under which individuals have security of tenure to work the land, even though the land i t s e l f s t i l l belongs to the state. Apart from those i n the State of Sonora, most ej idos are not worked on a (16) c o l l e c t i v e basis and are i n a desperate p o s i t i o n . Potential investment i n economically depressed areas i s given p o l i t i c a l assistance to remove the problems facing the mining industry with regard to mineral rights but the assistance requires the use of p o l i t i c a l power already referred to i n t h i s section. Obtaining building 5Q permits i s given s i m i l a r p o l i t i c a l encouragement when mining a c t i v i t y i s contemplated. A l i s t of n a t i o n a l p r i o r i t i e s presented i n 1976 to a USA/Mexico businessmen's meeting had s i x o f the f i r s t t e n p r i o r i t i e s o f d i r e c t r e l e v a n c e to mining i n Mexico. F.R. Miranda suggested the areas of r u r a l e d u c a t i o n (#2), water r e s o u r c e s (#3), t r a n s p o r t a t i o n (#4) i n f r a s t r u c t u r e f o r mining (#5) , r e c o g n i t i o n of the i m p r a c t i c a l i t y of the e j i d o system (#7) and the r e c o g n i t i o n of p r i v a t e p r o p e r t y i n the r u r a l zones (#8) were r i g h t behind the (17) h i g h e s t p r i o r i t y o f p o p u l a t i o n c o n t r o l . I t i s e v i d e n t the mining i n d u s t r y i n Mexico has g r e a t poten-t i a l to a s s i s t the n a t i o n s o l v e some o f i t s most p r e s s i n g problems. 3.4 Mexican economics Mexico's economy i s changing r a p i d l y r e s u l t i n g from l a r g e o i l and gas d i s c o v e r i e s i n r e c e n t y e a r s . The importance o f mining to the nation's w e l l - b e i n g i s on the d e c l i n e but s t i l l g r e a t . Mining i s no longer the prime t a r g e t of government revenue seekers t h a t i t was u n t i l the mid 1970's. Now there i s another source and the tax l o a d can be shared. T h i s i s a new s i t u a t i o n and one which w i l l l i k e l y reduce the r i s k o f new harsh tax laws being enacted. The a p p a r e n t l y u n r e l a t e d o i l b u s i -ness i s seen as making mining f o r e i g n investment l e s s prone to unfavourable changes i n law and more funds are 51 being directed to Mexico as i t s c r e d i t rating improves. The o i l bonanza w i l l have other side e f f e c t s , not least of which i s the forecast a v a i l a b i l i t y of cheap f e r t i l i -zers to improve the l o t of the r u r a l population. A massive problem facing the administration i s the move-ment of the r u r a l population to the already overcrowded r e l a t i v e l y prosperous c i t i e s . A host of secondary pro-blems need solutions before the population w i l l be encouraged to stay put. Food prices are controlled so as not to antagonize urban dwellers, but the po l i c y keeps the farming community poor. Job opportunities i n r u r a l areas are few and the c i t i e s o f f e r hope. The cautious mining investor w i l l assess the effects of the o i l re-venue on the demands of the people for too rapid a r i s e i n t h e i r share of the national wealth; a demand which could s p i l l over to the mining industry. At the end of the 1970-1976 p r e s i d e n t i a l term of o f f i c e , an economic c r i s i s occurred i n Mexico and c u l -minated i n the devaluation of the Mexican Peso which had been fixed i n terms of the United States d o l l a r for many years. I n f l a t i o n i n the years since August 1976 has been high; 1977 saw i n f l a t i o n of 20-25%. ( 1 8 ) 1977's r e a l GDP growth rate of a mere 2.5% followed the lowest i n decades (19) 2% rate of increase of r e a l growth xn 1976. Indica-tions i n 1979 are that i n f l a t i o n has slowed but that the benefits of devaluation have been worked through the economy and domestic costs such as wages are back to t h e i r pre-devaluation l e v e l s i n terms of United States d o l l a r s . The bank lending rate to t h e i r best customers i s i n the region of 26.0% p.a. i n Mexico (A.E. Ames & Co. , Vancouver, March 1980) and there i s a chronic shortage of domestic long-term c r e d i t . ^ 2 0 ' Legal requirements for Mexican equity ownership i n mining compounds d i f f i -c u l t i e s for Canadians In finding a suitable partner who has both the willingness and c a p a b i l i t y to share the business r i s k s and obligations of mining ventures i n the country. The flow of foreign exchange i n and out of Mexico i s not subject to exchange control. Even during the 1976 economic c r i s i s controls did not materialize. History has shown that the r i s k of being unable to convert revenues into foreign exchange for payment of debt obligations, dividends or purchase of imports required to operate a Mexican mining project can be regarded as acceptable. There i s only a small proba-b i l i t y that the federal government i n Mexico City w i l l require a l l foreign exchange earnings to be surrendered to the central bank. Nevertheless, foreign exchange and reconversion rights should be negotiated and, to the extent possible, set out i n any agreement to invest i n Mexico between partners and government. Mexico i s a heavy international borrower and the 1976 c r i s i s induced the international Monetary Fund to impose 53 conditions for new loans which required public sector d e f i c i t s to reduce as a percentage of GDP. New foreign debt was limited i n 1977 and 1978 and the IMF also s t i -pulated there be no exchange controls and a reduction (21) i n trade protection. The economic c r i s i s and the subsequent recession produced a more sympathetic stand toward foreign and private business, but for reasons that are far more p r a c t i c a l than i d e o l o g i c a l . The re-c o n c i l i a t i o n of government and business should not be taken as a movement away from basic foreign investment control measures enacted i n the early 1970's. The new government has set long-term goals with an understanding of short-term necessities and has insisted,on thorough (22) planning and e f f i c i e n t management. The IMF r e s t r a i n t s on government spending may prove to be a blessing to Mexico. 3.5 Government attitudes toward mining There has been no relaxation of l i m i t s on the per-centage of equity ownership i n Mexican mining ventures and none i s expected. However, the new government does encourage mining investment and i t s s i m p l i f i c a t i o n of tax laws i n the opening years of i t s administration i s evidence of i t s willingness to improve the business climate i n the industry. The e f f e c t i v e rates of taxes coupled with Mexicanization of ownership p o l i c i e s has lead to the need for larger mines of higher grade i n Mexico than i n other countries i n order to remain compe-t i t i v e for the Mexican, as well as for foreign, investor's money. Expressed another way, i t means that otherwise economic orebodies i n Mexico are rendered worthless 4- • 4. (23) under present circumstances. The mining industry continues to be viewed as an important source of new jobs i n the f i g h t to create an enormous number of opportunities needed so badly to reduce unemployment. The c a p i t a l intensive industry i s known to have a high r a t i o of i n d i r e c t jobs to d i r e c t jobs at a mine and the forward and backward linkage e f f e c t s are not l o s t on government administrators. Mexican manufacturing c a p a b i l i t y i s considerable a l -though trade protection p o l i c i e s are i n c l i n e d to leave products high priced for t h e i r quality; an area of cost control concern to foreign mining investors and operators. The mining industry i s welcome i n Mexico but bureau-c r a t i c red-tape i s formidable. The delays and costs involved i n s t a r t i n g up a mining venture w i l l test the fortitude of even the most enthusiastic and w i l l i n g investor. Why invest i n Mexico? Placer has already made a s i g n i f i c a n t commitment of i t s resources since i t s decision i n 1969 to include Mexico as a target area for exploration. The exploration programme has at times proceeded rapidly and on other occasions come to a complete h a l t . The company's ten year stay i n the country has not produced a source of revenue but the recent renewal of in t e r e s t i n the most promising of i t s Mexican interests i s a sign of c o n f i -dence i n the long-term future there. The gestures of welcome to foreign mining interests are manifested i n improved tax laws, not generous by any means, and the continuation of free currency exchange p o l i c i e s tested through very tough economic conditions. The acceptance of foreign investment together with the primary ingre-dients; the existence of geologically i n t e r e s t i n g areas for exploration and the prospect of p r o f i t i n the long run, a l l point to a favourable view of Mexico by Placer. The conditions for successful investment i n Mexico are present and the l i k e l i h o o d of locating an economically viable orebody i s high. The prospect of p r o f i t i s much better than reports from Latin America of corruption, (24) revolution and expropriation might lead us to think. v ' 56 CHAPTER THREE REFERENCES 1. D. Gordon, "Mexico", The Economist,22 A p r i l 1978, page 4 2. IBID, page 4 . 3. IBID, page 7 4. IBID, page 16 5. The Statesman's Yearbook: s t a t i s t i c a l and h i s t o r i c a l  annual of the states of the world for the year, London, Macmillan, 1978/79, page 842 6. "Mining A c t i v i t y i n the Western World", Mining Magazine, January 1979, page 55 7. L.V. Padgett, The Mexican P o l i t i c a l System, 2nd ed i t i o n , pages 66-67 8. D. Gordon, "Mexico", The Economist, 22 A p r i l 1978, page 10 9. IBID, page 34 10. T.E. Weil, Area handbook for Mexico, 2nd ed i t i o n , Washington GPO 1975, pp 21-22 11. Investing, Licencing and Trading Conditions Abroad:Mexico, Business International Corp., 1978, page 2 12. L.V. Padgett, The Mexican P o l i t i c a l System, 2nd ed i t i o n , page 69 13. Supra, page 3 14. L.V. Padgett, The Mexican P o l i t i c a l System, 2nd ed i t i o n , page 13 15. Investing, Licencing and Trading Conditons Abroad: Mexico , Business International Corp., 1978, page 6 16. D. Gordon, "Mexico", The Economist, 22 A p r i l 1978, page 31 17. F.R. Miranda "Social R e s p o n s i b i l i t i e s of Business Enterprises. The Economic and S o c i o - P o l i t i c a l Environment". Speech delivered at the 31st Plenary Meeting of the United States-Mexico Businessmen's  Committee, Cancun, Mexico, 30 October 1976. 18. D. Gordon, "Mexico", The Economist,22 A p r i l 1978, page 19 5:7 19. Supra, page 20 20. "Domestic Financing-Mexico" Financing Foreign Operations, Business International Corp, 1978, page 918 21. D. Gordon, "Mexico", The Economist,22 A p r i l 1978, page 19 22. Investing, Licencing and Trading Conditions Abroad:Mexico, Business International Corp., 1978, page 2 23. T.S. Nye, "Mexico, the Closely Guarded Mineral Storehouse" Mining Engineering Volume 74, December 1972, page 42 24. J.B. Utley, "Doing business with Latin n a t i o n a l i s t s " , Harvard Business Review January-February 1973, pp 77-86 58 CHAPTER FOUR  TAXES 4.1 The tax comparison A Canadian company, such as Placer, viewing the tax burden on a Mexican mining venture undoubtedly measures Mexican mining taxes on a scale based on Canadian taxes. There i s l i t t l e to j u s t i f y such a comparison but i t seems inevitable. What r e a l l y matters i s the cash flow aft e r taxes forecast to be di s t r i b u t a b l e to the investor and that forecast i s , among things, dependent on the degree of s t a b i l i t y of tax laws perceived by the investor. In the 1970's the mining industry has witnessed a considerable number of changes i n Canadian tax laws, some so s i g n i f i c a n t as to be confiscatory. Even i f such deeper issues as the i n f l a t i o n a r y e f f e c t s on de-preciation for tax purposes are ignored, the mining industry has been i n B r i t i s h Columbia and continues to be i n Saskatchewan saddled with e f f e c t i v e tax rates greater than 100% of i n c o m e . A favourite of the industry was l o s t when i n 19 72 the three year income tax free period was abolished; a t r u l y major change. The frequency of tax amendments has l e f t the mining industry i n the position of coping with a "banana republic" on i t s home ground. The previously favourable Canadian tax environment has been downgraded i n the minds of Canadian mining management. The p r a c t i c a l e f f e c t i s to sharply reduce the perceived difference i n l e v e l of uncertainty 59 attached to foreign taxes as Canadian managements learn to l i v e with unsettled conditions at home. The l i k e l i h o o d of s i g n i f i c a n t changes i n tax law i n either Canada or Mexico a f f e c t i n g the net d i s t r i b u t i o n to the Canadian investor i n a Mexican mine should be (2) considered i n the assessment of the mine project. An example of a possible change i s the rate of withholding tax on income passing from Mexico to Canada. Canada and Mexico do not have a tax treaty to minimize double taxa-t i o n of income but perhaps t h i s may a l t e r . As the management of Placer i s expected to make the rela t i o n s h i p of Canadian and Mexican taxes an important issue i n the investment decision process, a b r i e f outline of the more s i g n i f i c a n t of such taxes i s given i n t h i s chapter. 4.2 Canadian taxes on mining business Federal, p r o v i n c i a l and municipal governments levy taxes on the mining industry i n Canada and as they each set t h e i r rules and have tax bases which d i f f e r i n some manner, only the taxes of Canada and B r i t i s h Columbia as they a f f e c t new mines are considered here. The federal government imposes an income tax on mining companies but c o l l e c t s both i t s own and p r o v i n c i a l income taxes by agreement with the provinces. As a general rule, federal and p r o v i n c i a l income tax laws compute the income amount to which the tax rates are applied on the same basis. There are differences, of 60 course, and those which deserve mention are discussed l a t e r i n t h i s chapter. Taxes borne by the B r i t i s h Columbia mining industry are the two income taxes a l -ready mentioned, resource tax and c a p i t a l tax levied by the province and a number of taxes on materials and services such as f u e l tax, sales taxes and even a stum-page tax on timber cut. 4.3 Canada's federal income tax The federal income tax rate i s presently 36% of taxable income from mining but, before a r r i v i n g at the amount of taxable income, there i s an important deduction of 25% of certain resource p r o f i t s which e f f e c t i v e l y reduces the tax rate to 27% (36% less 25%) of q u a l i f y i n g income. The rules also allow f l e x i b l e rate write o f f of construc-ti o n costs of a new mine deductible from taxable income of the same company up to 100% of the cost i n any year (3) including the construction period. This f l e x i b i l i t y offered through c a p i t a l cost deductions can be a s i g n i -f i c a n t advantage to companies with other sources of income as up to approximately 50% of the construction cost can be recouped through tax payment reductions p r i o r to completion of mine construction. The advantage i s the present value of the d e f e r r a l of tax payments and i s often a major factor bringing the date forward when a mineral prospect transforms into an economically feasible ore-body. Exploration also deserves attention i n any 61 discussion of federal income taxes. Chapter Two refers to the net aft e r tax cost of exploration expenses where i t i s shown i n Table V that taxes saved as a result; of exploration expenses can be as much as 88% of the expenditure. F l e x i b l e and fast write-off c a p i t a l cost deductions, plus extra deductions from taxable income based on q u a l i f y i n g construction expenditure (called "earned depletion") and the favourable treatment of exploration costs for tax purposes, combine to o f f e r substantial i n -centives to the mining industry. These incentives, perhaps they are reductions of tax disincentives, present an a t t r a c t i v e federal tax structure i n Canada but there i s a notable exception. The Canadian c o n s t i t u t i o n a l squabble manifests i t s e l f i n the federal government d i s -allowing resource taxes paid to provinces as a deduction i n determining net taxable income for federal tax pur-poses. The inter-governmental dispute puts the mining industry i n the middle and i t w i l l continue to suffer unjustly high combined e f f e c t i v e tax rates on mining income u n t i l the governments come to terms on an equitable a l l o c a t i o n of tax revenue between them. 4.4 B r i t i s h Columbia's taxes on income There are two important taxes on income of the mining industry i n B r i t i s h Columbia; Income tax and Mineral Resource tax. The p r o v i n c i a l income tax rate at 15% of taxable income i s the highest p r e v a i l i n g rate of a l l the provincei^and the Mineral Resource tax at 17%% of taxable income i s also a s i g n i f i c a n t burden. Like i t s federal counterpart, p r o v i n c i a l income tax laws allows f l e x i b l e rate fast write o f f of mine construction costs and, by so doing, the p r o v i n c i a l government contributes the tax rate share of the project cash flow to the investment payback at the same or at an even faster pace than the investor himself can d i r e c t his share of net cash flow to the repayment. Earned depletion i s available for pro-v i n c i a l income tax purposes, which make extra deductions available for mining exploration and development costs incurred; however unlike i t s federal income tax equiva-lent, there i s no resource allowance of 25% of q u a l i f y i n g income. The resource allowances and resource tax deduct-i b i l i t y are the two major causes for d i f f e r i n g amounts of taxable income for federal and p r o v i n c i a l income tax purposes. The mineral resource tax i s regarded by government as a royalty based on income and i t i s perhaps for that reason that requests to allow losses for resource tax purposes to be carried forward u n t i l u t i l i z e d have so far been ignored. The denial of losses i s more important to a new mine where start-up problems and the timing of the f i s c a l year-end can r e s u l t i n a high e f f e c t i v e rate of resource tax on mining income. Another feature of the mineral resource tax act i s that a loss cannot be o f f s e t 63 against taxable income of another mine owned by the same company. Each mine i s s e l f contained for resource tax purposes. The o v e r a l l e f f e c t of the mineral resource tax i s that i t i s onerous and i s the cause for the large pro-v i n c i a l tax bite from mining income compared with other income. Table VII shows the taxes on income levied by the federal and p r o v i n c i a l governments. A new mine's e f f e c t i v e tax rate i s less owing to earned depletion but the l e v e l of income can rais e the rate. TABLE VII Canadian Federal and B r i t i s h Columbian E f f e c t i v e v Tax  Rates on Mining Income (Current and Deferred Tax  Expense Combined) Newly Constructed Mature Mine Mine Federal income tax 20.25% 27% Pro v i n c i a l income tax 11.25% 15% Pro v i n c i a l mineral resource tax 11.16% 15% 42.66% 57% 4.5 Other taxes i n Canada Sales taxes are levied by the federal and p r o v i n c i a l governments, not on mine product sales as lo g i c might lead one to believe, but on the value of purchases. Federal taxes are often hidden i n the purchase price but p r o v i n c i a l taxes are disclosed on a l l purchases. In general, sales taxes and duty paid on supplies consumed i n transforming ore into a saleable product for export (a large portion of production i n Canada i s exported) are 64 not applied or, i f applied, are refundable. A large por-ti o n of the cost of mine construction does not suffer sales tax but more items, p a r t i c u l a r l y machinery and equipment suffer p r o v i n c i a l sales tax than federal sales tax. In addition, a mining company pays property taxes based on the assessed value of i t s assets and, since i t i s i n a c a p i t a l intensive industry, a disproportionately high share of property taxes are borne compared with labour intensive industries. In the region of 1% of the assessed value i s paid annually as a property tax. A tax not usually noticed by Canadians i s the with-holding tax on cert a i n income of non-residents. The rate depends on the country of residence of the r e c i p i e n t and i s 25% for "non-treaty" countries and a lower 15% for "treaty" countries. Mexico f a l l s i n the 25% category; an important factor when i t comes to considering the Mexican withholding tax rate of 21% of income passing to Canadians from Mexico. 4.6 Mexican taxes on mining business The federal government i n Mexico City takes the l i o n ' s share of taxes imposed on the mining industry through a variety of taxes but mostly production taxes and taxes based on income. The production tax i s shared by agree-ment with the appropriate state government and a r e l a -t i v e l y minor property tax i s col l e c t e d d i r e c t l y by the 65 s t a t e . Other s i g n i f i c a n t taxes are the w i t h h o l d i n g taxes and v a l u e added taxes (VAT). The l a t t e r comes i n t o e f f e c t 1 January 1980 to r e p l a c e the p r e s e n t 4% gross r e c e i p t s tax as w e l l as a s u b s t a n t i a l number of s p e c i a l t a x e s . ^ I n c e n t i v e s through taxes have been a v a i l a b l e f o r years to Mexico's mining i n d u s t r y . U n t i l 1976, the i n c e n -t i v e s were t a i l o r e d to i n d i v i d u a l mines and n e g o t i a t i o n s were necessary p r i o r t o the s i g n i n g of f i s c a l agreements known as "convenios". Convenios were never a s a t i s f a c t o r y mechanism to management as the c o s t s of i n i t i a l n e g o t i a -t i o n s and the subsequent renewals were d i f f i c u l t to p r e -d i c t and the n e g o t i a t i o n s themselves h e a v i l y weighted i n favour of government. Management never knew the t a x a t i o n ground r u l e s u n t i l the l a s t minute when the p o t e n t i a l l o s s caused by any breakdown of n e g o t i a t i o n s was c o n s i -d e r a b l e . At p r e s e n t , the convenio system i s not used and i n i t s stead i s a system of economic zones i n Mexico which a t t r a c t d i f f e r e n t tax exemptions and abatements. N e g o t i a t i o n s with government are s t i l l r e q u i r e d , however, so c o s t s may s t i l l be i n c u r r e d simply t o f i n d out the tax r u l e s t h a t w i l l be a p p l i e d and the s i z e and l e n g t h of time abatements are to be a v a i l a b l e . 4.7 Mexico's p r o d u c t i o n taxes P r o d u c t i o n taxes are e x i g i b l e on m e t a l l i c and n o n - m e t a l l i c m i n e r a l s and payable by the producer a t 66 percentage rates of the values of metal content commer-c i a l l y useful and non-metal dry weight. Values are based on smelter terms before deductions for r e f i n i n g . Gold and s i l v e r a t t r a c t 9% and lead and zinc 7%. An unfor-tunate provision of the law allows the Ministry of Finance to determine values monthly which leaves the door open to f i x i n g income leve l s for tax purposes i n -consistent with actual revenue. An amount up to the value of two percentage points of the production tax can be earned by the tax payer who, i n the same calendar year as the abatement, incurs prospecting exploration and development costs. The amount earned i s c o l l e c t e d by way of reduced production taxes. The commercially useful metal content of a mine's production may well include metals for which there are no sale proceeds. It may be the metal i n concentrate i s a nuisance to the customer or worse s t i l l i t may be regarded as a penalty metal. Either way, the mine i s i n an invidious position of paying tax on something which has no value to i t . The e f f e c t i v e rate of the combined production taxes w i l l vary for each mine owing to the method of t h e i r deter-mination. The lower the mine's operating p r o f i t margins the greater the impact of the production tax and i t i s easy to foresee situations where the tax exceeds the earnings before taxes. 67 4.8 Mexico's taxes on income The two major taxes on mining income are the income tax and employee tax of 4 2% and 8% respectively of tax-able income computed on p r i n c i p l e s similar to Canadian methods- Deduction from income i s allowed for production taxes which i s an improvement over the Canadian treatment of mineral resource taxes. In general, the rules for the deduction of c a p i t a l cost allowances are not as f l e x i b l e as those i n Canadian law as rates are lower and, once set, the allowance must be taken. This rule leaves the tax payer open to loss of cost d e d u c t i b i l i t y as losses can not be car r i e d forward more than three years and an adverse metal price period often l a s t s longer than three years. The years 1975 to 1979 for copper i s an example. In 1979 there i s a 10% investment tax c r e d i t available earned on e l i g i b l e expenditure which includes certain mining expenditure. Unfortunately the c r e d i t requires annual renewal by government regulation so no future mine can r e l y on the tax c r e d i t . The c r e d i t i s more a t t r a c t i v e under Mexican conditions than Canadian owing to the longer period of tax d e f e r r a l related to the speed that c a p i t a l cost allowances may be claimed i n the two countries. Dividends paid by Mexican companies including mining companies are subject to a 21% withholding tax but the ultimate bearer of the tax depends on the circumstances of the r e c i p i e n t . It i s possible for a Canadian resident r e c i p i e n t of Mexican dividends to get Canadian tax r e l i e f 68 from the tax deducted at source i n Mexico hut the law i s complicated. The combined e f f e c t i v e rate of taxes on income of Mexican mining companies i s not constant or comparable owing to the d e d u c t i b i l i t y of production taxes: prices and the metals produced a l t e r the e f f e c t i v e rates. Per-haps i t w i l l s u f f i c e to refer to Table XXIII where i t shows that i n the p a r t i c u l a r circumstances of the Mexican Mining Company S.A. de C.V. mine prospect in.Zacatecas, the o v e r a l l mine l i f e e f f e c t i v e rate of taxes on earnings i s 42% when the production taxes already absorb another 18% of earnings before taxes. 4.9 Other taxes i n Mexico The impact of the value added tax of 10% which comes into e f f e c t January 1980 can only be estimated at t h i s time, but i t i s not expected to be s i g n i f i c a n t to the export oriented s i l v e r producer. The administrators of the tax w i l l doubtless take two or three years to s e t t l e p o l i c y matters and u n t i l then mining, l i k e everyone else i n Mexico, w i l l have to watch the i r s i t u a t i o n c a r e f u l l y . An i n i t i a l area of concern i s the b e l i e f that technical services rendered to Mexicans by non-residents w i l l . a t t r a c t the VAT which, combined with the e x i s t i n g 42% (6) technical services withholding tax, serves to starve Mexico of badly needed technical help. If the cost of the service to be rendered i s assumed to be $80 and the p r o f i t $20, then the $100 b i l l i n g y i e l d s a net recovery a f t e r Mexican tax of 42% of $58: a loss to the technical provider of $22. Two courses of action are encouraged. F i r s t l y , the service can be withdrawn and, secondly, the b i l l i n g can be adjusted to $172.41 (up $72.41) which w i l l net the non-resident his o r i g i n a l $100. Meanwhile, the Mexican government col l e c t e d an additional $72.41 plus ten percent VAT t o t a l l i n g $79.65. The Mexican purchaser of the non-residents services suffers a 72% increase i n the before income and employee tax cost of imported services, ($189.65 vs $110) and a whopping 245% increase i n the after tax cost ($134.65 vs $55) as the technical services tax i s a non-deductible expense. Another cycle of calculations i s needed i f the non-resident providing the services i s also an equity holder (assume 34% for the purpose) i n the Mexican user. A re-duction of p r o f i t s remittable to the owner occurs i n the amount of $21.39 (34% of $79.65 less 21% withholding tax) It i s easy to see why the Mexican 42% withholding tax i s a stumbling block to the introduction of Canadian mining (7) expertise to Mexico. v' Recovery of $100 by a foreign provider of technical services to a Mexican corporation when that provider i s also a 34% equity holder i n the Mexican corporation, requires a b i l l i n g of $250. The $250 invoice nets $145 i n cash which represents his b i l l i n g of $100 plus $45 dividends received i n advance 70 of other partners i n the Mexican venture. The extra invoice cost of $150 ($250 vs $100) att r a c t s ten percent VAT and there i s no income and employee tax reduction. The foreign equity holder picks up 34% of the higher cost of $165 ($275 vs $110) and afte r 21% dividend withholding tax saved i s worse o f f by approximately $45 as future dividends are reduced. 71 CHAPTER FOUR  REFERENCES 1. B r i t i s h Columbia's Gibraltar Mines Limited annual report 1975 records taxes of 123% of income before tax. Noranda's Central Canada Potash i n Saskatchewan bore 137% of i t s 1978 income before tax according to a Noranda Information Booklet supplemental to an Information C i r c u l a r r e l a t i n g to i t s 1979 a c q u i s i t i o n of Mattagami Lake Mines Limited (NPL) 2. D.G. Krige, "The impact of taxation systems on mine economics", Decision-making i n the mineral industry C.I.M. Special Volume No. 12, 1971 pp 283-288 3. "Income tax act, Chapter 63 S.C. 1970-71-72 as amended", Regulation 1210 (1) and regulation 1100 (1) (w) 4. "Canadian income tax act with regulations", CCH Canadian Limited, 51st e d i t i o n , 1979 page X 5. Gonzalez V i l c h i s y Cia, Boletin Informativo No 1A issued 2 January, 1979, page 4 6. Mexican foreign investment and transfer of technology laws, Spanish-English e d i t i o n , CCH Inc., A p r i l 197 3 7. F.C. Miranda, "Developments i n the area of technology and foreign investments i n Mexico: Speech delivered at Canada-Mexico B i l a t e r a l Businessmen's Committee meeting, Montebello, Quebec, 26 May 1978, page 3 72 CHAPTER FIVE  VALUATION METHODS FOR A POTENTIAL MINE 5.1 What to value A decision has to be made early i n the exercise to evaluate a mining i n t e r e s t and the decision problem con-cerns what needs to be valued. I t i s easy to ask "what i s the value of a holding i n mining company A?" or "what i s the value of mining property B?" but d i f f i c u l t i e s arise i n the valuation process when the valuator must select what has value to whom and what influences the value. A potential mine property may have value i n the form of an anticipated flow of cash from mining the property's reserves. It most l i k e l y has a value based on i t s re-placement cost and government w i l l also value the mining i n t e r e s t i n terms of tax revenues, employment, foreign exchange and some intangible costs and benefits. An example of an intangible benefit i s the encouragement to others i n the industry provided by the act of investment i t s e l f , p a r t i c u l a r l y i f the investment f a l l s into the category of needed foreign investment. The valuator must determine who the interested parties are as they each set a value on the property based on the i r own objectives for holding an ownership inter e s t or, i n the case of govern-ment, for deciding on the amount of extra p o l i t i c a l or f i n a n c i a l help to be made available. In addition, the valuator ought to review the circumstances surrounding the c a l l for a valuation. If the holder of the property or of an inte r e s t i n i t wants to s e l l , i t has a value which i s probably going to be d i f f e r e n t from the value attached when the holder wants to make an investment decision related to the property or when an o f f e r to purchase has been received. Any valuation of a potential mine i s going to be expressed i n terms of another asset. Usually that other asset i s a national currency but i t could well be a share i n a company, government bonds or a ca r r i e d i n t e r -est i n the potential mine i t s e l f . Individual objectives of the parties interested i n a valuation w i l l have an impact on the valuation too. A question of what to maximize and the degree of control exercised by the parties can a l t e r the rate of anticipated cash flow, for example. A mine l i f e of t h i r t y years may s u i t government for s o c i a l reasons but present values of cash flows may be maximized at f i f t e e n years. Perhaps p r o f i t i s to be maximized (as d i s t i n c t from cash) and then a new set of constraints w i l l apply i n a r r i v i n g at a value of the potential mine. This paper w i l l describe the valuation process leading to a number expressed i n terms of United States d o l l a r s mainly to avoid a lengthy discussion on the forecast exchange rates of the Canadian d o l l a r i n terms of United States d o l l a r s . It i s recognized that the mine i n t h i s case i s i n Mexico which means the host government and l o c a l national equity owners deal i n Mexican pesos. Those parties w i l l most l i k e l y do t h e i r sums in pesos but as the pesos/US d o l l a r exchange rate i s unsettled and because the potential mine product i s to be exported, they too w i l l express a value i n United States d o l l a r s . The United States d o l l a r i s a national currency accepted by Mexicans and Canadians a l i k e as a value measuring s t i c k . Even the use of a national currency as the medium for value has some special problems. The US d o l l a r i s fre e l y convertible to other currencies, at least at present, but i t does suffer from the e f f e c t s of i n f l a t i o n . The valua-tor has to decide whether i t i s appropriate to use the concept of constant d o l l a r s ^ (deflated future dollars) i n the valuation process as a s i g n i f i c a n t change i n value w i l l occur i f the concept i s rejected. The valuator knows that any sale of an i n t e r e s t i n the potential mine w i l l be based on a price expressed i n terms of today's values but i t i s also known that the expectation of i n -f l a t i o n a f f e c t s the thought process of the p a r t i e s . Another area of possible dispute, p a r t i c u l a r l y i f p r o f i t maximization i s a high p r i o r i t y target, i s the accounting (2) method used i n a r r i v i n g at the value. Governments and foreign investors, for example, use quite d i f f e r e n t accounting concepts of p r o f i t s . Sometimes i t ' s a matter (3) of cost a l l o c a t i o n which causes a difference. It may be corporate costs (as opposed to project costs) or exploration costs which leads to p r o f i t s at variance i n actual amount or i n the timing of t h e i r recognition. 75 Timing of sales recognition i s another source of c o n f l i c t e s p e c i a l l y for the foreign investor i n charge of marketing. Perhaps the most important area of potential c o n f l i c t i n any valuation i s the l i s t of assumptions made i n a r r i v i n g at a value. There i s no doubt that long-term future product prices cannot be gauged accurately and even a s p e c i f i c price may have d i f f e r e n t levels of pr o b a b i l i t y of occurrence as perceived by any two experts on the subject. What has value 'to .whom: i si /largelyv sub jectiveiiand'.the value amount arrived at i s only part of the information needed by the user of the valuation. The lo g i c used to establ i s h the value i s just as s i g n i f i c a n t . The circum-stances surrounding the potential mine property, the motives leading to the c a l l for the valuation, the basis (4) on which the value i s derived and the l i m i t s of accuracy are a l l part of the evaluation needed i f the user i s going to be able to use the value i n t e l l i g e n t l y . 5.2 Valuation methods Some business assets have in d i v i d u a l industry accepted value-measuring s t i c k s ; for example, the o i l and gas production industry uses ,$x per barrel or barrel equiva-lent of proved reserves for p a r t i c u l a r locations as one of i t s more important methods. Although ore reserves play a v i t a l r ole i n the mine evaluation process, there i s no meterstick $ per tonne of metal contained i n proven ore reserves i n common use i n the mining industry. Each mine has i t s own p e c u l i a r i t i e s of metallurgy,ground con-d i t i o n , location and so on, such that i t s product i s not homogenous with any other mine product and the condition leads to an in d i v i d u a l net return from smelters (the usual mine product purchasers). In the example given, a s i g n i f i c a n t difference between the o i l and mining indus-t r i e s i s that o i l reserves require major expenditures p r i o r to being proven and the cost of l i f t i n g and marketing them i s r e l a t i v e l y small whereas i n mining the reverse holds true. The value of mining reserves i s therefore highly sensitive to both product price and the cost of getting the product to the buyer. Here, the term 'reserves" has been used loosely implying that the economic f e a s i b i l i t y of s e l l i n g the reserves i s not mandatory whereas i n r e a l i t y proven reserves mean the reserves can be sold at (5) a p r o f x t . v ; The valuator i s therefore obliged to look at various methods of valuation and sel e c t those appropriate to a potent i a l mine property. Clearly, any d o l l a r figure applied to the tonnes of proven mineral reserves ignores the f a c t that mining costs are unique to a mine^^ and, even though valuations are subjective, i t s use i s en-t i r e l y inappropriate. A second aspect relates to the user of the valuation. Government, as has been said, views a potential mine i n a quite d i f f e r e n t l i g h t and may need a value based on foreign exchange earnings. 77 Such a valuation has l i t t l e relevance to an equity holder except that of an i n t e r e s t i n ensuring the government's balance of payments permits favourable treatment for the pot e n t i a l mine. In t h i s study, the p o t e n t i a l mine property i s held by a Mexican corporation which i n turn i s owned by three equity partners. The valuation i s being undertaken for a Canadian minority holder of the equity and these circum-stances could materially a f f e c t the value of the potential mine to the Canadian. Any value placed on the i n t e r e s t ought to take into consideration the manner i n which the asset i s l e g a l l y held and i t s r e l a t i v e ease of transfer or sale to new owners. Adjustments late i n the evaluation process should take these situations into account. Methods of valuation that may be used by a Canadian investor for the p o t e n t i a l mine i n Mexico and discussed i n greater d e t a i l l a t e r i n t h i s chapter are: the cash flow method, the asset appraisal method, the earnings c a p i t a l i z a t i o n method, a l l of which are usually followed by the private sector . and the s o c i a l cost/benefit method often practiced by government. An understanding of t h i s l a t t e r method by the Canadian investor may lead to im-proved presentation to the host government of the case i n favour of the project. Another approach to the valuation i s to t e s t the 78 assumptions and valuation methodology employed i n the above methods on available data regarding a purchase made by a competitor for a s i m i l a r mining prospect, preferably a recent transaction i n Mexico. If the valuator's methods and l o g i c produces a value close to or.reconcilable with the actual price paid, greater levels of confidence can be placed on the value established for the potential mine being valued. A target i s to place no greater a value on the property than others are w i l l i n g to substantiate with the i r wallets, giving due consideration to the objectives of the parties concerned. The valuator ought to consider the economic environ-ment surrounding the potential mine i n p a r t i c u l a r and the economy i n general as related calculations and assumptions are made for each method. The uses to which the valuation w i l l be put have a strong bearing on the f i n a l value and may require a range of values, e s p e c i a l l y i f changes i n c r i t i c a l assumptions w i l l be useful as negotiators seek avenues of agreement least costly or most b e n e f i c i a l . The le v e l of confidence i n certa i n assumed s t a t i s t i c s may be relaxed i f the purpose of the valuation i s , for example, to decide whether more exploration expenditure i s j u s t i -f i e d or the property i s to be dropped. 5.3 Investment and financing decisions Two questions are posed i n any study of a project leading to a potential commitment of resources. F i r s t l y , should the investment be made? This question relates to the valuation process designed to dis t i n g u i s h the accept-(7) able from the unacceptable investment projects. Secondly, how to finance the proposed .investment? How to finance the investment must be kept quite separate from whether to invest or not. They are related questions, of course, but i t i s important not to c l u t t e r the issue of investment with matters purely concerned with the source of funds to be used i n making the investment. Just as the objectives of investors can d i f f e r which may lead to d i f f e r e n t project values and preferred valuation methods, so the f i n a n c i a l situations and preferences of investors d i f f e r widely. It may be that a project i s acceptable but that the f i n a n c i a l constraints prevent implementation. These two questions are characterized i n t h i s paper as the investment decision and the financing decision p a r t i c u l a r l y i n the cash flow data prepared for the Mexican Mining Company S.A. de C.V. and the Canadian investor (Tables XIX and XX). The decision to invest i s not made i n i s o l a t i o n from (8) the i n t e r n a l and external environments of the investor. Many factors are involved such as other project proposals, r i s k s inherent i n the project (discussed l a t e r i n t h i s (9) chapter), c a p i t a l constraints and the long run effects of the p r o j e c t . ^ 1 0 ^ If there are other projects being considered then a means of ranking the proposals i s needed. Some useful ranking tools are the present value 80 of forecast cash flow, the percentage return on investment and the investment payback term which are described i n greater d e t a i l elsewhere i n t h i s chapter. Another ranking tool i s the p r o f i t a b i l i t y i n d e x w h i c h u t i l i z e s the quotient of the sum of the present values of the bene-f i t s divided by the sum of the present values of the costs of the project. The advantage of the p r o f i t a b i l i t y index i s that a h i s t o r i c a l perspective i s possible as the e f f e c t s of i n f l a t i o n are removed from the index but i t s detraction i s that the size of projects i s ignored. The wealth (12) growth rate i s yet another ranking tool which may be used i n conjunction with others to provide the investor with ranking guides i n cases where the luxury of more than one prospect e x i s t s . Most mining companies are r a r e l y faced with two mining prospects at any one time at s i m i l a r stages of development along the path to becoming a mine. However, on many occasions two or more mine prospects are present and a po s i t i v e decision to invest i n one may delay the imple-mentation of the next mine investment. The cost of regret (the present value of delaying future income) i n making a decision to invest now with the p o s s i b i l i t y of delaying a future p r o f i t a b l e investment i n a property already owned, or perhaps to be owned, may be s i g n i f i c a n t . If an investment proposal i s accepted t h i s time, what does i t do to the next proposal? The decision maker may fi n d i t useful to allow for the long run effects of a 81 decision to invest: regret i s but one of the many factors and to attach a value to i t the p r o b a b i l i s t i c expectations of future investment opportunities and forecast c a p i t a l (13) a v a i l a b i l i t y are considered. The decision to borrow funds c a r r i e s with i t certain obligations u n t i l payback i s achieved and those obliga-tions have a price mostly i n the form of i n t e r e s t and other financing costs but also i n business constraints (14) such as working c a p i t a l minimums. The presence of greater business r i s k owing to the decision to borrow funds instead of using equity c a p i t a l , demands higher re-wards and the minimum acceptable investment returns for equity funds ought not to be acceptable from invested funds which are borrowed. To achieve a greater return, the percentage cost of borrowing has to be less than the percentage return on investment of equity funds i n the investment decision case. The leveraging e f f e c t i s necessary when funds are borrowed but the decision maker should take note that the additional rewards from the po t e n t i a l mine are compensation for undertaking the addi-t i o n a l obligations. I t can be demonstrated that t h i s i s so by altering..the financing scheme to either reduce or increase the lender's r i s k i n which case the cost of borrowing and/or the business constraints w i l l change likewise. Business constraints and obligations commonly imposed on borrowers concern dividend declaration r e s t r i c t i o n s , 82 merely to permit the long-term s u r v i v a l of the company. Theoretically, when an investment i s forecast to achieve a rate of return equal to the cost of c a p i t a l , the market-price of the investing company's shares w i l l grow at the required rate. The market value of Placer Development Limited i s arrived at based on i t s entire business and no separate values are attributed to i n d i v i d u a l mines or other businesses. No r e l i a b l e breakdown of the corporate cost of c a p i t a l to the Mexican project i s available although i t i s recognized that business environmental factors i n Mexico would est a b l i s h a higher cost of c a p i t a l there than an (15) equivalent mine m Canada. The Mexican mine project i s anticipated to be financed partly out of funds from Placer Development Limited and i t s partners and partly out of funds borrowed by Mexican Mining Company S.A. de C.V. As the l a t t e r borrowings w i l l not appear on the Balance Sheet of Placer i n accordance with established accounting p r i n c i p l e s , they do not appear i n the c a l c u l a t i o n of the cost of c a p i t a l to Placer. Lenders to Placer w i l l include a l l Placer's commitments and there-fore w i l l consider off-balance sheet business which may i n turn a f f e c t Placer's borrowing cost. These l a s t two points ought not to encourage putting strong emphasis on Placer's corporate cost of c a p i t a l , i n eluding the exploration factor, i n determining a hurdle rate (Appendix 18)for an investment decision on a proposed mine i n Mexico. The exploration factor i s analogous to the fixed 83 loan repayment schedules and terms, mine completion guarantees, mine performance guarantees, new borrowing r e s t r i c t i o n s , asset disposals and mortgages, working c a p i t a l minimums and r a t i o s , equity minimums and r a t i o s and a myriad of covenants. A l l these r e s t r i c t i o n s have to be considered for the period p r i o r to loan payback. In some cases, the time comes when new equity c a p i t a l has to be sought to reduce the impact of business con-s t r a i n t s to be taken on so that the question 'how to finance the proposed investment' can be solved. 5.4 Cost of c a p i t a l The cost of c a p i t a l i s a topic unto i t s e l f and to a large degree requires a subjective assessment. Much has been written elsewhere on the matter and academic d i s -cussion on any chosen l e v e l of cost can be lengthy with-(14 A). out reaching a consensus. The primary purpose of esta-b l i s h i n g a cost of c a p i t a l i s to set a minimum percentage rate of return on investment at which l e v e l the share price of the investor w i l l grow at a rate perceived to be required by the market. Every investor's cost of c a p i t a l i s affected by i n d i v i d u a l circumstances so, for the purpose of t h i s paper, cost of c a p i t a l i s dealt with by discussing Placer Development Limited's cost with p a r t i c u l a r attention to i t s proposed Mexican project. At Placer, a determination of the cost of c a p i t a l has been made from time to time and a wide range of 84 values established. In the ten years to 1978 the values rose from 5% i n 1967, to a peak i n 1974 before f a l l i n g back to 8% as calculated below. The 1974 peak cost of c a p i t a l can be attributed to high dividend expectations concomitant with copper concentrate and metal market euphoria. The cost of c a p i t a l i s regarded by Placer's manage-ment as a r e l a t i v e l y small part of mining investment c r i t e r i a . The foremost cause for t h i s relates to the cost of exploration. The industry i s renowned for i t s operating uncertainties but one factor i s certain; that mining an orebody w i l l eventually render i t uneconomic and the mine's closure can be r e l i e d upon. The cost of exploration i s not regarded as a v a l i d cost of a poten-t i a l mine, however. Exploration i s discretionary and i t s cost unrelated to an operating mine. The cost of future exploration, other than minor amounts for payments i n l i e u of Mexican production taxes referred to elsewhere i n t h i s paper does not appear, i n the cash flows of Mexican Mining Company S.A. de C.V. for that reason, even though the l i k e l i h o o d that future exploration i n Mexico w i l l be funded by that company i s s i g n i f i c a n t . Future exploration costs are a burden of a l l Placer's mining projects and the exploration e f f o r t may be directed to countries other than those generating the funds. The outcome i s that Placer i s obliged to increase the costs to be included i n the c a l c u l a t i o n of cost of c a p i t a l 85 cost portion of t o t a l fixed and variable costs of a busi-ness i n that the marginal p r o f i t i s f i r s t applied to re-coup fixed costs. If the rate of earnings from a mining investment prospect i s expected to exceed the cost of c a p i t a l excluding the exploration factor, the project may be b e n e f i c i a l to the investor even i f the excess percent-age i s small. Placer's management has not set s p e c i f i c targets for the exploration "on-cost" to the cost of c a p i t a l but instead, combines the factor with other fac-tors such as p o l i t i c s and r i s k of substantial mine operating problems, to arrive at an o v e r a l l hurdle rate. A c a l c u l a t i o n of Placer's forecast cost of c a p i t a l at 31 December 1980 of 8% without the exploration "on-cost" i s given i n Table VIII and that cost has been used as a discount factor for the stream of cash to the Canadian investor i n the Mexican mine i n the case cash flows summarized i n Table XX. Cost of Capital Calculated as at 31 December 1980 Capital breakdown 31 December 1980 (see Table III) TABLE VIII PLACER DEVELOPMENT LIMITED Cdn $ m i l l i o n s Debt - current portion - long-term portion $ 24.7 94.8 $119.5 26% Equity - from shareholders - from earnings reinvested i n the business 327.0 18.3 70% 4% $464.8 100% 86 The cycle of building new mines, loan drawdown and subse-quent loan repayment i s captured i n mid-term at 31 December 1980 as the Equity S i l v e r Mine loan i s at i t s maximum. It i s assumed that the average debt/equity relationship i n the long run i s : The forecast i n t e r e s t cost for funds loaned to Placer over the next f i v e years to 1984 i s 11.5%. No attempt i s made here to j u s t i f y that i n t e r e s t l e v e l . Interest expense i s a cost deductible for tax purposes but certa i n methods of finance r e s u l t i n costs of finance which are not tax deduct-i b l e . This c a l c u l a t i o n assumes that Placer w i l l arrange i t s finance i n the more commonly accepted manner of incurring costs deductible for tax purposes even though the Equity S i l v e r Mine i s not financed that way. Placer's marginal tax rate applicable to in t e r e s t expense i s strongly influenced by Canadian tax law as p r o f i t s derive mostly from Canada. Loan funds are u t i l i z e d i n Placer companies operating i n Canada where in t e r e s t expense may have the benefit of a marginal tax rate as high as 51%. It i s assumed that the average marginal tax rate applicable to i n t e r e s t expense of Placer over the next f i v e years to 1984 i s 51%. No account i s taken of the e f f e c t on marginal tax rates of "fast write-off" c a p i t a l expenditures and investment tax c r e d i t s . These and other tax incentives delay the payment of taxes which t h e o r e t i c a l l y necessitates an adjustment to the average marginal tax rate i n any year. Cost of the debt segment of Placer's c a p i t a l i s determined using the formula: Debt Equity - from shareholders - from earnings reinvested i n the business 20% 4% 76% 100% k (1-t) where k and t the i n t e r e s t rate (see 3 above) the marginal tax rate (see 4 above) k d 0.115 (1-0.51) k d 0.0564 87 Cost of the equity from the shareholders segment of Placer's c a p i t a l i s determined using the formula: k = D + g S P where D = the expected dividend per share ($1, May 1979) P = the current market price of a Placer share ($26, 10 May 1979) and g = the expected rate of dividend growth (see 7 below) • k = _1 + 0.06 S 26 k = 0.0985 Placer's Annual Report for 1978 shows that dividend payout po l i c y i n the period 1970 to 1978 resulted i n 41% of net earnings being d i s t r i b u t e d to shareholders although the years 1976, 1977 and 1978 witnessed 54%, 45% and 54% d i s -t r i b u t i o n s respectively. The nine year period started with annual dividends of $0.59 per share and i n May 1979, the dividends are at the rate of $1.00 per year; an annual growth rate approximating 6%. The growth rate i s affected by Canadian tax incentives to Canadian individuals i n the form of dividend tax credits but, for the purposes of t h i s paper, the adjustment i s regarded as minor and ignored. It i s assumed that the group of individuals and corporations com-p r i s i n g Placer's shareholders expect future Placer dividends to continue to grow annually at 6%. Cost of the equity from earnings reinvested i n the business segment of Placer's c a p i t a l i s determined using the formula: k = k (1-T) (1-B) e s where k = the cost of equity c a p i t a l from shareholders (9.85% from 6 above) T = the weighted average marginal tax rate of a l l Placer's shareholders (estimateJ.10% - see note) and B = the weighted average transaction cost that would be incurred i f the earnings were to be paid out and reinvested elsewhere (estimated at 1%) k e = 0.0985 (1-0.10) (1-0.01) k = 0.0878 Note: eCorporate shareholders marginal rate i s zero. The cost of 8.78% r e f l e c t s the current market price of Placer's shares, as well as the dividend history i n the 1970's, and i s the rate of return which, i t i s assumed, w i l l s a t i s f y present shareholders. It i s inferred that a lower rate of return would r e s u l t i n shareholders s e l l i n g 88 the i r holdings to seek investments with the same degree of investment r i s k which can provide a suitable rate of return. The weighted cost of c a p i t a l i s 8% as follows: Weight Weighted Cost (see 1 above) Cost Debt 0.0564 26% 0.0146 Equity from shareholders 0.0985 4% 0.0039 Equity from earnings reinvested i n the business 0.0878 70% 0.0615 0.0800 Risk The r i s k s involved i n a potential mining investment appear to be endless and, l i k e the cost of c a p i t a l , can be the topic of another paper. Some of the r i s k s have already been referred to such as the inaccuracy of a v a i l -able data, exploration, attitudes toward foreign invest-ment and related laws including n a t i o n a l i z a t i o n dangers, and the l i k e l i h o o d of changes i n governmental resource p o l i c i e s considered adverse by the industry. Suscepti-b i l i t y to changes i n the p o l i t i c a l and tax environments i n Mexico are alluded to i n Chapters three and four res-pectively and these two r i s k s are high on the l i s t to be reviewed by a decision maker i n assessing the r i s k s of a foreign mining investment there. The r i s k of foreign exchange r e s t r i c t i o n s on the d i s t r i b u t i o n of after-tax earnings has been mentioned as also have the additional business r i s k s added when the potential investment i s financed with borrowed funds. 89 Two r i s k s deserving of special note which f a l l within the r i s k of inaccurate available data are the quantity and character of ore reserves and metal market prices fore-casts. Time li m i t a t i o n s and the high cost of d r i l l i n g render i t impractical to learn everything about the ore-body and the experience of geologists has to be employed in providing the raw data for mining engineers and others to use i n assessing the nature and size of the orebody. A reasonable number of d r i l l holes usually provides a good l e v e l of confidence i n the orebody data and t h i s i s one area of concern which can be minimized by putting down more holes u n t i l the decision maker i s s a t i s f i e d that the nature of orebody i s well understood. The forecast metal prices are usually c r i t i c a l to the f e a s i b i l i t y of the proposed project with the exception of the high grade/low production cost properties which are unlikely to be affected by anything but a complete collapse of the mar-kets for t h e i r products. The c y c l i c a l nature of metal market prices i s important i n the early years of mining from a property as the generally accepted p o l i c y of op-timizing the present value of cash flow, e s p e c i a l l y i n the early years of operation to achieve a rapid invest-ment payback, necessitates high-grading from the orebody. Marginal orebodies need to commence production i n the up-cycle of prices and they w i l l generally be held i n inventory u n t i l i t i s judged the up-cycle w i l l l a s t long enough to allow payback within the period acceptable to 90 the i n d i v i d u a l decision maker. The r i s k of reading the market price cycle poorly i s high and represents one of the most s i g n i f i c a n t variables i n a r r i v i n g at a decision to invest i n a mining project. Hedging may be an a l t e r -native open to the metal producer but even that course of action has special drawbacks as the a b i l i t y to produce the quantity on time becomes the major r i s k . In t h i s strike-prone age and with long delivery times for material and equipment many decision makers fi n d hedging an un-acceptably high r i s k . In the case of Placer's i n t e r e s t i n Mexico, there i s an additional r i s k associated with a decision to invest i n partnership with others. The common purpose of owning a successfully operated mine i s dependent on the objectives of each party being i n harmony throughout the l i f e of the mine. Even the j o i n t preparation of the f e a s i b i l i t y study presents extra r i s k and requires careful coordination and control to ensure a l l parties work with the same data. The assessment of r i s k attached to an investment i n a mining project i s an i n t e g r a l part of the evaluation of (17) . . the property. The size of the project and the severity of the r i s k has a relationship of i n t e r e s t as a minor pro-je c t with good possible gains can be r e a d i l y accepted accompanied by high r i s k but i t i s improbable that a major project carrying a high r i s k of loss or bankruptcy w i l l be (18) approved by the decision maker. Although the degree of r i s k i s thoroughly reviewed by the private sector i n i t s evaluation process, t h i s i s rarely the case with government when no equity i n t e r e s t i s held. Government's review of a project proposal, perhaps submitted i n support of a request for government tax concessions or assistance with infrastructure costs, generally concentrates on the (19) size of the percentage return on investment. In the case of Mexican Mining Company S.A. de C.V. i n which government holds 33% of the shares, government can be expected to assess the r i s k of loss owing to the p o l i t i c a l advantage that could be presented to i t s c r i t i c s . The assessment would form part of the s o c i a l cost/benefit c a l c u l a t i o n r e l a t i n g to the proposed mine investment. The d i f f i c u l t y i n assessing r i s k l i e s in.the assumptions made and t h e i r impact on the valuation. Each assumption involves i t s own degree - often a high degree - of uncer-tainty; and, taken together, these combined uncertainties can multiply into a t o t a l of c r i t i c a l p r o p o r t i o n s . ^ ^ Behind the precise calculations for cash flows and other values are data which are not that precise. At best, the calculations are based on an average of d i f f e r e n t opinions with varying r e l i a b i l i t i e s and d i f f e r e n t ranges of probabi-l i t y . However, the d i s c i p l i n e of thinking through the uncertainties of the investment project w i l l i n i t s e l f help to ensure improvement i n making an investment deci-sion. It i s important to appreciate that the calculations of cash flow and other values are far from certain and although they may be more l i k e l y to be the calculated 92 figure than any other the decision maker w i l l have doubts (21) and may be only, say, 60% sure of the actual figure. 5.6 The cash flow method The cash flow method uses as i t s base the forecast net cash outcome of the project calculated from a l l the known, estimated and assumed data r e l a t i n g to the invest-ment. The year by year cash flow forecast may be compiled for the indicated l i f e of the project or some arb i t r a r y shorter period l i k e twenty years. As cash flow statements are presented i n a sim i l a r manner universally and close to the format of corporate f i n a n c i a l statements for earnings, cash flows are very informative and o f f e r a useful h i s t o r i c a l record for comparison purposes. There i s general agreement that to receive cash today i s better and more s a t i s f y i n g than to anticipate the re-ceipt of cash i n the future. The cash flow method recog-nizes t h i s when the stream of forecast cash flow from an investment i s reduced to a present day value. Clearly, the longer one has to wait before receiving the cash, the further one i s from receiving the cash today and the less i t i s worth as a percentage of i t s nominal value. The present value can be expressed two ways: as a d o l l a r amount having applied a s p e c i f i c discount rate to the stream of forecast cash, or as a discount rate having set the present value of the stream of forecast cash to (22) zero. The reduction of the value of the forecast stream of cash to a present value has an inherent assump-tio n that the rate of earnings from funds reinvested a f t e r release from the project i s equivalent to the s p e c i f i c discount rate or to the i n t e r n a l rate of return which leaves a present value of zero. In cases where the in-:, t e r n a l rate of return i s high, i t becomes unlikel y that investment alternatives are available which can provide the reinvestment earnings rate needed. Also, the i n t e r n a l rate of return c a l c u l a t i o n has the disadvantage of pro-ducing more than one answer i n cases where the forecast stream of cash includes more than one change from negative to p o s i t i v e amounts and vice versa. After taking a l l considerations into account, most experts agree that the use of a s p e c i f i c discount rate i s superior to the method of s e t t i n g the present value to zero for the purpose of 1 4 - - 4. (23) evaluating an investment. The present value, as has been said, i s established using a discount rate s p e c i f i e d or calculated. The cash flow method of valuing a mine prospect requires a bench mark or hurdle rate to be set by the decision maker and that l e v e l i s compared with the results obtained by d i s -counting the stream of forecast cash flow from the poten-t i a l mine. The hurdle rate i s expressed as a percentage and a decision to invest requires the present value of the cash flow to be a p o s i t i v e amount when the discount rate applied equals the hurdle rate, or the calculated i n t e r n a l rate of return to be greater than the hurdle rate when the 94 present value of the cash flow i s set at zero. The hurdle rate i s a matter of in d i v i d u a l preference for most investment decision makers. Industry norms are common and a rate often quoted i n mining c i r c l e s for properties at the stage of f e a s i b i l i t y studies i s 15% (24) a f t e r taxes but rates from 12% to 20% are also used. Although each investor tends to leave the hurdle rate unchanged, i t i s better to recognize that the investment climate i s dynamic and amend the hurdle rate to s u i t changing conditions. The hurdle rate i s not i n v i o l a t e and circumstances may suggest that a lower rate of d i s -count i s acceptable from an investment's forecast cash flow. Another common hurdle rate i s the investor's cost of c a p i t a l rate discussed e a r l i e r i n t h i s Chapter; the theory being that a posit i v e present value using the cost of c a p i t a l percentage rate maintains the needed rate of growth i n the investor's share market p r i c e . A weakness in the use of the cost of c a p i t a l rate has already been discussed. A mining company must explore for or other-wise acquire new mines and the cost of ensuring the long-term survival of the company i s an unknown quantity. Experience has taught the industry's decision makers to add s i g n i f i c a n t l y to the cost of c a p i t a l but the norms have been i n use for so long and with current int e r e s t rates and i n f l a t i o n i t may be that the 12% or 15% rates (25) require upward adjustment. v ' Also, the hurdle rate acceptable for Canadian mining investments may be lower than i s needed for higher r i s k foreign ventures. The hurdle rate should be adapted to the p r e v a i l i n g investment conditions but always commensurate with the l e v e l of r i s k involved. Measurement of the r i s k i s where d i f f i c u l t y i s encountered and the investor's propensity to r i s k dominates. Valuation of a potential mine by the cash flow method enjoys great popularity at present as i t depends primarily on the mine's expected future earning power. The cash flow calculations indicate the investment outlay payback period that can be anticipated and the decision maker w i l l undoubtedly take the period into account when assessing the r i s k s inherent i n the project. A r i s k may be accept-able for a r e l a t i v e l y short duration but over a longer period may be too onerous. The payback period should be a constraint rather than an investment decision c r i t e r i o n , for not to do so. would f a i l to recognize the cash flows r e s u l t i n g from the investment aft e r payback and the timing (26) and magnitude of cash flows p r i o r to payback. The value established for the potential mine by the cash flow method, l i k e any value for an asset, i s arrived at af t e r accounting for the supply and demand of the p a r t i c u l a r type of mineral property; i t s form of ownership and t r a n s f e r a b i l i t y ; the circumstances of the buyer and the form of sale consideration. However, the basis of the valuation i s the present value of the stream of forecast cash flow discounted at the hurdle rate assuming no 96 borrowed funds are used to finance the project. 5.7 The asset appraisal method The asset appraisal method has as i t s base the re-placement cost of the asset assuming there i s a need for the asset. Exploration being the game of chance that i t i s , may eventually lead to the location of a sim i l a r po-t e n t i a l mine but i t could well be at a cost far i n excess of the potential benefits. It i s also possible to acquire a potential mine property by purchase but, here again, valuation on a replacement cost requires an acceptable solution to the same problem of exploration. By going back far enough, every pot e n t i a l mine property has i t s beginnings i n exploration e f f o r t . Accordingly, exploration costs are c r i t i c a l to any estimate of the replacement cost of a potential and operating mine. The large majority of the cost of a r r i v i n g at the stage of producing a mineral product i s , i n most instances, i n - , curred af t e r the decision to construct the mine has been taken. As each mine has i t s own c h a r a c t e r i s t i c s and i t s costs of construction and mining are independent of other mines, valuation of a potential mine at the f e a s i b i l i t y stage on a replacement cost basis overlooks a v i t a l aspect of mining. That i s that two i d e n t i c a l orebodies are seldom found. Adjustments can, of course, be made by valuators to allow for differences i n future costs but few buyers and s e l l e r s w i l l agree on the- magnitude of 97 adjustments when the basic number for replacement cost i s i t s e l f a suspect value. As soon as future costs are considered the basis of valuation s h i f t s to the cash flow method which considers both revenue and.cost. The asset appraisal method i s rarely used to value a potential mine property and, even for an operating mine (27) the method seldom finds favour. The method i s i n -appropriate owing to the lack of confidence assigned to the costs of exploration and i t s disregard for the future net benefits that may accrue once the property i s taken beyond the f e a s i b i l i t y study stage. 5.8 The earnings capitalization.method The value of a potential mine property arrived at using the earnings c a p i t a l i z a t i o n method i s dependent on the size of a m u l t i p l i e r applied to anticipated average annual earnings from the mine. Neither the m u l t i p l i e r nor the earnings are d e f i n i t i v e quantities owing to factors such as the c a p i t a l costs to bring the property into production and the r i s k s associated with the project, par-t i c u l a r l y with regard to the levels of production and the unit cost of production forecast i n the f e a s i b i l i t y study. A going concern offers a history of earnings exper-ience and r e l a t i v e l y high lev e l s of confidence can be placed on c a r e f u l l y prepared future earnings forecasts. A potential mine lacks the history: even the a b i l i t y to produce has to be proven. Both a potential mine and an 98 operating mine r e l y on forecast product prices to support future earnings estimates but a potential mine has to look further down the road because of the intervening period of mine construction. The potential mine's earnings are therefore bound to be less secure i n the mind of a valuator of the property at the f e a s i b i l i t y study stage than l a t e r when designed production levels have been achieved. Earnings are a function of revenue and cost and the c y c l i c a l nature of metal markets means that when the product price i s low, cost of production from the potential mine assumes greater s i g n i f i c a n c e . A danger that exists i n any industry where, i n general, world wide supply and demand determines product price le v e l s and ind i v i d u a l producers have minor influence over prices, i s that the potential mine may be unable to earn any p r o f i t i n some years; may have to suspend opera-tions and i t s very existence may be threatened. The temporary or long-term cessation of operations i s a r i s k which can be assessed using the forecast costs of produc-t i o n , according to the potential mine's f e a s i b i l i t y study, plus industry information. If the poten t i a l mines unit cost of production i s low i n comparison with the majority of the volume produced by the industry as a whole, then i t follows that under free market conditions the potential mine w i l l continue operating i n most down-price-cycle periods. S i m i l a r l y the proportion of forecast unit pro-duction costs to the long-run metal price enables a valuator to assess the l e v e l of r i s k of business closure facing a pot e n t i a l mine. Earnings mean d i f f e r e n t things to d i f f e r e n t people. In t h i s paper, earnings are determined using generally accepted accounting p r i n c i p l e s i n Canada and are there-fore after both current and deferred taxes. The earnings c a p i t a l i z a t i o n method uses a m u l t i p l i e r of earnings to arrive at a value and the m u l t i p l i e r i s i t s e l f based on the valuator's knowledge of what other parties pay for a mine with similar r i s k . Although the m u l t i p l i e r i s deter-mined largely by subjective means, the earnings can be calculated with more precision; not foregetting the under-l y i n g assumptions fundamental to the earnings numbers. However, i t must be recognized that accounting p r i n c i p l e s do not require a l l earnings to be computed i n i d e n t i c a l manner. For example, percentage rates of depreciation expense can be d i f f e r e n t between companies. What matters then i s consistency and the valuator may be obliged to amend earnings figures to achieve i t . The valuation of a potential mine based on earnings c a p i t a l i z a t i o n has an Important difference compared with a similar valuation of an operating mine. The potential mine's earnings can not be received u n t i l the cost of construction has been incurred whereas the investment i n an operating mine i s already i n place. The m u l t i p l i e r chosen must allow for c a p i t a l funds to b u i l d the new mine and for th e i r recovery towards the end of the investment 100 payback period. Another adjustment to earnings may be necessary to allow for the mining practice of extracting the highest available grade ore i n the e a r l i e r years of operation. Frequently, average earnings refers to earnings over a short period of say f i v e to ten years and, in the normal mining sequence of events always subject to the timing of market price cycles, the next f i v e to ten year period's average earnings w i l l be l e s s . Two courses of action w i l l account for the gradual decline i n annual earnings; f i r s t l y , take the average annual earnings over the l i f e of the mine and, secondly, adjust the m u l t i p l i e r downward. These adjustments to the valuation for c a p i t a l cost and the gradual decline of earnings as the potential mine matures are substantial changes to the earnings c a p i t a l i z a t i o n method so often applied to the valuation of investments outside the mining industry. The time value of money i s not dealt with adequately in the earnings c a p i t a l i z a t i o n method. To some extent i t i s possible to consider i t by amending the size of the m u l t i p l i e r but the change i s l i k e l y to be done i n t u i -t i v e l y unless cash flow forecasts are available. The m u l t i p l i e r chosen has to take into consideration the l i f e of the potential mine as those l a t e r years' earnings not included i n the valuation have to provide the return on the investment made to acquire the potential mine at the f e a s i b i l i t y study stage. Ore reserves, which i n turn are dependent on geological conditions combined with metal 101 prices, production rates and costs and taxes, set the mine's expected l i f e . Due consideration of these factors and how they a f f e c t one another i s advisable before a r r i v i n g at the m u l t i p l i e r to be used i n the valuation. The earnings c a p i t a l i z a t i o n method applied to a poten-t i a l mine property requires v i r t u a l l y the same information that i s needed to prepare cash flows. A l l the basic assumptions to compile the cash flows from the i n i t i a l construction costs to the cost of marketing the f i n a l pro-duct are needed; only the l a s t steps of changing cash flows to earnings statements and f i x i n g the m u l t i p l i e r are peculiar to the c a p i t a l i z a t i o n of earnings. These two steps are i n l i e u of the ca l c u l a t i o n of present values of discounted cash flows from the potential mine. The very s u b j e c t i v i t y of the m u l t i p l i e r indicates that the earnings c a p i t a l i z a t i o n method of valuing a poten t i a l mine property i s i n f e r i o r to the cash flow method. Risk i s allowed for i n much the same way for both earnings capi-t a l i z a t i o n and cash flow methods. Adjustment i s effected vi a the m u l t i p l i e r and present value respectively and both have the same degree of decision maker s u b j e c t i v i t y . 5.9 The s o c i a l cost/benefit method The s o c i a l cost/benefit method of evaluating a poten-t i a l mine i s used increasingly by governments i n th e i r assessment of a project's value to the host nation i n l i g h t of national p o l i t i c a l and economic p r i o r i t i e s . The 102 method involves considerable subjective judgment and w i l l not conclude with a price for an i n t e r e s t i n a potential mine. What the method does provide i s an indica t i o n of the project's a c c e p t a b i l i t y to the host government which i s useful for at least two reasons. F i r s t l y , the more favourable the net s o c i a l benefits accruing to the host nation from the project, the greater the opportunity to extract improved operating and f i n a n c i a l concessions from government before investment commitments are made. Secondly, the value of the Canadian investor's i n t e r e s t i n a foreign project w i l l be influenced by the magnitude of the net s o c i a l benefits. Large net benefits are more l i k e l y to reduce the chance of host government i n t e r f e r -ence or hindrance. Both reasons o f f e r improved confidence leve l s concerning the s t a b i l i t y of a foreign investment serving to reduce uncertainty over the duration of a project. A private sector view of a project i n a foreign country i s quite d i f f e r e n t from the host government's view of the same investment. The two parties have d i s -similar objectives and the natural tendency i s for each to a r r i v e at independent and d i f f e r e n t values for the project. The cost and benefit items have d i f f e r e n t values for in d i v i d u a l nations depending on t h e i r special p o l i t i c a l , economic and other pressures and p r i o r i t i e s . Experience obtained i n one country does not necessarily help the valuator i n assigning values to cost and benefit 103 items i n another country. Some governments may be anxious to avoid placing an issue i n the laps of opposition parties by being seen to concede too much to foreign investors or by incurring a loss through accepting a project with too high a business r i s k . These and other factors can be brought to the attention of the decision maker when assessing the v i a b i l i t y of a potential mine outside Canada. The method s t r i v e s to value e x t e r n a l i -t i e s not captured i n a set of f i n a n c i a l statements but the importance attached to p a r t i c u l a r items of cost or benefit can materially a l t e r the o v e r a l l net r e s u l t and the user of a valuation has to allow for t h i s l i m i t a t i o n . The very act of c a r e f u l l y considering the e x t e r n a l i t i e s surrounding the potential mine i s l i k e l y to lead to an improved understanding of the views of host country i n -vestors, both public and private, by the Canadian inves-tor. Negotiations r e l a t i n g to the potential mine, p a r t i c u l a r l y on the matter of the a l l o c a t i o n of the (28) value of production from the mine, w i l l undoubtedly be held i n a better environment when the parties have an understanding of one another's targets and the best (29 possible case made for the project can be put forward. E x t e r n a l i t i e s have been mentioned and they refer to costs and benefits not generally considered i n the cash flows and other f i n a n c i a l records of a business. They can be described as the side e f f e c t s or i n d i r e c t e f f ects of making an investment and t y p i c a l l y are of d i r e c t con-104 cern to persons other than the private sector investors. There i s a wide range of items to examine when evaluating e x t e r n a l i t i e s and a comprehensive l i s t w i l l not be given here. More obvious areas of concern to the host nation re l a t e to employment, job t r a i n i n g , technology, i n f r a -structure, foreign exchange, backward and forward l i n k -ages, regional development, the dynamic e f f e c t of invest-ment on future investment, savings and consumption habits, p o l l u t i o n and the supply of entrepreneurship and c a p i t a l . The net benefit amount established by the valuator of s o c i a l items i s the maximum price a host government i s l i k e l y to pay i n terms of accepting i n f e r i o r economic returns from a project and the extent a government w i l l make concessions Is dependent on i t s various non-economic p r i o r i t y objectives. Frequently, a high p r i o r i t y target i s p o s i t i v e foreign currency flows to the -host nation and, although a complete c a l c u l a t i o n involves guesses of the ef f e c t s at the more remote ends of the backward and f o r -ward linkages to the project, the answer whether po s i t i v e or negative i s probably r i g h t providing reasonable d i l i -gence i s applied to the currency c a l c u l a t i o n e f f o r t . It i s lar g e l y a matter of f a i t h to assign, a;, s o c i a l benefit value to the dynamic e f f e c t of a current invest-ment on future investment. Transportation and power supply are e s s e n t i a l preconditions for economic develop-ment of a region. These elements sometimes lead and at other times follow development. In the case of the 105 po t e n t i a l Mexican mine transportation leads the investment but power arrives i n the area as a r e s u l t of the project investment. The subjective value depends on the degree of f a i t h that the project w i l l be followed by investment elsewhere using part of the newly created i n f r a s t r u c t u r e . The s o c i a l cost/benefit method of c a l c u l a t i n g a value of a potential mine in a foreign country i s simple i n concept but d i f f i c u l t i n application. It i s a method which has a p r a c t i c a l use to Canadian investors i n foreign ventures as i t provides a means of assessing the l e v e l of acceptance or welcome of both the project i t s e l f and the investor, for i t i s often the same method that i s used by host governments to judge them. If the Canadian investor promotes the advantages to the host nation which can be brought to the nation through external linkages with the project, then the chance of achieving the project's success i s enhanced. D i f f i c u l t i e s arise i n the application of the method owing to i n d i v i d u a l perceptions of the worth of e x t e r n a l i t i e s . However, once the s o c i a l items related to the project are i d e n t i f i e d and valued, i t i s a simple matter to sum the values and determine the net amount. 5.10 Valuation method: a preference Four valuation methods to be used by a Canadian i n -vestor for a potential mine are discussed i n t h i s chapter: methods based on cash flow, appraisal of assets, c a p i t a l i -106 zation of earnings and s o c i a l costs and benefits. The appraisal of assets method i s not considered an acceptable valuation method owing to the lack of confidence assigned to the cost of exploration to replace the potential mine asset and the method's disregard for future net benefits that may accrue once the property i s taken beyond the f e a s i b i l i t y stage. The s o c i a l cost/benefit method seeks to e s t a b l i s h a value to a host government and i s not based on objectives of the Canadian investor. The use to which the valuation i s to be put may have a bearing i f , for example, the i n t e r e s t i n the potential mine i s to be sold. In such a case the project's value to t h i r d parties i s important and the value placed on the asset by government i s but one view of the p o t e n t i a l mine. The r e a l advantage of the s o c i a l cost/benefit method l i e s . i n i t s a b i l i t y to find a range of values which can form the basis of requests to government for economic concessions to the Canadian i n -vestor and i t s partners. The advantage can be s i g n i f i c a n t and for that reason the net s o c i a l cost/benefit should be established. However, the inherent weakness of s u b j e c t i -v i t y i n any valuation method i s overwhelming i n a r r i v i n g at value amounts for s o c i a l items. The r e s u l t i s that the s o c i a l cost/benefit, method, whilst useful, i s not . acceptable to a Canadian investor for the purpose of f i x i n g a value upon a potential mine. Except for the r i s k of loss providing p o l i t i c a l 107 ammunition to the opposition parties, r i s k i s ignored i n the c a l c u l a t i o n of s o c i a l costs and benefits but i s con-sidered i n both the cash flow and earnings c a p i t a l i z a t i o n methods. The ad hoc approach to r i s k found i n the earnings c a p i t a l i z a t i o n method through the f i x i n g of the m u l t i p l i e r number i s considered i n f e r i o r to the combina-tio n of the choice of discount rate and recognition of r i s k over time that i s t i e d to the cash flow method of valuation. The cash flow and earnings c a p i t a l i z a t i o n methods use much the same information as the base for valuation but the l a t t e r method does not adequately account for the time value of money. Three of the four methods should be employed by the Canadian investor i n a valuation of a potential mine property but the cash flow method i s preferred. The earnings c a p i t a l i z a t i o n method should be used to corro-borate the value established through discounting fore-cast cash flows by ascertaining the necessary m u l t i p l i e r and being s a t i s f i e d as to i t s reasonableness. The s o c i a l cost/benefit method should be used to es t a b l i s h both the l e v e l of host country acceptance of the project and the possible amount of economic concessions that may be available to the investors: again the r e s u l t w i l l support the valuation arrived at v i a the cash flow method. 108 CHAPTER FIVE REFERENCES 1. H.D. Drechsler, J.B. Stevenson, "The e f f e c t of i n f l a t i o n on the evaluation of mines" C.T.M. B u l l e t i n , February 1977, pp 76-82 2. R.F. Mikesell, "Financial considerations i n negotiating mine development agreements" Mining Magazine, A p r i l 1974, page 259 3. A. Drory, "Economic evaluations for the decision maker" Cost and Management, July-August 1978, page 20 4. D.B. Hertz, "Risk analysis i n c a p i t a l investment" Harvard Business Review, January-February 1964, pp 95-106 5. H.K. Taylor, "Mine valuation and f e a s i b i l i t y studies" Mineral industry costs, Northwest Mining Association, Spokane, 1977, page 8 6. B. 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MacKenzie, " R e a l i s t i c evaluation of r i s k s of mining project investment and managements' a b i l i t y to control them" A.G.M. of C.I.M., Vancouver, A p r i l 1978, page 1 D.B. Hertz, "Risk analysis i n c a p i t a l investment" Harvard Business Review, January-February 1964, page 98 L.T. Wells Jnr., "Negotiating with t h i r d world governments" Harvard Business Review, January-February 1977, page 73 Supra, page 95 G.A. Brown, "The evaluation of r i s k i n mining ventures" Paper presented at the A.G.M. of C.I.M. Toronto, 21 A p r i l 1970, pp 1-5 C. Pegels, "A comparison of decision c r i t e r i a for c a p i t a l Investment decisions" The Engineering Economist, Volume 13, No. 4, 1968, page 212 D. W. Gentry, T.J. O'Neil, "A short course on f i n a n c i a l  modelling and evaluation of new mine properties" Colorado School of Mines, A p r i l 1974, page 96 W.F. Atkins, "Fair market value of a mining property" C. I.M. Bulletin,. September 1977, page 115 J.J. Dran, H.N. McCarl, "An examination of int e r e s t rates and t h e i r e f f e c t on valuation of mineral deposits" Mining Engineering, June 1977, page 47 D. W. Gentry, T.J. O'Neil, "A short course on f i n a n c i a l  modelling and evaluation of new mine properties" Colorado School of Mines, A p r i l 1974, pp 87-88 W.F. Atkins, "Fair market value of a mining property" C.I.M. B u l l e t i n , September 1977, page 113 110 28. J.L. C o l l i n s et a l , "Possible modes of government p a r t i -c ipation i n marginal mining operations" Application of  computer methods i n the mineral industry, South African Institute of Mining and Metallurgy, Johannesburg, 1973, pp 51-64 29. L.T. Wells, Jnr., "Social cost/benefit analysis for MNC's" Harvard Business Review, March-April 1975, page 40 30. D.N. Smith, L.T. Wells, Jnr., Negotiating t h i r d world  mineral agreements, Ballinger Publishing, Mass., USA, 1975, page 98 I l l CHAPTER SIX PARTNERS AND THE POTENTIAL MINE IN MEXICO 6 .1 The partners A condition of doing business i n Mexico's mining i n -dustry to be met by a foreign investor i s to operate i n a minority ownership p o s i t i o n . It i s an important part of the "Mexicanization" p o l i c y followed by successive Mexican federal governments which requires non-Mexicans to own less than f i f t y percent of the issued shares of corporations i n the mining business. In cases where special land, such as national lands, are to be included i n areas of mining a c t i v i t y , the percentage that may be owned by foreign nationals or foreign corporations i s r e s t r i c t e d to a maximum of t h i r t y - f o u r percent. Placer's investment i n Mexico f a l l s within the l a t t e r category although forty-nine percent was held o r i g i n a l l y . The change from forty-nine down to t h i r t y - f o u r percent came about when in t e r e s t i n g prospects were brought to Placer's attention and the company was persuaded to reduce i t s inter e s t by trans f e r r i n g part ownership to a Mexican government agency. The requirement to find j o i n t venturers from Mexico meant Placer needed a partner i t considered compatible and one with which i t could work for many years. I n i -t i a l l y a partner has to have the determination to invest time and money i n exploration e f f o r t which i n most cases w i l l prove f r u i t l e s s . In the event the exploration pro-112 gramme i s successful and a mine i s contemplated, a part-ner has to have the f i n a n c i a l means to assume i t s owner-ship share of the cost. Furthermore, a partner has to possess business experience and the personnel to devote to the j o i n t venture as and when required. The w i l l i n g -ness to enter the j o i n t venture together with the finan-c i a l and business c a p a b i l i t y to carry the share of the j o i n t venture obligations i s important. Long term business ventures i n the exploration and mining business are unlikely to succeed i f the goals of the parties do not mesh. Common goals have to be sought out and esta-blished by the potential j o i n t venturers to ensure obvious areas of c o n f l i c t of inte r e s t do not e x i s t . Business methods of achieving the venturers' objectives also have to be considered p a r t i c u l a r l y with regard to corrupt practice controls implemented by the Securities and Exchange Commission (the S.E.C.) i n Washington. Placer's shares are quoted on the American Stock Exchange and as a r e s u l t the Canadian company i s subject to the reporting requirements of the S.E.C. and i t s supporting l e g i s l a t i o n . In the early seventies,tax law i n Mexico included the use of special negotiated agreements with government which set the tax and other operating terms of business for a mine before commitments to b u i l d a mine were made. This type of agreement and a l l other dealings with government which the foreign investor i s concerned with,means that the attributes of the i d e a l 113 j o i n t venturer have to include the a b i l i t y to negotiate well with government. These requirements of a Mexican j o i n t venture partner are what Canadian firms such as Placer ought to look for i n the process of seeking a p a r t n e r . ^ The f i r s t Mexican partner that Placer became asso-ciated with was a bank who saw i n Placer a company ex-perienced and well respected i n the mining business on an international scale, keen.to fi n d and operate a mine i n Mexico and possessing the necessary resources to do so. The partnership flourished u n t i l the government entered the j o i n t venture and relations between govern-ment and Placer became d i f f i c u l t . The bank withdrew from the partnership and transferred i t s i n t e r e s t i n the ven-ture to a Mexican mining company. The new partner meets the requirements of Placer discussed above, p a r t i c u l a r l y i n the common goals of s u r v i v a l as mining companies and shareholder wealth maximization with the pursuit of p r o f i t as the prime motivation. Joint ventures nearly always involve a substantial sharing of project control and t h i s e n t a i l s a d e f i n i t e r i s k of disagreement. Two mining companies i n the partnership as opposed to one mining company and a bank d e f i n i t e l y increases the r i s k that the a l l o c a t i o n of project management w i l l s t r a i n the partner-ship. The size of the Mexican mining company measured in terms of operating mines, value of assets i n i t s b a l -ance sheet and number of personnel employed i s comforting 114 to Placer. Not so small as to be stretched to the l i m i t of i t s resources and not so large as to be seen as a danger to the s t a b i l i t y of the partnership. Management attitudes toward the role of private enterprise, the need for p r o f i t s and for exploration appear to be i n harmony and the business f i t of the two mining companies seems good. 1979 has witnessed an improvement i n r e l a t i o n s between the two private sector partners and the Mexican bureau-cracy. A l l parties changed t h e i r negotiation representa-tives and progress i s evidenced by a resolution to review and up-date the 1975 f e a s i b i l i t y study. Mexican govern-ment public announcements on the resolution added a state-ment to the e f f e c t the mine w i l l be b u i l t i n the near future, despite the lack of a r e l i a b l e f e a s i b i l i t y study upon which to make such a decision. The statement points to the d i s p a r i t y between the objectives of government and the two mining companies. P r o f i t i s not the primary factor for the former. The 1975 f e a s i b i l i t y study found the pro-je c t t e c h n i c a l l y f e a s i b l e and that i s good enough for government. Government can therefore turn to i t s objectives of employment creation p a r t i c u l a r l y a t t r a c t i v e when such jobs are outside the major urbanized areas of the country, the promotion of foreign investment, the generation of tax revenues and the creation of new infrastructure to the national advantage. The two mining companies have joined forces with a giant they may have d i f f i c u l t y i n handling. 115 They w i l l be wary of the partner who has no fear of bank-(3) ruptcy and of his c a p i t a l that demands no dividends. Both mining companies w i l l be aware of the creeping na t i o n a l i z a t i o n of mining i n Mexico and know there are ri s k s that government's thirty-three percent i n t e r e s t could become much larger i f the bureaucracy d i s l i k e s some action or inaction on the part of Its private (4) enterprise partners. The Mexican public already owns substantial portions of i t s production and service industries and, as Table IX indicates, to a considerably greater extent than the equivalent i n Canada. TABLE IX Pub l i c l y Owned Production and Service Industries i n Mexico and Canada Mexico Canada E l e c t r i c i t y 100% 100% Gas 100% — O i l production 100% — Coal 100% _ Shipbuilding 100% — Posts 100% 100% Telecommunication s 100% 25% Railways 100% 75% Steel 75% -A i r l i n e s 50% 75% Automobiles 25% Notes: (1) Pu b l i c l y owned means any government owned and/or controlled business s e l l i n g goods and services to the public on a large scale. (2) Percentages are approximate and the l i s t of indus-t r i e s i s not comprehensive. Source: Adapted from a chart i n The Economist 30 December 1978 and reprinted i n Harvard Business Review, March-April 1979, page 161. 116 6.2 Ownership i n the potential mine Mineral rights covering the orebody and the sur-rounding area necessary for mining are held by a company incorporated i n Mexico which for purposes of t h i s paper i s c a l l e d Mexican Mining Company S.A. de C.V. Thi r t y -four percent of Mexican Mining Company S.A. de C.V. i s owned by Placer. S.A. de C.V. (Sociedad Anonima de Capital Variable) i s a corporate v a r i a t i o n on the S.A. (Sociedad Anonima) company which most clos e l y resembles the Canadian public company. The S.A. de C.V. has two s i g n i f i c a n t differences from S.A.: f i r s t l y , that the S.A. de C.V. offers greater f l e x i b i l i t y for increasing or decreasing c a p i t a l and secondly, that the S.A. de C.V. cannot issue bearer shares and may only issue shares registered i n the names of the owners. There are no re-quirements that labour be represented on the Board of Directors. A minority shareholder with twenty-five per-cent or more of the company has the r i g h t to appoint one direc t o r and at shareholders' meetings to appoint exa-miners (comisarios) to supplement examiners appointed by (5) the majority holders. An examiner i s a representative of shareholders; a position held by directors i n Canada but not by directors i n Mexico. A mining law passed late i n 1975 cuts the maximum foreign equity allowed i n Mexican mining companies upon renewal of twenty-five year mining concessions from forty-nine percent to forty percent for regular concess-117 ions and from t h i r t y - f o u r percent to twenty-five percent for "special concessions". At the same time a new "net c a p i t a l " concept was introduced under which the foreign equity of majority Mexican-owned firms i s prorated i n ca l c u l a t i n g the net foreign p a r t i c i p a t i o n i n a new ven-(6) ture with a partly or wholly foreign-owned firm. These two laws serve to reduce the value of Placer's inte r e s t i n Mexican Mining Company S.A. de C.V. as that company's a c t i v i t i e s now bear additional r e s t r i c t i o n s on t h e i r freedom to do business i n Mexico. 6.3 Partnership p o l i c i e s At the time the parties come together i n j o i n t ven-ture, few procedural problems exi s t and the relationship between them i s good. It i s the most opportune time to set out the acceptable rules governing t h e i r relationship and i t s termination. Certain conditions can be agreed and included i n the documents formally incorporating the company through which the j o i n t venture i s carr i e d out. Such conditions w i l l cover the issue of shares, necessary shareholder approvals, minority rights to pro-rata a c q u i s i t i o n of new shares on the same terms as offered to others, dividend and l i q u i d a t i o n r i g h t s , c a p i t a l re-ductions, r e s t r i c t i o n s on borrowing and lending power and the very important voting rights at shareholder meetings. The agreed p o l i c i e s and rights set out i n the incorpora-tion papers are an esse n t i a l part of the evaluation pro-118 cess as they determine the l e v e l of protection afforded the minority shareholding. Inadequate safeguards i n t h i s area contribute unnecessary r i s k s for a prospective pur-chaser of a minority i n t e r e s t i n the corporate j o i n t venture and the value of the minority shares i n the mine w i l l be reduced. The corporate rules governing Mexican Mining Company S.A. de C.V. contain the required condi-tions and no problems are anticipated. There are many other matters of business p o l i c y which i d e a l l y are agreed upon i n writing as soon as the j o i n t venture i s struck. Such an agreement often c a l l e d a "shareholders' agreement" ought to cover p o l i c i e s con-cerning accounting standards, dividend maximization, (7) a v a i l a b i l i t y of foreign exchange, loan repayment sche-dules i n general (for example 80% or 100% of available cash), management sharing, voting r i g h t s , information dissemination, approval lev e l s and minority i n t e r e s t rights concerning expenditure and c a l l s for funds. These p o l i c i e s serve to r e s t r i c t the obligations that may be imposed on the minority holders i n the j o i n t venture corporation. Other p o l i c i e s just as important to the venture seek to avoid one party withholding approval to go ahead with or operate e f f i c i e n t l y the very project which brought the venturers together. These include minimum levels of a c t i v i t y i n areas such as mine f e a s i -b i l i t y studies, mine and m i l l design capacities, explora-t i o n , operating levels of production, sales and inventory 119 and rules governing matters to be arbitrated. Another area of int e r e s t to i n d i v i d u a l venturers i s the r i g h t to s e l l t h e i r holdings and the r i g h t to approve new members of the corporate j o i n t venture p r i o r to sale by one of the shareholders. Any new venturer ought to be bound by the same terms i n the "shareholders' agree-ment" acceded to by the vending shareholder. The share-holders' agreement concerning Mexican Mining Company S.A. de C.V. i s not as comprehensive as i t would l i k e l y have been had the venturers a l l come from Canada but the agreement i s considered adequate under Mexican business circumstances. 6.4 Negotiations Negotiations between the venturers are a v i t a l part of the process leading to the successful conclusion of mine construction and operations. In any negotiations, understanding the viewpoint of the other party i s the key to success and obtaining formal agreement on areas of p o t e n t i a l c o n f l i c t i s a worthwhile target during the discussions. An attempt should be made to determine the objectives of each of the other venturers and some govern-ment objectives are mentioned i n Chapter f i v e . Placer's in t e r e s t i n Mexico means dealing with another culture and i t i s to be expected that differences i n methods of doing business w i l l a r i s e . The art of negotiating i s one such area of difference which i n part can be attributed to the 120 macho society i n Mexico referred to i n Chapter three. A negotiator who understands the ways of negotiating by his opponent w i l l have less chance of misreading signals (8) of concession, intransigence or delay. This i s a two way matter as the Mexican negotiators encounter the same culture gap i n th e i r dealings with Canadians. The nego-t i a t i o n s surrounding Mexican Mining Company S.A. de C.V. have c l e a r l y been d i f f i c u l t and, although Mexican p o l i t i c s takes a share of the blame, the main obstacles have been problems of negotiation. Several rounds of negotiations are to be expected for a foreign investment project. I n i t i a l l y there i s the j o i n t venture to set up and generally no problems a r i s e . As target mining properties are i d e n t i f i e d i t i s a wise group that formalizes more detailed p o l i c i e s on how to go about implementing the j o i n t venture and how to allocate the gross value of production from a mine. A l l parties (9) s t r i v e for trouble-free longevity of agreements and to that end i t i s esse n t i a l negotiators at the bargaining table do not attempt to impose a r i g i d set of conditions on others. The next major stage i n negotiations i s per-haps when a f e a s i b i l i t y study i s planned and the parties have to agree on the timing and sharing of work contribu-tions. It i s at t h i s time that any ex i s t i n g misunder-standings on what constitutes p r o f i t generally come to the surface and t h i s i s p a r t i c u l a r l y so when governments deal with foreign investors. ^  ^ Government negotiators 121 are often lawyers or economists with a limited under-standing of accountancy who experience d i f f i c u l t y with concepts of depreciation and p r o f i t s versus cash flow. On the other hand, private sector negotiators usually know l i t t l e of governments cost/benefit analysis, i m p l i c i t exchange rates, shadow wage rates and externalities.^'''^ A l i k e l y cause for the three year delay i n progress on the potential mine property held by Mexican Mining Company S.A. de C.V. i s disagreement over the a l l o c a t i o n of revenue from future production between government and the other two private sector partners, including repay-ment of a l l f i n a n c i a l obligations of the j o i n t l y held corporation. A s i g n i f i c a n t measure of agreement has now been made and, as stated e a r l i e r , a new up-dating f e a s i -b i l i t y study i s i n progress. Future negotiations may be anticipated following recoupment of a l l outlays for the construction and opera-tion of the mine and a reasonable return on investment has been earned. The timing of future renegotiations w i l l depend on the government's perception of what c o n s t i -tutes "reasonable". Not only does the issue of p r o f i t s and cash flow a r i s e but also the thorny problems of i n -f l a t i o n and fluc t u a t i n g exchange rates and th e i r e f f e c t s on both p r o f i t s and cash flow. The r e c o n c i l i a t i o n be-tween government and foreign investor calculations of the f i n a n c i a l r esults of the project, whether p r o f i t s , cash flow or return on investment, i s very d i f f i c u l t owing to 122 divergent viewpoints. The foreign investor can help his case i n the future i f , at the time a mechanism i s formu-lated whereby a decision to go-ahead with the project i s agreed upon by the j o i n t venturers, the foreign investor sets a minimum rate of return on investment. When the f e a s i b i l i t y study indicates the minimum i s not expected to be achieved the project i s shelved but i f results are forecast to improve on the minimum then one of the condi-tions needed for a posit i v e decision to bu i l d the mine i s met. The method of computing the rate of return should be s p e c i f i e d and, for reasons discussed i n Chapter f i v e , the "investment decision" a l l equity financed case ought to be used. A review of the foreign investor's rewards from a mining project may come at any time but a ten year operating period i s often half way through the t o t a l mine l i f e and perhaps three or four years aft e r investment funds have been recouped. An a r b i t r a r y ten year cut-off of a project's forecast f i n a n c i a l results i s useful to ascertain the exposure to economic hardship i n the event the foreign investor's asset i s l o s t to him at the end of that time. Renegotiations may be prompted by excellent f i n a n c i a l r esults or p o l i t i c a l events. Other causes may relate to ri s k s reduced over time by successful mining, higher than expected infrastructure costs borne by government to ser-vice the mine, the need for increased tax revenue or the desire for reduced foreign ownership.. The terms nego-123 t i a t e d to a t t r a c t a foreign investor i n i t i a l l y are usually quite d i f f e r e n t from those required to r e t a i n him and as c a p i t a l i s locked-in the foreign investor i s at a clear disadvantage. Any valuation of a Canadian's investment i n Mexico must allow for the p o s s i b i l i t y that the finan-c i a l ground rules w i l l deteriorate over time. 6.5 The p o t e n t i a l mine i n Mexico The orebody i s located i n the south-east of the State of Zacatecas i n Mexico, about one hundred and forty road kilometres from San Luis Potosi and thirty-seven k i l o -metres on secondary roads from the highway 4 9 main road to Zacatecas eighty-seven kilometres from the orebody. The orebody l i e s at the 2 200 metre elevation and i s delineated down to the 2 000 metre l e v e l . The ore re-serves as shown in Table X are determined using cut-off grades expressed i n terms of s i l v e r , as s i l v e r i s the p r i n c i p a l economic metal i n the ore. Other economic metals are lead and zinc and the mine product i s forecast to be i n separate concentrates: a l e a d - s i l v e r concentrate and a zinc concentrate. A cut-off grade i s an operating control which i s a minimum grade s p e c i f i e d for the purpose of declaring the more general tonnes of ore i n geological reserves. A calculated cut-off i s used for mineable ore reserves based on assumed economic data for saleable con-centrate values net of smelter costs, operating and mar-keting costs and taxes. The operating control l i e s i n 124 TABLE X Mexican Mining Company S.A. de C.V. Ore Reserves to 2 000 Metres Elevation Ore Reserves Silver(Ag) Lead(Pb) Zinc(Zn) OOOt g/t % % Geological ore reserves Cutoff 25 g/t,Ag 54 000 77 1.05 0.96 Mineable ore reserves Cutoff 25 g/t,Ag 51 000 78 1.06 0.97 Note: For imperial measurement equivalents refer to Appendix 2 Source: Placer Development Limited the fact that the cut-off grade i s used i n separating two choices of action; i n rock breaking and i n the drawing (12) and disposal of broken material. Inverse cut-off grades are also operating controls and they relate to maximum contents of impurities i n ores and concentrates which are of p a r t i c u l a r importance economically when smelters demand penalties where contract maximum impuri-t i e s are exceeded. Mineable ore reserves calculated to optimize the size and cost of the plant to provide a predetermined rate of return on investment w i l l e s t a b l i s h a cut-off grade which i s not necessarily acceptable. Op-timal output to obtain the desired return on investment may well exhaust the mineable ore reserves too quickly with undesirable s o c i a l e f f e c ts on the workforce. On the one hand, the aim i s to capture the economies of scale often present i n mining but, on the other, r e l a t i v e l y high production may not a l l be r e a d i l y saleable at a t t r a c t i v e prices without the necessity for heavy inventories. Pro-duction levels at less than optimal lev e l s leads to the de f e r r a l of cash flow otherwise attainable but the present value of deferred cash flow has to be weighed against the s o c i a l benefits of operating a mine with a f i f t e e n to (13) twenty year l i f e . Placer's aim i s to est a b l i s h eco-nomically viable mines forecast to operate a minimum of (14) approximately twenty years. The mining and m i l l i n g rates selected by management and recorded i n the 1975 f e a s i b i l i t y study, unchanged for the purposes of t h i s paper, are as shown i n Table XI. The rates allow a twenty year mine l i f e with an average s t r i p r a t i o of 1.45:1.00 waste to ore which exhausts the mineable reserves. TABLE XI Mexican Mining Company S.A. de C.V. Mining and M i l l i n g Rates  Operating Years Mined Waste M i l l i o n s of tonnes annually Ore Mining: 1- 5 6-14 15-20 4.5 to 5.0 7.4 to 8.6 4.0 to 4.9 2.0 to 2.5 4.9 to 6.1 1.5 to 2.4 2.5 2.5 2.5 M i l l i n g : 6 900 tonnes average d a i l y 1-20 2.5 Source: Placer Development Limited Clearly, the p r i n c i p a l constraint on plant size to o p t i -mize the present value of forecast cash flows from the potential mine i s the minimum mine l i f e . In such a case 126 cash flow i s maximized when the cash flow per tonne of (15) ore milled i s maximized. To arrive at estimated ore reserves, the orebody i s t h e o r e t i c a l l y divided into quite small blocks and each block i s assigned i t s revenue value, processing and marketing costs, a minimum p r o f i t and taxes. The minimum p r o f i t i s included so that those blocks included i n mineable reserves contribute s u f f i c i e n t cash to meet the target return on investment for the pro-j e c t . In practice, d i f f i c u l t i e s a r i s e i n determining the amount of p r o f i t required from a block to be c l a s s i f i e d as ore and several calculations of ore reserves may be necessary to reach a feasible solution with a sa t i s f a c t o r y (16) return on investment. It i s in t e r e s t i n g to note that the ore reserves and grades according to Table X indicates that only 2% of the orebody contains economic metals and therefore the cost of transforming the economic metals to a saleable condition i s largely the cost of handling the gangue thrown away. The selected m i l l s i z e i s forecast to achieve an average throughput of 6 900 tonnes of ore d a i l y assuming shutdowns on eight l e g a l holidays annually. Operating on a twenty-four hour day basis for ninety-five percent of the time, the m i l l capacity needed has to be rated at 7 250 tonnes per day. Laboratory t e s t work by Placer on d r i l l cores and bulk samples from the Zacatecas property prove that two concentrates w i l l be necessary to optimize the project cash flow and the forecast output i s shown i n 127 Table XII. A project may be t e c h n i c a l l y feasible of becoming an operating mine but, as mentioned above, one of the variables highly correlated to mineable reserves i s the metal pr i c e . Metal prices have great significance both at the beginning of the mining process and at the more obvious end of the process when sales are r e a l i z e d . As prices r i s e and f a l l , so mineable reserves are created or l o s t . TABLE XII Mexican Mining Company S.A. de C.V. Concentrate Output  Concentrate Operating '000 tonnes  Year Total Lead-Silver Zinc 1 60.5 31.6 28.9 2 70.0 35.4 34 .6 3 78.3 40.5 37.8 4 78.6 38.1 40.5 5 66.7 31.9 34.8 6 73.4 36.6 36.8 7 74.2 38.0 36.2 8 72.1 37.6 34.5 9 75.1 38.6 36.5 10 66.6 33.2 33.4 11 65.5 31.7 33.8 12 64.4 31.7 32.7 13 69.3 34.7 34.6 14 72.3 36.5 35.8 15 73.5 36.9 36.6 16 75.7 39.1 36.6 17 75.3 39.5 35.8 18 70.7 38.0 32.7 19 79.8 42.1 37.7 20 107.2 59.0 48.2 1469.2 750.7 718.5 Note: Metal contained i n ore i s forecast to be recovered as follows although i n i t i a l years recoveries are l e s s : Lead to l e a d - s i l v e r concentrate 90% S i l v e r to l e a d - s i l v e r concentrate 85% Zinc to zinc concentrate 80% Source: Placer Development Limited 128 TABLE XIII Mexican Mining Company S.A. de C.V. Metal Production i n Concentrates Silver(Ag) i n Concentrates tonnes . : Lead(Pb) i n Zinc(Zn) i n Operating Lead Concentrates Concentrates Year Total S i l v e r Zinc '000 tonnes *000 tonnes 1 147 131 16 19.4 17.0 2 175 163 12 21.6 19.6 3 201 192 9 24.5 21.1 4 209 202 7 23.1 22.3 5 164 157 7 19.4 19.1 6 169 164 5 22.0 20.2 7 161 156 5 23.0 19.9 8 176 171 5 22.8 19.0 9 186 181 5 23.3 20.2 10 184 179 5 20.0 18.4 11 147 143 4 19.2 18.6 12 146 142 4 19.2 18.0 13 154 150 4 21.0 19.0 14 139 134 5 22.0 19.7 15 161 156 5 22.3 20.1 16 195 190 5 23.7 20.2 17 157 152 5 23.9 19.8 18 139 135 4 23.0 18.1 19 132 127 5 25.4 20.9 20 179 173 6 35.6 26.8 3321 3198 .123 454.4 398.0 Note: The l e a d - s i l v e r concentrate contains more than 99% of the lead and 96% of the s i l v e r production but less than 7% of the zinc production. The balance of the metals i s in the zinc concentrate. Source: Placer Development Limited 6.6 Metal revenue forecasts The potential mine has three payable metals i n the two concentrates: s i l v e r , lead and zinc. The small amount of lead i n the zinc concentrate (less than 1%) i s , however, not expected to be paid for by the customer. Many organizations devote much time and e f f o r t to the 129 matter of future price trends for metals and Placer has marketing experts who provide t h e i r forecasts for the short-term and long-term trends In price s . The price forecasts may be used for d i f f e r e n t purposes and so may be stated with varying lev e l s of confidence that they w i l l be equalled or bettered at the relevant time. At the economic study stage of the prospect, the l e v e l of confidence may be r e l a t i v e l y low at, say, f i f t y percent, as more d r i l l i n g may be required to delineate the orebody and the p o s s i b i l i t y of establishing greater mineable re-serves i s strong. The f e a s i b i l i t y study i s a detailed and c a r e f u l l y prepared document which requires greater certainty of input data than i t s predecessor; the economic study. Perhaps seventy or ninety percent lev e l s of certainty of prices are required by management. It i s recommended that metal price forecasts used i n economic and f e a s i b i l i t y studies be kept simple; f i r s t l y , because minor fluctuations are d i f f i c u l t to j u s t i f y and, secondly, because negotiations with venture partners and government agencies have less cause to become bogged down in detailed (18) price discussions. Mexico has price controls on seventy-nine consumer goods or i n d u s t r i a l materials (as of 1 March, 1978) which includes "minerals" under the general heading for items controlled termed "basic (19) i n d u s t r i a l products." Although s i l v e r , lead and zinc prices for the metals i n concentrate form are not subject to controls, the r i s k i s r e a l owing to the existence of 130 the law which covers minerals. The payable metals from the Zacatecas mine are ex-pected to be sold at prices based on the d a i l y quotations for the in d i v i d u a l metals on the London Metal Exchange (the LME) over the quotational periods s p e c i f i e d i n the sales contracts from time to time. The s e l l i n g prices for the payable metals receivable by concentrate producers are determined i n two parts. The LME price for the metal i s the f i r s t and the second i s the deduction from the LME price by the customer for smelting and r e f i n i n g the con-centrate. The supply and demand cycles for the s i l v e r metal and the s i l v e r i n concentrate do not necessarily run p a r a l l e l and the same can be said for lead and zinc. Any forecasts of mine revenue from production of concen-trate ought to take both factors into consideration. Long-term contracts with smelter customers have become much less common and those that remain contain clauses c a l l i n g for early termination or renegotiation under cer t a i n conditions, such as hardship. The smelters operating cost increases due to i n f l a t i o n are being passed along to the miner i n keeping with the t r a d i t i o n a l concept of the smelter as a service provider, and the (21) miner as the r i s k taker. P a r t i c i p a t i o n i n the price of the metal has been a feature of the concentrate market for zinc but as the r e l a t i v e strength of the zinc smelters increased over the miners i n the second half of the 1970's, so the r i s k i s being removed from the smelter and returned 131 to the miner through fixed charges. A fixed charge favours the miner i n a strong market and the smelter i n a weak market. The metal price and smelter cost forecasts i n the i n i t i a l years of mine production during the investment payback period are e s p e c i a l l y important owing to the e f f e c t on present values of cash flows i n the early years. The supply and demand for smelter capacity which can handle the concentrate expected to be produced from the mine has to be reviewed to ensure the product i s saleable. The anticipated c h a r a c t e r i s t i c s of the zinc concentrate to be produced by the project may prevent Mexican smelters buying i t as twelve percent iron also i n the concentrate cannot at this time be handled by them. However, other smelters i n the USA, Japan, Canada and Europe have the technical c a p a b i l i t y so the concentrate i s saleable. Both concentrates are expected to be sold i n terms of United States currency. The LME prices are expressed i n s t e r l i n g and sales contracts provide for t r a n s l a t i o n of the s t e r l i n g to d o l l a r s . Smelter charges are often contracted for i n United States currency by mines i n Mexico and North America thereby reducing the miner's r i s k of exchange loss. However, the decline i n the value of the American currency i n terms of European and Japanese currencies i s leading to pressure by smelters for miners to accept greater r i s k of currency f l u c t u a t i o n . The price cycle common to most metals encourages the completion of new mines on the upswing of the price cycle and price forecasts play an important role on the timing of a go-ahead decision to b u i l d . The hazards of metal price swings are emphasized when the planned mining se-quence requires the high grading of the orebody to maxi-mize cash flows i n the early years. If high grading coincides with the trough i n the price cycle, the econo-mic v i a b i l i t y of the project can be endangered. High grading can arise through the nature of the orebody i t s e l f where a "plum" i n the orebody i s mined f i r s t , or by i n -creasing the amount of p r o f i t i n certa i n blocks of the orebody and consigning some otherwise good ore to waste. Part of the concentrate revenue forecasts for metal price and smelter charges i s concerned with the timing of receipt of funds from the customer and the other terms of sale. Again i t i s the i n i t i a l operating years which are important when loan inte r e s t i s a major cost of the busi-ness. Perhaps the term of greatest significance i s the penalty for impurities contained i n the concentrate which the smelting and r e f i n i n g processes have to remove. The addition to smelter costs has to be weighed against the cost of meeting the penalty metal(s) maximum grade i n de-ciding on the mining sequence and the design of the m i l l i n g process. Forecast product prices and forms of sales for Mexican Mining Company S.A. de C.V. are given i n Table XIV. The price of s i l v e r i s affected by the dual role the metal 133 plays: that of an i n d u s t r i a l commodity and a monetary store of value. At times the price may r e f l e c t condi-tions of the i n d u s t r i a l market and at others the specula-tors view of world p o l i t i c a l and economic conditions. TABLE XIV Mexican Mining Company S.A. de C.V. Forecast Product Prices and Terms of Sale (Expressed i n 1979 constant United States dollars) Average Price: Payable metal and L i f e of Mine smelter deductions Lead/Silver Concentrate: Silver(Ag) US $193/kg 1 grade % deduction 95% of Ag Refining $0.04/kg Ag payable Lead(Pb) US $750/t 90% of Pb Refining $54/t Pb payable Treatment $35/t concentrate Zinc concentrate: Zinc(Zn) US $882/t 85% of Zn Treatment 37% of payable Zn Silver(Ag) US $193/t 60% of Ag above 155 g/t Notes: 1) The above prices are used i n the base cases. 2) Average prices are stated to be 70% of being equalled or surpassed. 3) For imperial measurement equivalents refer to Appendix 2. Source: Placer Development Limited Demand for s i l v e r f a l l s into three broad categories of i n d u s t r i a l demand, decorative and jewelry demand and i n -vestment or speculative demand. Overall, s i l v e r consump-tio n i s cl o s e l y related to i n d u s t r i a l production and economic growth i n developed countries. The debasement of world currencies i n the s i x t i e s accounted for a 134 dramatic decline i n consumption i n that decade but since 1970, consumption of s i l v e r for coins has remained low (22) but r e l a t i v e l y constant. The health of the world economies i s now a more s i g n i f i c a n t factor on s i l v e r prices than at any time t h i s century and the OPEC induced world economic c r i s i s presently being played out i s bringing speculative demand to bear on s i l v e r prices at t h i s time (August 1979) as the United States d o l l a r goes through a c r i s i s of confidence. On the other side of the balance, supply from mines has been outstripped by t o t a l (23) demand and only above ground supply has m recent years been able to bring i n the remainder to meet the consump-(24) t i o n . In 197 9, the Indian government banned the d i s -hording and export of s i l v e r and t h i s t r a d i t i o n a l source of above ground s i l v e r running at six hundred to twelve hundred tonnes annually, or approximately f i v e percent of consumption, has added another dimension to the mid (25) 1979 dramatic r i s e i n the price of s i l v e r . S i l v e r prices were i n the range US $45/kg to US $100/ kg for years p r i o r to the meteoric r i s e i n late 1973 at the time of the f i r s t OPEC o i l c r i s i s . The price then stayed i n the range US $125/kg to US $200/kg u n t i l mid 1979 and the price i s now trading i n the US $300/kg area (August 1979). Placer Development Limited predicted a long-term average price for s i l v e r expressed i n mid 1979 constant United States d o l l a r s of US $193/kg ($6.00/troy ounce) with a 70% l e v e l of confidence that that price w i l l be equalled or surpassed. In a mining context, US $193/kg w i l l be low for fourteen years out of the twenty year mine l i f e In Zacatecas but too high for the remaining s i x . The r i s k l i e s i n the fact that the repay-ment period for the recoupment of investment funds i s 6.7 years for Placer i n the base financing decision case (Table XX). S i l v e r production i n Mexico w i l l be boosted s i g n i f i -cantly i n the event, the Zacatecas, property i s developed and i t w i l l ensure Mexico remains one of the world's largest suppliers of the metal. Production of s i l v e r i n Mexico was increased by new or expanded mines i n the mid (26) seventies but s t i l l smelter capacity i s s u f f i c i e n t within the country to handle any anticipated new supply. The Zacatecas property w i l l represent about ten percent of the t o t a l national s i l v e r production. S i m i l a r l y , lead and zinc production from the property w i l l each represent about ten percent of the t o t a l Mexican production of those metals. Lead supply and demand i s forecast to be i n near balance i n the 1980's with a reduced growth rate i n demand (27) i n the two percent annual range. Small differences can have a very s i g n i f i c a n t impact on price, however the long-term delicate supply/demand balance i s anticipated to keep average lead prices somewhat lower than 19 79 pre-v a i l i n g prices as currently there i s a supply shortage. Placer Development Limited forecast i n early 1979 long-136 term lead prices to average US $750/tonne during the l i f e of the Zacatecas mine with a 70% l e v e l of confidence that the price w i l l be equalled or surpassed. The difference between zinc supply and demand i n the next decade i s expected to be r e l a t i v e l y small compared with annual world demand of approximately four m i l l i o n tonnes. Again, price movements can be s i g n i f i c a n t during (28) short-term inbalahces. In early 1979, Placer Develop-ment forecast long-term zinc prices to average US $882/ tonne over the twenty year project l i f e with a 70% l e v e l of confidence. Smelter deductions a l t e r frequently i n tune with the v o l a t i l e concentrate markets for each metal. Character-i s t i c s of i n d i v i d u a l concentrates have t h e i r e f f e c t on smelter terms also and sometimes r e s t r i c t the number of smelters able to handle the product. The l e a d / s i l v e r concentrate i s a straight-forward marketing problem and the smelter deduction to account for the processing of concentrate to refined metals i s regarded as normal. The forecast long-term average deductions by the smelter are one grade percentage of the s i l v e r i n concentrate, f i v e percent of the payable s i l v e r and four cents per kilogram of payable s i l v e r . The lead smelter cost to the mine i s forecast to be ten percent of the lead contained, $54 per tonne of lead payable and $35 per tonne of l e a d / s i l v e r concentrate. The zinc concentrate i s expected to have a high iron impurity and consequently low net returns are 137 forecast. Although the zinc concentrate w i l l include recoverable s i l v e r and cadmium, the net smelter return from those two metals w i l l be small. The zinc i t s e l f w i l l suffer a f i f t e e n percent of metal, or minimum eight grade percentage points, deduction and then a t h i r t y -seven percent r e f i n i n g charge on average over the mine l i f e . However, during the operating period the basis of smelter and/or r e f i n i n g charges may a l t e r . An example mentioned i s the tendency for zinc r e f i n i n g charges to switch from fixed charges to a price sharing formula. 6.7 Mine costs A company i s never sure of i t s mineable ore reserves u n t i l expensive mining operations give i t access to them. The cost of mining i s incurred i n two stages: that of construction and that of operations. Table XV shows that, ignoring the time value of money, the major portion of costs w i l l be incurred during the operations stage of the Zacatecas mining prospect. There i s considerable r i s k attached to the mine's construction and i t i s that phase of the project which gets the lio n ' s share of attention. The plant must be capable of producing a saleable product e f f i c i e n t l y and meet a l l the regulatory control standards at the same time. Just ten percent of the t o t a l costs forecast to be incurred on the project are committed pr i o r to operation's commencement which i l l u s t r a t e s the reason why healthy growth and confident planning (or stable rules 138 of business) are v i t a l to the mining industry which i n -vests many mil l i o n s of dol l a r s over a long period of time before recording a single cent of return on that invest-(29) ment. The Zacatecas mine requires a construction period of t h i r t y months which, when added to the base loan case payback period of 6.7 operating years, means recoupment of the f i r s t d o l l a r invested on a l a s t out basis w i l l take 9.2 years. Even 9.2 years excludes the sunk costs of exploration and other resources devoted to locating a viable orebody i n Mexico. TABLE XV Mexican Mining Company S.A. de C.V. Mine Costs  (Expressed i n 1979 constant United States dollars) Capital expenditures Preproduction - acquisitions - finance costs Table XVI Postproduction - acquisitions Table XVII Operations expenditures Operating costs Table XVIII Finance costs -13% p.a. Table XXI Taxes Table XXIII Total mine costs $75 4 105 975 000 000 67% 4% 80 080 000 71% 10% 33 010 000 29% 4% 113 090 000 100% 389 010 000 57% 21 278 650 158 000 000 3% 40% 688 818 000 100% 86% $801 908 000 100% Note: The above costs are used i n the loan base case (Appendix 14) Source: Placer Development Limited 139 The c a p i t a l cost of mine construction i s forecast as $75 105 000 1979 United States constant d o l l a r s plus the preproduction cost of financing the project of US $4 975 000 at 13% Interest. A summary breakdown i s given i n Table XVI. The costs expressed i n 1979 values are estimated on the basis of 1975 c a p i t a l cost c a l c u l a -tions u p l i f t e d for Mexican i n f l a t i o n at varying rates for labour, material, equipment and other items and adjusting for the new exchange rates. Import duties otherwise pay-able are forecast to be reduced to twenty-five percent of t h e i r normal l e v e l ^ r e s u l t i n g i n a "saving" of US $1 700 000 i n construction costs. Postproduction c a p i t a l expenditure i s forecast to be incurred throughout the mine l i f e but with, larger amounts a r i s i n g i n operating years six, eleven and twelve. A summary i s given i n Table XVII. TABLE XVI Mexican Mining Company S.A. de C.V. Capital Construction Expenditures (Expressed i n 1979 constant United States dollars) Open p i t preparation and equipment $ 7 500 000 E l e c t r i c a l equipment and i n s t a l l a t i o n 10 000 000 Concentrator and t a i l i n g s 32 000 000 Townsite 4 000 000 Contractors 6 000 000 Design, engineering and research 6 000 000 Overhead, Vancouver and Mexico 8 000 000 Start-up operations 1 605 000 $75 105 000 Finance costs to end of construction - 13% 4 975 000 Total construction cost - Table XV $80 080 000 Construction cost per tonne m i l l i n g annual capacity $32.50 Note: The above costs are used i n the base cases Source: Placer Development Limited - amended by the author for i n f l a t i o n and exchange rates. 140 TABLE XVII Mexican Mining Company S.A. de C.V. Postproduction C a p i t a l Expenditures (Expressed i n 197 9 constant United States dollars) Operating Year Expenditure 1 $845 000 2 750 000 3 650 000 4 1 110 000 5 1 955 000 6 3 680 000 7 2 235 000 8 1 110 000 9 1 250 000 10 2 235 000 11 4 010 000 12 2 820 000 13 2 165 000 14 935 000 15 1 825 000 16 2 100 000 17 1 680 000 18 1 330 000 19 195 000 20 130 000 $33 010 000 Note: The above costs are used i n the base cases. Source: Placer Development Limited - amended by the author for i n f l a t i o n and exchange rates. An understanding with government has to be reached on the provision of infrastructure necessary.to b u i l d and oper-ate a mine. The Zacatecas property at present lacks the power, f a c i l i t i e s and townsite required and government agencies w i l l be asked to schedule t h e i r construction i n harmony with the c r i t i c a l path set for the o v e r a l l pro-ject construction. Negotiations w i l l take place con-cerning the share of infrastructure costs to be assumed by the general taxpayers as well as the timing of payment by the mine for the portion to be borne by i t . 141 Operating costs over the twenty year mine l i f e are l i s t e d i n Table XVIII and cover mining and m i l l i n g costs, water, townsite, road maintenance and administration. In addition, the concentrates transportation costs to smel-ters are included here and they represent approximately eleven percent of the t o t a l . Operating costs excluding transportation of concentrates average US $7.27 per tonne of ore milled throughout the mine l i f e and transportation costs average US $20 and US $43 per tonne of l e a d / s i l v e r and zinc concentrate respectively. TABLE XVIII Mexican Mining Company S.A. de C.V. Operating Costs  (Expressed i n 1979 constant United States dollars) Operating Year Transportation Operating Costs Total 1 $1 769 000 $16 250 000 $18 019 000 2 2 072 000 16 250 000 18 322 000 3 2 300 000 16 250 000 18 550 000 4 2 364 000 16 250 000 18 614 000 5 2 012 000 16 250 000 18 262 000 6 2 182 000 18 012 000 20 194 000 7 2 185 000 18 873 000 21 058 000 8 2 111 000 18 873 000 20 984 000 9 2 207 000 18 873 000 21 080 000 10 1 984 000 18 873 000 20 857 000 11 1 972 000 18 873 000 20 845 000 12 1 925 000 18 873 000 20 798 000 13 2 059 000 18 012 000 20 071 000 14 2 141 000 18 012 000 20 153 000 15 2 180 000 16 250 000 18 430 000 16 2 223 000 15 831 000 18 054 000 17 2 198 000 15 645 000 17 843 000 18 2 044 000 15 645 000 17 689 000 19 2 325 000 15 645 000 17 970 000 20 3 072 000 18 145 000 21 217 000 $43 325 000 $345 685 000 $389 010 000 Per tonne of ore milled $7.27 Per tonne - Pb/Ag concentrate $2 0 - Zn concentrate $43 Source: Placer Development Limited - amended by the author for i n f l a t i o n and exchange rates. 142 Postproduction finance costs are calculated on the outstanding loan balance at the beginning of the operating period at thirteen percent assuming p r i n c i p a l repayments are made at each year end out of the entire available cash flow. The costs of finance other than i n t e r e s t i t s e l f i s incorporated i n an o v e r a l l rate of thirteen percent. 6.8 F e a s i b i l i t y study Considerable e f f o r t and resources are needed to com-p i l e a comprehensive f e a s i b i l i t y study and most mining companies s a t i s f y themselves the exercise i s worthwhile by preparing a preliminary economic study f i r s t . The economic study deals with broad concepts and often has unproven data based on experience and f a i t h . The f e a s i -b i l i t y study aims to prove beyond reasonable doubt that: (a) s u f f i c i e n t economically recoverable ore reserves are available on mineral properties held, and (b) the mineable ore reserves can be transformed into a saleable product and sold into the market. Data assembled for ore reserves, l e g a l r i g h t s , con-struction and other c a p i t a l costs, operating costs, re-venues and taxes i s used to prepare cash flows for the project. The cash flows are i n turn submitted to lenders of funds to support the request for loans to finance the project. A f u l l y documented f e a s i b i l i t y study of the entire mine process from ore i n the ground to cash i n the bank does much to minimize the f i n a n c i a l costs of funding 143 agreements, construction completion guarantees, operating performance bonds and most of a l l the rates of i n t e r e s t . The f e a s i b i l i t y study prepared i n 1975 for the Zaca-tecas property did prove points (a) and (b) above beyond reasonable doubt. However one more ingredient i s needed and that i s that there must be a willingness and capabi-l i t y among owners and government to make the mine project viable. The lack of a common purpose s t a l l e d the project i n Zacatecas for three years. 144 CHAPTER SIX  REFERENCES 1. J.W.C. Tomlinson, M. Thompson "A Study of Canadian Joint  Ventures i n Mexico" Div i s i o n of International Business Studies, Faculty of Commerce and Business Administration, University of B r i t i s h Columbia, 1977, page 11 2. P.J. P e r i l l e , F.J. Saathoff, "Why Not Project Financing?" Management Accounting, October 1978, page 15 3. K.D. Walters, R.J. Monsen "State-owned business abroad: new competitive threat." Harvard Business Review, March-A p r i l 1979, pp 165-170 4. D.G. Bradley "Managing against expropriation", Harvard  Business Review, July-August 1977, pp 75-83 5. Investing, l i c e n s i n g and trading conditions abroad: Mexico Business International Corp., 1978, pp 9-10 6. IBID, page 8 7. R.F. Mikesell, "Financial considerations i n negotiating mine development agreements." Mining Magazine, A p r i l 1974, page 265 8. L.T. Wells, Jnr., "Negotiating with t h i r d world governments" Harvard Business Review,January-February 1977, page 79 9. IBID, page 7 3 10. R.F. Mikesell, "Financial considerations i n negotiating mine development agreements." Mining Magazine, A p r i l 1974, page 259 11. Supra, page 7 9 12. H.K. Taylor, "General background theory of cutoff grades" Transactions of the I n s t i t u t i o n of Mining and Metallurgy, Volume 81, 1972, Section A, page 160 13. H.K. Taylor, "Mine valuation and f e a s i b i l i t y studies" Mineral Industry Costs, Northwest Mining Association, Spokane, 1977 14. R.G. Duthie (President of Placer Development Limited) statement to author on 10 August 197 9, Vancouver, B.C. 15. M.R.L. Blackwell, "Some aspects of the evaluation and planning of the Bougainville copper project" Decision- making i n the Mineral Industry, C.I.M. Special Volume No. 12, 1971, page 266 145 16. J.L. Halls, D.P. Bellum, C.K. Lewis, "Determination of optimum ore reserves and plant size by incremental f i n a n c i a l analysis", I n s t i t u t i o n of Mining and Metallurgy  Transactions 78, Part A, 1969, page 20 17. H.K. Taylor, "General background theory of cutoff grades" Transactions of the I n s t i t u t i o n of Mining and Metallurgy, Volume 81, 1972, Section A, page 163 18. J.B. Utley, "Doing business with l a t i n n a t i o n a l i s t s " , Harvard Business Review, January-February 1973, page 80 19. Investing, Licencing and Trading Conditions Abroad: Mexico Business International Corp., 1978, page 11 20. R.H. Lesemann, "Commercial and price considerations i n mine f e a s i b i l i t y and cost studies: smelting and r e f i n i n g charges", Mineral Industry Costs, Chapter 12, Northwest Mining Association, Spokane, 1977, page 200 21. IBID, page 201 22. A. McQuire, " S i l v e r " unpublished memo dated 2 May, 1978, Placer Development Limited 23. " S i l v e r " Annual Review and Outlook, J. Aron Commodities Corporation, Precious Metals Research Department, New York, January 1979, page 39 24. World Metal S t a t i s t i c s , World Bureau of Metal S t a t i s t i c s , London, January 1979, pp 9-10 25. S.P. Rana, "Precious metals advance sharply" Northern  Miner, 10 May 1979, page 10 26. " S i l v e r mining at Las Torres" Mining Magazine, February 1979 pp 110-123 and "New mines and expansions boost Mexican s i l v e r output" Mining Magazine, February 1976, pp 115-121 27. "Outlook for lead", A paper issued by Cominco Limited, Vancouver, February 197 9, page 3 28. "Outlook for zinc", A paper issued by Cominco Limited, Vancouver, May 197 9, page 4 29. "Placer p o l i c y " Western Miner, Volume 49, No. 8, August 1976, page 55 30. Gonzalez V i l c h i s y Cia, Boletin Informativo No. 1 issued 2 January 1978, page 5 146 CHAPTER SEVEN  PROJECT ECONOMIC RESULTS AND VALUATION 7.1 Cash flow forecasts Assumptions used to compile the cash flows for the base cases are described i n Chapter six and summarized i n Tables X to XVIII. Four base case sets of cash flow re-suits are given i n Tables XIX and XX together with three selected cash flows for each of: 1) the investment decision case for the project and, 2) for Placer Development Limited's shareholding i n the Mexico project, 3) the financing decision case for the project and, 4) for Placer Development Limited's shareholding i n the financing case of the project. Cash flow results for other cases are given i n Appen-dices 3, 4, 7 and 8 and the results of a l l cash flows coupled with p r o b a b i l i t i e s of t h e i r occurrence (Appendices 11 and 12) establish expected r e s u l t s . Chapter f i v e refers to the need for investment deci-sions and financing decisions to be kept separate: the f i r s t to a s s i s t deciding whether projects are acceptable and meet the investment c r i t e r i a and the second to decide on the method of financing an acceptable project. Table XIX data shows that the base case for the corporate ve-h i c l e , Mexican Mining Company S.A. de C.V., assuming a l l equity financing throws o f f t o t a l cash flow, after recoup-ment of the investment cost, of US $196 726 000. That sum discounted at 15% annually back to March 1979 i s just US $577 000 for a return on investment of 15.2%. The equivalent data for Placer's 34% shareholding i n the TABLE XIX Mexican Mining Company S.A. de C.V. Results of Selected Cash Flows - The Project (Expressed i n 1979 constant United States dollars) Prob a b i l i t y Case of Case Number occurrence Description Investment Decision Cases Production Years to Payback Return on Investment After Tax Net Present Values d i s -counted at Mar.1979($000) 0^  15% 20% 1 0.224 Base 5 .2 15 9 9- 196 726 577 (14 424) 3 0.160 - minus 10% of metal prices 6 .4 12 9 & 147 817 (10 585) (22 340) 14 0.112 - no production tax for 5 years and 20% acce-lerated depreciation 3 .6 18 . 6 % 210 297 12 469 ( 3 845) 15 0.017 - no production tax and income tax for 5 years 3 .3 22 .7% 251 904 27 723 7 569 Expected 5 .1 14 .9% 176 537 ( 305) (14 294) Financing Decision Cases 101 0.1613 Base 6 .5 17 9 S-• ^ o 180 927 6 060 ( 5 592) 103 0.1440 - minus 10% of metal prices 7 .8 13 .4% 130 457 ( 4 279) (12 470) 114 0.1008 - no production tax for 5 years and 20% acce-lerated depreciation 4 .4 21 .1% 196 543 15 441 2 065 115 0.0151 - no production tax and income tax for 5 years 3 .9 25 7 9- 231 601 27 564 10 985 Expected 6 .5 16 163 338 4 570 ( 6 173) Notes: 1) The above data i s selected from case results l i s t e d i n Appendices 3 and 4 for investment decision and financing decision cases respectively. 2) Expected re s u l t s are based on results l i s t e d i n Appendices 3 and 4 together with p r o b a b i l i t i e s of occurrence according to Appendices 11 and 12. 148 project shown on Table XX i s US $47 018 Q00. for a, reduced return on investment of 10.5%. The primary cause for the s i g n i f i c a n t drop to 10.5% i s the 21% withholding tax on dividend remittances to Canada from Mexico. These invest-ment decision s t a t i s t i c s are discussed more f u l l y l a t e r i n t h i s chapter. The financing decision base case re s u l t s i n Table XIX where two-thirds of the project i s loan financed show a project payback period of 6.5 production years with a mine-life net cash flow of US $180 927 000 discounted at 15% to a March 1979 present value of US $6 060 000. Once again, the impact of 21% withholding taxes r e s t r i c t s Placer's 34% share of the project to US $47 788 000 over the twenty years which, discounted at 15%, i s only US $234 000 (Table XX). Project cash flows are discounted at 20% annually as i t i s a more l i k e l y hurdle rate for a private enterprise mining investor i n Mexico for investment decision pur-poses. Two incentive tax structure cases are selected from Appendices 3 and 4 to demonstrate the extent of i n -centives needed to push the present values to p o s i t i v e amounts at March 1979. The project needs incentives of considerable magnitude and case number 15 i n Table XIX takes advantage of a f i v e year period with income tax and production tax exemptions to record a present value of US $569 000 after discounting the mine l i f e flow of US $251 904 000 20% annually. The same tax structure f a i l s Case Number Prob a b i l i t y of occurrence TABLE XX Placer Development Limited Results of Selected Cash Flows - Shareholder i n Mexican Project (Expressed i n 1979 constant United States dollars) Production Return on Net Present Values d i s -ease Description Years to Payback Investment After Tax counted at Mar.1979 ($000) Investment Decision Cases 0% 8! 15', 1 3 14 15 0.224 Base 0.160 - minus 10% of metal prices 0.112 - no production tax for 5 years and 20% acce-lerated depreciation 0.017 - no production tax and income tax for 5 years Expected 6, 8, 10, 8, 5% 2% 47 018 33 881 764 357 (6 499) (9 497) Financing Decision Cases 101 103 114 0.1613 Base 0.1440 - minus 10% of metal prices 0.1008 - no production tax for 5 years and 20% acce-Notes 1) 2) 20% (10 684) (12 811) 4. 9 12 R 9- 50 663 ~9 407 (3 305) ( 7 843) 3. 9 15 .6% 61 839 15 759 792 ( 4 777) 6. 8 10 .0% 41 583 4 498 (6 751) (10 665) 6. 7 15 "3 9- 47 788 10 427 234 ( 2 959) 8. 3 11 33 537 4 628 (2 842) ( 5 036) 115 lerated depreciation 4 .6 18 7 9- 51 982 13 865 2 919 ( 733) 0.0151 - no production tax and income tax for 5 years 4 .0 22 .7% 61 399 19 033 6 161 1 648 Expected 6 .7 15 .0% 43 147 9 296 ( 13) ( 2 956) The above data i s selected from case results l i s t e d i n Appendices 7 and 8 for investment decision and financing decision cases respectively. Expected r e s u l t s are based on results l i s t e d i n Appendices 7 and 8 together with p r o b a b i l i t i e s of occurrence according to Appendices 11 and 12. 150 to reach the 20% target for Placer's 34% shareholding and barely makes the 15% marker. Table XX shows case number 15 achieves a 15.6% return on investment. Expected results are close to the base case results but examination of the cases selected and the writer's determination of case p r o b a b i l i t i e s indicate a strong bias i n the expected r e s u l t s . Cash flows for the project are very metal-price sensitive and 0.3 p r o b a b i l i t y i s assigned to prices below base case prices and none to prices i n excess. The price e f f e c t i s counterbalanced by the predominance of cases which include tax incentives. 7 . 2 Earnings forecasts It i s assumed that the Mexican corporate vehicle undertaking the mining venture i n Zacatecas has no other business. The base loan case cash flow (Appendix 14) i s used to prepare a forecast earnings statement for each of production years one to f i v e (Table XXI) and assumptions required i n the conversion process are given i n notes 1 and 2 of Table XXI. The f i r s t few years of operation are characterized by r e l a t i v e l y high sales revenue and high depreciation expense. The f i r s t year sales of US $41 532 000 are lower than l a t e r years owing to the m i l l i n g of oxide zone ore at the surface of the orebody and i t s e f f e c t on concentrate production i s shown by comparison i n Table XII. The combined e f f e c t of oxide ore and depreciation on net earnings of Mexican Mining 151 Company S.A. de C.V. i s to produce a loss . Recognizing the importance of the non-cash expense for depreciation i n that loss leaves the analyst unconcerned. The planned mining sequence within the orebody to optimize the cash flow's present value means that net earnings w i l l tend to decline over time: the decline slowed by the f a l l i n depreciation expense on the reducing book value of the mine. Good earnings years can be forecast for the high revenue years of six through ten (Appendix 14) as depre-c i a t i o n f a l l s to lower l e v e l s . TABLE XXI Mexican Mining Company S.A. de C.V. Forecast Earnings Statement - Production Years 1 to 5 ($000 1979 constant United States dollars) Note 1 2 3 4 . 5 Sales 41 532 49 387 56 445 58 043 46 716 Operating costs Table XVIII 18 019 18 322 18 550 18 614 18 262 State property taxes 350 350 350 350 350 Interest expense Table XV 6 835 6 664 4 832 2 847 472 Depreciation, deple-t i o n and amortiza-ti o n 1 16 200 13 100 10 600 . 8 7.00- 7 4 00 41 404 38 436 34 332 30 511 26 484 Earnings before taxe s 128 10 951 22 113 27 532 20 232 Taxes On production 2 3 379 4 217 4 983 4 685 3 748 On income Current 3 - 2 729 9 845 11 673 8 443 Deferred 4 (1 625) 638 (1 280) ( 250) ( 201 5 1 754 7 584 13 548 16 108 11 990 Net earnings (loss) US $ d 626) 3 367 8 565 11 424 8 242 Average annual net earnings 6 5 994 over 5 years Average to shareholders 4 7 35 over 5 years 152 A combined rate of 20% declining balance deprecia-ti o n rate i s assumed. Includes exploration expense which would have to be incurred i n order to reduce production taxes. Current taxes on income represent payments of both income tax (42% of taxable income) and employee tax (8% of taxable income). Deferred tax i s an accounting adjustment to r e f l e c t timing differences between corporate and government recognition of taxable income. A combined e f f e c -t i v e rate of taxes on income of 50% i s assumed. The Mexican corporate e f f e c t i v e tax rates for pro-duction years 1 to 5 are 1400%, 69%, 61%, 58% and 59% for years 1 to 5 respectively. Before withholding taxes not borne by Mexican Mining Company S.A. de C.V. Mine-life average annual net earnings to share-holders are US $7 146 000 calculated as follows: 20 year project net cumulative cash flow Table XIX, Case 101 $180 927 000 less 21% withholding tax 37 995 000 $142 932 000 Average US $ 7 146 000 7.3 A l l o c a t i o n of mine generated cash The cash benefits of the mine project are not d i s t r i -buted to the owners of Mexican Mining Company S.A. de C.V. i n the proportion that share ownership i s held. An analysis of the a l l o c a t i o n of cash generated by the mine, assuming the underlying conditions of the base loan case cash flows (Appendix 14), shows that 80% of the earnings are paid to the Mexican government (Table XXII, item C i i ) . Notes: 1) 2) 3) 4) 5) 6) 7) TABLE XXII Mexican Mining Company S.A. de C.V. Forecast A l l o c a t i o n of Mine Generated Cash-Loan Base Case ($000 1979 constant United States dollars) A Cash Inflow - Sales Capital B Cash Outflow Preproduction corporate costs Capital expenditure Operating costs and i n t e r e s t Taxes on income,employee tax,duty on c a p i t a l equipment during construction and state tax Loan repayment D i s t r i b u t i o n of earnings Withholding taxes - 21% Totals 984 168 82 580 1 066 748 1 333 111 118 410 659 280 131 52 580 210 927 0 Goods and Services, Loan Repayment Mine L i f e Cash Outflows  Equity Owners Mexican Public Private 1 333 111 118 410 659 52 580 280 131 69 606 29 677 Di s t r i b u t i o n of Cash (i) A l l cash revenue 100% A l l earnings,before taxes,after c a p i t a l input recovery 100% A l l net earnings, a f t e r withholding tax 100% A l l net earnings, a f t e r withholding tax and c a p i t a l input recovery 100% 54^  ( i i ) ( i i i ) .(iv) 35% 80% 47% 49% 69 606 (14 617) US $ 1 066 748 575 690 379 414 54 989 5% 10% 26% 25% Canadian Private 71 715 (15 060) 56 655 6% 10% 27% 26% Ul E f f e c t i v e Tax Rate (i) E f f e c t i v e tax rate on a l l earnings, before taxes, after c a p i t a l input recovery suffered by (a) Mexican Government (b) Mexican partner and Canadian investor ( i i ) . E f f e c t i v e tax rate on a l l earnings, before taxes, a f t e r c a p i t a l input recovery, assuming Mexican Government holds no equity i n Mexican Mining Company S.A. de C.V. Totals 0% 70% 155 80% appears unreasonably large at f i r s t , but i t i s im-portant to recognize that the government would take approximately 72% (Table XXII, item Dii) through taxation without part ownership i n the mine. The government's 72% would be from taxes on production and income, employee tax and duty on i n i t i a l c a p i t a l expenditure amounting to US $280 131 000 (Table XXIII) plus 21% withholding taxes of US $44 294 000 on dividends from 100% of cash d i s t r i -butions to owners (instead of US $29 677 000 from a 67% ownership i n Table XXII). The Mexican government w i l l focus on t h e i r 33% contribution to c a p i t a l investment to earn an incremental 8% of earnings. This too i s mis-leading because the 8% i s an after tax change as taxes have already been included to obtain the f i r s t 72%. The private equity owners w i l l f i n d i t useful during negotiations for f i n a n c i a l consideration of tax concess-ions and possible government assistance towards the mine construction cost, to emphasize the s i g n i f i c a n t 35% share of a l l cash outflow during the projected mine l i f e which i s taken by government i n Mexico (Table XXII, item C i ) . If c a p i t a l contributions and repayments are ignored, the government i s shown to take a huge 37.5% of a l l sales revenue (33% i f government had no equity i n t e r e s t i n the pro j e c t ) . These percentages do not consider the tax revenue from smelter, refinery and transportation costs taken out of gross sales amounts and the tax revenue generated out of payments for goods and services. 156 The a l l o c a t i o n of mine generated cash i s heavily i n favour of government and i t seems there i s negotiating room for the government to ease the burden. A r e l a -t i v e l y small change, say US $10 m i l l i o n , i n the construc-t i o n cost of the mine w i l l make the project much more at t r a c t i v e to the private sector held equity owners. This p o s s i b i l i t y i s referred to l a t e r i n t h i s paper and the related cash flow results are detailed i n Appendices 7 and 8, cases 16 and 116. The 60% e f f e c t i v e rate of tax for the project (Table XXIII) and 70% for shareholders (Table XXII) over the mine l i f e b e l i e s the d i s t r i b u t i o n of earnings over the early years of operations. Appendix 14 points to a s i t u a t i o n at the end of operating year six at which time the equity owners have yet to achieve payback of t h e i r investments (US $6 731 000 i s s t i l l to be recouped) but government i n i t s capacity as a c o l l e c t o r of taxes has extracted US $69 883 000. Eight years of r i s k and no p r o f i t whilst government reaps nearly US $70 m i l l i o n i s hardly encouragement to the domestic private sector and foreign investors i n the mining industry. Table VII refers to a combined deferred and current e f f e c t i v e tax rate of 42.66% in the early years of a B r i t i s h Columbia mine. However, the current tax s i t u a t i o n i s markedly d i f f e r e n t i n that at the end of year six i n 157 TABLE XXIII Mexican Mining Company S.A. de C.V. E f f e c t i v e Tax Rates over the Mine L i f e - Loan Base Case Operating earnings before taxes-Appendix 14 $563 946 000 Add back exploration as i t represents production tax 2 562 00 0 566 508 000 Less c a p i t a l expenditure, including d u t y , f u l l y depreciated and preproduction corporate costs 114 42 3 000 Earnings before taxes below 452 085 000 100% Production taxes 81 238 000 18.0 Income tax 159 533 000 35.3 Employee tax 30 387 000 6.7 Total taxes (see notes below) 271 158 000 E f f e c t i v e tax rate over the mine lif e - p r o j e c t ( N o t e 1). 60.0% Project net cash flow (Appendix 14) US $ 180 927 000 Notes: 1) Total taxes of $271 158 000 are of the type usually.recorded as "taxes" i n Canadian f i n a n c i a l statements. 2) Taxes as above $271 158 000 State property taxes 7 000 000 Table XV 278 158 000 Duty 1 973 000 Table XXII 280 131 000 less employee tax 30 387 000 Table XXIV $249 744 000 3) Taxes not computed on p r o f i t s amount to $90 211 000 or 32% of the t o t a l taxes of $280 131 000 (note 2 above) 4) Withholding taxes on dividends not included above amount to $29 677 000 (Table XXII). 158 B r i t i s h Columbia that same US $69 883 000 would have gone to repay the investment funds and a l l taxes deferred. No mention has been made of the preproduction cor-porate costs of US $1 333 000 shown i n Table XXII. The sum i s an estimated amount of costs incurred by Placer p r i o r to production year minus-two for exploration i n Mexico for the benefit of the partnership forecast to be recoverable by Placer. The amount appears as "Exploration costs recovered" i n the Canadian cash flow of Placer (Appendix 16) i n production year f i v e . No withholding tax i s suffered on the cash remittance to Canada. The recovery of the sunk cost by Placer reduced the cash available for project dividends and i s there-fore a legitimate charge against the project's revenue (Appendices 13 and 14). However, the item has no e f f e c t on forecast net earnings i n production year f i v e (Table XXI) as the payment s e t t l e s a l i a b i l i t y assumed to be carried on the balance sheet of Mexican.Mining Company S.A. de C.V. 159 7.4 S e n s i t i v i t i e s Base case cash flow r e s u l t s are summarized e a r l i e r i n t h i s chapter and selected results for project and shareholder cash flows are l i s t e d i n Tables XIX and XX. Sixteen variations from the a l l equity base case for the investment decision are described in.Appendices 5 and 9 for the project and shareholder respectively. Appendices 6 and 10 provide similar information for the twenty financing decision case va r i a t i o n s . Case 109 i n Appendix 6 relates to Mexican tax i n -centive circumstances where 100% accelerated rates of depreciation allowances familiar to Canadian miners i s assumed. When comparing the results of case 109 with case 108 which assumes a lesser accelerated rate of 33-1/3%, i t i s found that the advantage to be gained for the project by negotiating for the higher 100% rate i s not s u f f i c i e n t to make the project that much more attrac-t i v e to the investors. The 33-1/3% "fas t " rate already permitted by tax law i n Mexico appears adequate and, i f negotiations with government look favourably upon accelerated rates, government "concessions", i f any are sought or forthcoming, should be found i n other areas and the temptation to accept the 100% rate r e s i s t e d . Appen-dix 10 shows that the same case results when 100% i s available versus 33-1/3% rates improves shareholder payback by 0.3 production years, 0.4% return on invest-ment and US $201 000 present value a f t e r annual d i s -160 counting at 20%. If a concession i s sought from govern-ment, depreciation rates do not appear to provide an im-portant boost to the project's economics. Given present tax law i n Mexico, there i s danger that losses for tax purposes, including high depreciation deductions, w i l l f a l l o f f the shelf after three years no longer available for set o f f against future p r o f i t s . A 33-1/3% accelerated rate reduces t h i s r i s k . The only cases which produce re s u l t s at suitable le v e l s assume major tax concessions for f i v e years; cases not considered to have a high p r o b a b i l i t y of occurrence. Cases 15, 16, 115 and 116 s i g n i f i c a n t l y improve the economic picture for the project and private sector shareholders but s t i l l do not manage to top the 20% return on investment mark or provide i t s equivalent po s i t i v e present value of cash flow to Placer discounted at 20% i n the investment decision cases (Appendix 9). A $10 m i l l i o n reduction i n the t o t a l construction cost v i a d i r e c t subsidy or contribution to infrastructure costs included i n cases 16 and 116 i s perhaps one of the more l i k e l y concessions that may be available but combined with the f i v e year tax exemption period i s considered remote. $10 m i l l i o n i s a large portion of the cost and not a l l items of mine construction lend themselves to government control. Perhaps the costs of townsite, t a i l i n g s impoundment and power supply are the primary candidates for government absorption. The government 161 appears to favour subsidized power charges to a s s i s t new industry but as subsidies of that nature can be with-drawn l a t e r , a d i r e c t infrastructure cost reduction i s preferable. Cases 2 and 102 r e s t r i c t the ownership l i f e of the mine to ten years. Clearly, no po s i t i v e decision to i n -vest i n the project w i l l ever be taken on the basis of a ten year l i f e when the return on investment to Placer i s a dismal 5.7%. What i s important i n thi s instance i s that the financing decision case 102 offers a 10% rate return on investment a f t e r achieving loan payback aft e r 6.7 production years; a rate greater than Placer's c a l -culated cost of c a p i t a l i n 1980. The r i s k of severe losses through poor metal prices do not appear great as cases 3, 4, 103 and 104 show rates of returns on investment close to or i n excess of Placer's cost of c a p i t a l . However, the mine economic well-being i s quite d e f i n i t e l y sensitive to metal pro-duct prices as Appendices 5 and 6 indicate. Ten percent increases i n construction costs or operating costs and an increased i n t e r e s t rate over the payback period em-ployed i n cases 5, 6, 105, 106 and 120, whilst worthy of attention, do not give cause for concern when compared with results of the base cases. 7.5 Social benefits and costs Chapter f i v e advises of the d i f f i c u l t y i n determining 162 a net figure for s o c i a l benefits less costs owing to the subjective nature of the underlying assumptions used i n the various c a l c u l a t i o n s . What to value and what i n -fluences the value are the questions for which the valua-tor needs answers. Government w i l l l i k e l y assign values to tax revenues, foreign currency earnings, employment, infrastructure and a c a t c h - a l l group which could include regional development, the effects of changes i n savings and consumption habits, c r e d i t supply, p o l i t i c a l advan-tage and the dynamic e f f e c t of the project on future foreign investment. Costs could include the e f f e c t s of population movement, loss of a g r i c u l t u r a l land, en-vironment control, foreign ownership of mineral resources, p o l i t i c a l r i s k and infrastructure. There i s a danger of double counting benefits and costs and to reduce the error, c e r t a i n benefits and costs are weighted before establishing the net s o c i a l value to Mexico. An example of double counting i s that of tax revenues and foreign currency earnings. Both numbers are derived from the same sales receipts number and can conceivably add to an amount greater than sales. Tax revenues are estimated i n Table XXIV and atten-t i o n i s drawn to the assumptions i n making the estimates. No data i s available to the writer concerning the per-sonal marginal tax rates on prospective employees i n -comes. Not only w i l l i n d i v i d u a l mine employees have various lev e l s of wages and s a l a r i e s from Mexican Mining 163 Company S.A. de C.V. but some w i l l have outside sources of income. The same p r i n c i p l e s apply to i n d i r e c t jobs attr i b u t a b l e to the mine. A present value c a l c u l a t i o n i s included i n Table XXIV which shows that $42 392 000 i s the approximate amount government should consider the absolute maximum i t may subsidize the project out of tax revenue based on assumptions l i s t e d i n the same table. A discount rate of 20% i s used to f i n d the present value of the stream of forecast tax revenue. It can be argued that as shareholders have an inter e s t i n available cash flow subordinate to the tax c o l l e c t o r , the appropriate discount rate should be less than the hurdle rate for the shareholders. O f f s e t t i n g that factor i s the govern-ment r i s k of tax d e f e r r a l for such causes as new c a p i t a l investment by Mexican Mining Company S.A. de C.V. The mine project c a r r i e s s i g n i f i c a n t r i s k of f i n a n c i a l loss and the addition of tax d e f e r r a l p o s s i b i l i t i e s j u s t i f i e s use of a high discount rate of 20%. Foreign exchange reserves of hard currencies w i l l be boosted handsomely by the Zacatecas mine; probably i n US d o l l a r s but possibly yen. No less important than the magnitude of the contribution i s the forecast that even during the i n i t i a l years of construction and operation, the mine w i l l be a pos i t i v e contributor to Mexico's reserves. The s o c i a l value of foreign currency inflow l i e s i n the a b i l i t y to purchase imported goods of si m i l a r value without borrowing on international markets. 164 TABLE XXIV Social Benefits and Costs - Tax Revenue (Expressed i n 1979 constant United States dollars) Direct inflow: Mexican Mining Company S.A. de C.V. Project ex-cluding the employee sharing tax (Table XXIII) $249 744 000 Employees: : Estimated at 1.5% of d i r e c t labour content of construction costs (7 35%) 1 126 000 15% as an assumed marginal tax rate on the 38% labour con-tent of operating costs (Appendix 17, item 26) 22 174 000 20% as an assumed marginal per-sonal tax rate on the employee sharing tax of $30 387 000 6 077 000 Direct Total Inflow $279 121 000 Indirect inflow Incremental payrolls for smelter and ref i n e r y , product shipping organizations and the ser-vice industry. The mine project labour force w i l l be 400 persons and, assuming 1.5 jobs are created outside the mine for each d i r e c t mine job, 600 i n d i r e c t jobs w i l l give r i s e to tax revenue. 600 jobs at an assumed annual tax per person of $2 000 for twenty years. 600 x 2 000 x 20 24 000 000 Incremental business earnings, assuming a tax rate of 42% and earnings before taxes of 5% on the project's 34% domestic purchases (Appendix 17, item 26) of $132 263 000 (see Table XV) w i l l give r i s e to tax revenue of 2 7 78 000 Add an assumed marginal tax rate of 20% on the 8% employee sharing tax for the same business earnings before taxes 106 000 Indirect Total Inflow $ 26 884 000 Outflow: Increase i n government services related to the construction and operation of the mine. Ser-vices i n areas such as tax administration, environmental o f f i c e r s for water, a i r and land use control, mining practices inspectors, labour administration., l e g a l work and others. 165 Estimated government jobs created - 10% of new i n d i r e c t jobs - at an annual estimated cost per job of US $20 000 including wages, benefits, o f f i c e accommodation and other operating costs, but less personal taxes on income. 60 x 20 000 x 20 Total Outflow Total estimated tax revenue attributed to the mine over 20 years Present value of the flow of tax revenue (dis-count rate 20%) It i s assumed that tax revenue i s c o l l e c t e d at rates according to the base loan case cash flow. A discount rate of 20% i s used because of con-siderable r i s k that taxable income w i l l not arise and that rate i s l i k e l y to be used by the mining project owners i n t h e i r assessment of the project. Note 3 to Table XXIII advises that 32% of tax revenue does not d i r e c t l y r e l a t e to p r o f i t s and accordingly there i s less r i s k of non-collection by government. Table XXV shows foreign currency earnings exceed foreign currency costs by a margin of 4.3 to 1. The 2 to 1 rel a t i o n s h i p during construction demonstrates that the mine i s not forecast to be a drain on the nation's reserves at any time; a factor of considerable i n t e r e s t to government. In the event government makes any of the f i n a n c i a l concessions included i n the cash flow case studies, none of the concessions w i l l detract from the statements just made concerning the net inflow of hard foreign currencies. Numbers i n Table XXV which are can-didates for change as a r e s u l t of concessions are the inflow and outflow equity and loan funds and the d i s -t r i b u t i o n s to the Canadian investor. The lack of 24 000 000 $282 005 000 $ 42 .392 000 166 information available r e l a t i n g to the foreign exchange content of smelter deduction costs, c a p i t a l and operating costs necessitated making assumptions to ar r i v e at foreign exchange outflows. The important assumptions are given i n Appendix 17 which l i s t s i n greater d e t a i l the i n f o r -mation summarized i n Table XXV. TABLE XXV Social Benefits and Costs - Foreign Currency Inflow and Outflow (Expressed i n 1979 constant United States dollars) 20 year Mine L i f e Inflow Equity and loan funds Product value Appendix 17 Outflow Capital expenditure Interest Loan repayments Distributions to the Canadian investor - Placer Operating costs Appendix 17 Total estimated net foreign currency Mine Construc-ti o n Period $ 67 285 000 $67 285 000 1 114 647 000 -$1 181 932 000 $67 285 000 42 067 000 26 625 000 57 085 000 68 188 000 81 692 000 275 657 000 28 863 000 4 975 000 33 838 000 inflow Present value of the inflow (dis-count, rate 20%) Foreign currency inflow: outflow r a t i o US $906 275 000 33 447 000 $149 548 000 4.3:1 2.0:1 Note: Assumptions are given i n Appendix 17 Employment for four hundred persons during mine operations i s anticipated at the Zacatecas mine s i t e and an additional six hundred jobs are assumed to be created independently. The c a p i t a l cost of each d i r e c t job at the mine s i t e i s forecast to be US $200 000 and even 167 spread over the estimated .total.of one thousand d i r e c t and i n d i r e c t jobs the c a p i t a l cost of US $80 m i l l i o n i s approximately US $80 000. Indirect jobs created w i l l need additional c a p i t a l outlays however, so $80 000 i s misleading. Such high c a p i t a l outlay per job has, i n Canada, lead to an improved standard of l i v i n g . Hospi-t a l s and schools follow new mines and modern housing i s available. The improvement of l i v i n g standards for the population i s a high p r i o r i t y target of the Mexican government and the creation of jobs i n less developed areas of the nation, such as Zacatecas, are v i t a l to the long term s t a b i l i t y of the country. The s o c i a l value of one thousand jobs i s not necessarily the high cost der-ived from a c a p i t a l intensive industry. Less c a p i t a l intensive industries may be attracted to the state but before alternatives are found valuable time w i l l be l o s t . For these two reasons, the s o c i a l value of the jobs i s taken at f i f t y percent of the c a p i t a l cost of jobs created and set at US $40 m i l l i o n . Infrastructure improvements can be accurately costed but the s o c i a l value beyond the needs of the mine are again subjective. Improvements may be extensions to the mine of e x i s t i n g infrastructure, such as e l e c t r i c a l power, completely new f a c i l i t i e s such as a l o c a l hospi-^ t a l , or upgraded f a c i l i t i e s such as railway r o l l i n g stock and fresh water supply. Extensions and upgraded infrastructure may improve u t i l i z a t i o n of current 168 f a c i l i t i e s and provide economies which have a posi t i v e s o c i a l value that i s d i f f i c u l t to assess without access to detailed information. The road to the mine s i t e i s adequate but some improvements w i l l be made and the cost i s included i n the c a p i t a l cost of construction. Other s o c i a l benefits and costs are more d i f f i c u l t to value, p a r t i c u l a r l y so as the writer i s not Mexican. However, the position i s similar for a Canadian corpora-ti o n wishing to evaluate s o c i a l net benefits. An attempt needs to be made. The l i s t of national p r i o r i t i e s for Mexico referred to i n Chapter three placed r u r a l educa-ti o n (#2), water resources (#3) and infrastructure (#5) i n the top ten p r i o r i t i e s behind that of population con-t r o l . The potential mine i s seen as a p o s i t i v e c o n t r i -butor to the three mentioned as state property taxes and metal production taxes from the mine w i l l be available for new educational f a c i l i t i e s i n the town near the mine; the t a i l i n g s area w i l l provide new water storage capabi-l i t i e s i n excess of mine needs, and heavy i n d u s t r i a l power supply w i l l be extended to an area hitherto un-serviced. These p r i o r i t i e s have been "costed" for s o c i a l purposes i n Table XXVI concerning infrastructure but a p o l i t i c a l value i s also appropriate. The p o l i t i c a l value relates to the improved chance of popular goodwill being directed toward the federal government and the PRI party a r i s i n g from Zacatecas regional devleopment, reduced population movement to the major urban areas and job 169 creation a c t i v i t y with attendant l i v i n g standards improvement. These benefits are reduced by the cost of the p o l i t i c a l r i s k of project f a i l u r e for any cause, opposition p o l i t i c a l party advantage that may be con-ceded owing to the presence of foreign owners i n the project or apparently favourable treatment afforded the project. TABLE XXVI Social Benefits and Costs - Infrastructure (Expressed i n 1979 constant United States dollars) Up-grading of e l e c t r i c a l power to mine s i t e , the nearby town and locations along the new power-l i n e route. $1 m i l l i o n for f i v e years and $200 000 annually thereafter $8 000 000 Maintenance of extended portion of power f a c i l i t i e s , $100 000 per year (2 000 000) Contribution to cost of new power generation f a c i l i t i e s needed to replace the mine's maxi-mum draw when the next new demand for power i s required (6 000 000) 0 Road improvements, not required other than for mine purposes 0 Road maintenance increase related to greater usage, $100 000 per year (2 000 000) Townsite including housing, h o s p i t a l , school, hotel and other f a c i l i t i e s , at approximate cost (Table XVI) as the l o c a l population w i l l witness that improved l i v i n g conditions can be provided outside the major urban centres 4 000 000 Fresh water supply to surrounding d i s t r i c t per-mitted by the t a i l i n g s impoundment pond. Approximate cost of necessary dams and a n c i l -l a r y equipment, net of cost of additional ser-vice l i n e s not required for the mine 2 000 000 Railway revenue, less operating costs, from .. transportion of mine products, less cost of railway maintenance increase owing to greater track and engine usage: assume breakeven s o c i a l value, excluding employment 0 Railway r o l l i n g stock required to replace equipment allocated to the new mine project. Estimated 78 000 tonnes of concentrate annually, (Table XII) w i l l require 25 r a i l wagons on a ten day turn round at an estimated cost per wagon of $40 000 (1 000 000) 170 Estimated net s o c i a l b enefit-infrastructure $3 000 000 Present value deemed to be the same $3 m i l l i o n _________ Note: The above s o c i a l benefits and costs are as valued by the writer. No consultation with Mexican government o f f i c i a l s was attempted. The benefits are l i k e l y to be long-term given the f a i t h that new opportunities for employment w i l l be attracted to the area before the orebody i s exhausted. The costs are not seen to be s i g n i f i c a n t for the same length of time e s p e c i a l l y as foreign ownership does not extend to control of management. The employment factor i s regarded as the most important p o l i t i c a l advantage possessing a value i n excess of the actual "cost" of creating approximately one thousand jobs. Replacement of the jobs proposed w i l l take time and e f f o r t . The net p o l i t i c a l benefit i s a r b i t r a r i l y presently valued at $10 m i l l i o n . The proposed mine's output i s expected to be exported at world prices and no adjustment i s necessary to bring cash flow sales values into l i n e with the s o c i a l value of the products. In other words, equivalent products may be acquired at the same cost at i d e n t i c a l moments i n time. Mine input costs are distorted by t a r i f f s and other trade barri e r s and price revisions for those and other reasons for factors of input are necessary to e s t a b l i s h a more refined s o c i a l evaluation. The cost of labour would l i k e l y be reduced as alternative employment, even for many s k i l l e d and semi-skilled persons, i s limited and the 171 true market value of labour to be employed at the mine may be very low. If the mine's material input require-ments have alternative uses or are i n short supply, the material input cost may need adjustment to the s o c i a l value and government evaluators of the project w i l l consider the aspect i n d e t a i l . The f e a s i b i l i t y study for the p o t e n t i a l mine i s s i l e n t on the matter of ma-t e r i a l input supply positions but discussions with Placer personnel confirm that there are no d i f f i c u l t domestic supply situations known that may a f f e c t the project. An improved project s o c i a l value i s the fore-cast outcome of a detailed examination of the true costs of factors of input for the mine. As the purpose of t h i s paper i s to determine the value of Placer's i n t e r e s t i n the mine, nothing i s to be gained by c a l c u l a t i n g the amount the project's s o c i a l value ought to be increased owing to adjustments to the costs of inputs. However, i t i s worth noting the unadjusted s o c i a l value of the project from the viewpoint of factors of input. The outflows equal inflows i n Table XXII and as mentioned above the value of inflows do not require adjustment. Certain of the outflows do not have a s o c i a l cost as they represent domestic transfers. Accordingly, the net s o c i a l value of the mine production i s $404 403 000 as follows: 172 Taxes - Table XXII $280 1.31 000 Dividends less equity c a p i t a l - domestic shareholders - Table XXII 124 272 000 ($210 927 000, less $30 000 000, less $56 655 000) Unadjusted net s o c i a l value of mine production US $404 4 03 00 0 The above s o c i a l value i s once again part of the mine product value and, i f assigned a s o c i a l value, due re-cognition needs to be given to values placed on tax re-venue and foreign currency net inflow to avoid duplica-t i o n . Here, the choice has been made to ignore the above $404 403 000 and instead place values on tax revenue and foreign currency earnings. Table XXVII summarizes the s o c i a l net benefits ex-pressed i n present value terms which t o t a l s US $148 970 000. The posi t i v e value of such magnitude, a l -though i t i s a subjective assessment of the project, indicates a clear advantage to Mexico i n the event the mine i s b u i l t and operated under the base case circum-stances. The large s o c i a l values attributed to tax revenue, foreign currency earnings and employment r e f l e c t the pot e n t i a l advantages to be gained by a government which i s able to choose between lowering the t o t a l tax burden and providing improved services; by the nation better able to finance future imports of goods and services and the contribution to increased job opportuni-t i e s i n r u r a l areas of Mexico. The r e l a t i v e l y low pos i t i v e value of infrastructure means the project i s 173 s o c i a l l y s e l f "financing" yet i t does not appear to o f f e r major benefits that I n i t i a l thoughts on the pro-je c t indicated. The l a s t category of s o c i a l i n t e r e s t deals with p o l i t i c a l benefits p o t e n t i a l l y available. The creation of a town with modern f a c i l i t i e s may form a new focal point for the a g r i c u l t u r a l community, for example, and help i n the national task of keeping more people content to l i v e i n r u r a l areas. Improvements i n l i v i n g standards made available by the project and spread to a larger segment of the population w i l l contribute to na-t i o n a l s t a b i l i t y , providing of course, the project i s not to be an i s o l a t e d area of improvement for an e l i t e group. The size of the project's s o c i a l value leads to the con-clusion that the Mexican government acting i n the i n t e r -est of the nation w i l l encourage the investors to under-take the mine commitment. TABLE XXVII Mexican Mining Company S.A. de C.V. Social Benefits and Costs - Summary (Expressed i n 1979 constant United States dollars) Net Social Value Tax revenue Table XXIV 50% of 42 392 000 21 196 000 14% Foreign currency inflow and outflow Table XXV 50% of 149 548 000 74 774 000 50% Employment 40 000 000 27% Infrastructure Table XXVI 3 000 000 2% Other, mostly p o l i t i c a l value 10 000 000 7% Present value of estimated net s o c i a l benefit 148 970 000 100% Note: 1) Tax revenue and foreign currency net inflow are derived from the same source of mine product value. Both are v i t a l to the government for economic sta-b i l i t y and for purposes of t h i s paper are assigned equal weight. Hence, t h e i r present values are re-duced to 50% i n a r r i v i n g at the cumulative net so-c i a l value of the mine project. 174 7.6 Valuation of the pot e n t i a l mine The two s i g n i f i c a n t questions raised i n Chapter one re l a t e to a portion only of the potential mine i n Zacatecas: a t h i r t y - f o u r percent minority i n t e r e s t . The value of the part depends on the value of the entire project and t h i s section i s devoted to a valuation of the orebody held by Mexican Mining Company S.A. de C.V. The next sections w i l l answer the questions: What i s the value of Placer Development Limited's minority i n t e r e s t i n Mexican Mining Company S.A. de C.V., and should Placer invest additional funds and other resources i n Mexico to b u i l d and operate the proposed s i l v e r mine? The questions are assumed to be posed by Placer Development Limited i n an atmosphere of improved r e l a -tions with i t s partners i n Mexico, mid-1979 mining industry general conditions and a completed f e a s i b i l i t y study on the Zacatecas property. Four methods of valuation are discussed i n Chapter f i v e . The asset appraisal method i s rejected as having no relevance to a mineral orebody, but three others, i t i s suggested, can be used to e s t a b l i s h a mine value. One of the three methods i s used i n the previous section to arrive at a mine s o c i a l value of US $148 970 000 to Mexico. However, i t does not provide the basis of a commercial value of the orebody; instead i t indicates a high l e v e l of acceptance of the project i n the eyes of government. The size of the pos i t i v e s o c i a l value leads one to the conclusion that government w i l l not stand i n the way of development of the orebody and, providing po-l i t i c a l factors do not assume major proportions, the l i k e l y successful operation of the mine u n t i l the ex-haustion of ore i n approximately twenty years. The r i s k of grave f i n a n c i a l loss through government interference i s not considered high owing to the avowed policy of government to a t t r a c t foreign investment, the history of reasonable compensation for property nationalized, and the 12.1% return on investment forecast to be earned after ten operating years under base loan case conditions (Appendix 4, case 102). In the twenty-two years needed to prepare the mine and extract a l l the known ore reserves, f i v e presidents of Mexico w i l l have been i n power. Fore-casts of p r e s i d e n t i a l treatment of mineral resources and the Zacatecas property i n p a r t i c u l a r have l i t t l e basis in fact and i t i s believed nobody can provide a r e l i a b l e prediction. The future p o l i t i c a l trend i n Mexico repre-sents a r i s k the shareholders are w i l l i n g to take. The remaining two valuation methods; earnings c a p i t a l i z a t i o n and cash flow methods, take account of influences on the value of the orebody and a review of the f i n a n c i a l re-s u l t s , t h e i r underlying assumptions and the surrounding circumstances, i s needed pr i o r to making the valuations. Forecast r e s u l t s are described e a r l i e r i n t h i s Chapter and Table XIX summarizes selected cash flows and the expected results based on p r o b a b i l i t i e s of case occurr-176 ence set by the writer. As previously noted, the ex-pected results contain a bias toward a pessimistic view as metal prices higher than those used i n the base case are not included i n any other cases. Nevertheless, ex-pected values are not s i g n i f i c a n t l y d i f f e r e n t from base case values. Earnings forecasts average US $5 994 000 over the f i r s t f i v e years according to Table XXI, afte r allowing for a loss of US $1 626 000 i n the i n i t i a l operating year despite a v i r t u a l breakeven before taxes. However, the withholding tax of 21% borne by the share-holders (not Mexican Mining Company S.A. de C.V.) reduces the five-year annual average to US $4 735 000. Key assumptions made i n establishing the f i n a n c i a l r e s u l t s relate to data for ore reserves, saleable metal production, construction and operating costs and metal prices . Tables X to XVIII contain the d e t a i l s with notes. A d r i l l i n g programme has provided information to determine that s u f f i c i e n t proven mineable ore reserves e x i s t and tests on ore samples have shown that i t i s feasible to produce the concentrates i n saleable form from the ore reserves. The f e a s i b i l i t y study has been prepared by Placer personnel and production target s h o r t f a l l s are not anticipated as wide safety margins have been allowed for to ensure the forecast le v e l s of production are achieved. Accordingly, performance guarantees and cus-tomer contracts for minimum concentrate quantities to be sold do not represent major r i s k s to the owners of the 177 orebody at the time of the construction go-ahead decision. Metal prices i n the base case are said to be 70% certain of being equalled or bettered and they are at levels much below current p r i c e s . Sales w i l l not begin u n t i l the t h i r d year following the decision to invest so current prices are of l i t t l e i n t e r e s t except to the ex-tent they hasten a decline i n prices to coincide with the early years of the mine's operations. Mining com-panies accept a 70% certa i n l e v e l i n metal prices as conservative. Construction costs are estimated based on discussions with suppliers of materials and services using broad design concepts. Although some design changes w i l l occur to amend cost estimates, construction costs greater than 110% of the base case cost of $75 105 000 are not considered a high r i s k (Appendix 5, case 5). Operating cost forecasts are based on labora-tory tests and detailed cost estimates obtained through consultation between m i l l i n g experts and materials suppliers. Again a 10% increase above forecast costs does not represent an important r i s k (Appendix 5, case 6). There are two other assumptions worthy of attention. F i r s t l y , the use of constant d o l l a r s i n f i x i n g costs, revenues and benefits and, secondly, the ri g h t to conduct mining of the orebody. It i s accepted that Mexico w i l l continue to experience price l e v e l i n f l a t i o n . However, adjustments for price l e v e l changes i n the project's f i n a n c i a l calculations are d i f f i c u l t i f not impossible 178 to quantify with an acceptable degree of accuracy. It i s the practice of both Placer and the i r private sector Mexican partner to express f e a s i b i l i t y study and evalua-t i o n data i n terms of constant currency, using i n t e r e s t rates unadjusted for that portion of the rate thought to represent i n f l a t i o n a r y expectations. The r i g h t to con-duct mining of the orebody i s held by Mexican Mining Company S.A. de C.V. but just as rights are given, so they can be withdrawn. The r i s k of losing the r i g h t i s not considered great whether i t be i n the form of new mining conditions imposed which for some reason are not met or a method of na t i o n a l i z a t i o n . If the Zacatecas orebody i s singled out for such treatment foreign i n -vestment i n Mexico w i l l be affected detrimentally. A l l mining project f e a s i b i l i t y studies involve the use of uncertain data and the industry has learned to make decisions and operate with i t . It i s believed that assumptions referred to i n t h i s and p r i o r Chapters are within l i m i t s acceptable to the industry as a whole. There are conditions which can be foreseen leading to a much improved f i n a n c i a l picture such as higher metal prices, higher production rates based on a shorter mine l i f e and the removal of withholding tax on "dividends" which represent recoupment of the i n i t i a l equity c a p i t a l introduced v i a an intere s t free loan. There i s always the hope of finding new mineable ore reserves. A possible negative factor relates to changes i n r e a l wages i n Mexico. Although no increases i n r e a l wages are i n -cluded i n the ca l c u l a t i o n of construction and operating costs, an assessment of th e i r possible impact on the project's v i a b i l i t y has been made. Past experience has shown that as employee costs r i s e , changes i n mining and processing methods occur which o f f s e t the labour cost i n -creases. The size of the work force planned for Mexico leaves plenty of leeway to make the project less labour intensive. Mexico's economic and p o l i t i c a l circumstances d i s -cussed i n Chapter three from a mining viewpoint are i n a more favourable position i n 1979 than for several years past. The time for substantial investment there i s judged to be now. The orebody i s ready for develop-ment and the way i s clear to. do so. A l l l e g a l matters of consequence are se t t l e d , labour, equipment and supplies can be obtained to complete construction e f f i c i e n t l y and foreign exchange i s available to acquire necessary imports. Mexican government resource policy i s c l e a r l y supportive of mining development and, although the tax bi t e out of the value of production i s high, the forecast net cash flow i s adequate to provide a 15.2% return on an a l l equity investment. The r i s k that base case conditions w i l l prove o p t i -mistic over the mine l i f e , i n p a r t i c u l a r during the period of investment payback, i s at an acceptable l e v e l 180 to most experienced mining companies i n the medium and large size categories. The most contentious of the assumptions i s l i k e l y to be the forecast metal prices. Even during periods of stable s i l v e r p rices, discuss-ions on the subject of long term average s i l v e r prices w i l l open a wide range of values. In 1979, with s i l v e r prices at new all-time highs and the world-wide econo-mic picture unclear, the temptation i s to assume s i l v e r prices w i l l remain well above the t r a d i t i o n a l prices i n the $1.50 to $5.00 per ounce range. Mining companies are sometimes strained to think soberly i n times of rapid change in metal markets. 1979 i s one such period and the price of US $193/kg ($6/oz) of s i l v e r appears very low i n mid 1979 but not so i f viewed i n h i s t o r i c terms (Table XXVIII). The s i l v e r price i s currently on the up-swing but an investor i n the Zacatecas mine has to consider where i n i t s price cycle w i l l s i l v e r be at the time of the f i r s t concentrate shipment more than two years a f t e r an investment decision i s made. As mentioned e a r l i e r , a decision to hedge the s i l v e r price of future production i s considered very r i s k y owing to the lack of force majeure i n the futures market. At US $193/kg of s i l v e r less 9% production tax, the Zacatecas mine i s viable with a substantial margin over operating costs i n the range of US $105/kg of s i l v e r produced i n year 2 to US $136/kg of s i l v e r i n the penultimate year of operations. (Tables XIII and XVIII r e f e r ) . 181 TABLE XXVIII S i l v e r - H i s t o r i c Prices Selected New York Average Annual Prices - US $/kg (US $/troy oz) US $/kg US $/troy oz 1910 17.20 0.53 1920 32.44 1.01 1930 12.27 0.38 1940 11.18 0.35 1950 23.85 0.74 1960 29.38 0.91 1970 56.93 1.77 1975 142.06 4.42 1978 173.64 5.40 Si l v e r i s regarded within the mining industry as a good metal to be i n during the 19 80's and, as the margin of long term price over operating costs i s wide, the r i s k of mine closure owing to depressed market conditions i s not high. The r i s k of bankruptcy assumed afte r a go-ahead investment decision to b u i l d i n Zacatecas i s low and the size of the project i s such that many medium and large mining companies could, under dire circumstances, absorb the shock of a complete loss of the project. The size of the project and the low r i s k of bankruptcy coupled with the cash flow forecasts and supporting data, suggests there i s a large number of potential buyers should the orebody be offered for sale. Potential pur-chasers of mineral assets are to be found i n the o i l and gas industry as well as the mining industry i t s e l f . The major o i l companies have made major acquisitions i n mining during the late 1970's and price competition for a proven s i l v e r orebody i n Mexico could be intense. Even the Mexican government could be a w i l l i n g buyer. However, 182 non-Mexican potential purchasers w i l l be r e s t r i c t e d i n the percentage ownership they may acquire. At t h i s stage of the valuation, s u f f i c e i t to say the orebody i s read i l y saleable. The earnings c a p i t a l i z a t i o n method uses a m u l t i p l i e r factor which has to consider the average annual forecast earnings i n early years, the long-term trend i n earnings and the l i f e of the mine. The i n i t i a l f i v e operating years are forecast to record earnings a f t e r taxes to owners of the orebody of US $4 735 000 and the mine-life annual average i s US $7 146 000 (Table XXI, note 7). Both averages are p r i o r to depleting the cost of acquiring the orebody but after mine construction c a p i t a l expendi-ture. The payback period of 6.5 production years (Table XIX, case number 101) w i l l delay i n i t i a l cash recoupment of any portion of the orebody a c q u i s i t i o n cost a t o t a l of 8.5 years a f t e r a decision to acquire the orebody i s made. At that time the orebody i s approximately one t h i r d ex-hausted and Mexico i s under the guidance of i t s second president following the incumbent, President Lopez.... It may be possible to f i n d a purchaser of the orebody i n a position to obtain a deduction from taxable income for the amount paid to acquire the orebody. In such a case the net cost of a c q u i s i t i o n i s lower per d o l l a r of pur-chase consideration and the m u l t i p l i e r may be increased i f the purchaser wants the orebody badly enough. A de-duction i s possible i n Canada but Mexican tax law does 183 does not o f f e r the same f l e x i b i l i t y and a deduction against Mexican taxable income i s more d i f f i c u l t to arrange. For t h i s valuation, i t i s assumed no deduction i s available to reduce the net cost of acquiring the orebody. A m u l t i p l i e r of four applied to the average annual net earnings for the i n i t i a l f i v e years of operations places a value of US $18 940 000 on the orebody but the investment would not be recovered u n t i l approximately 7.8 years of operations had elapsed (Table XXIX); almost ten years aft e r purchase. On an earnings basis, the average net earnings would be reduced by depletion of the purchase price of US $947 000 annually. Therefore, incremental consolidated average net earnings to the new owner of the orebody are US $3 788 000 (US $4 735 000 less $947 000) over each of the f i r s t f i v e operating years and an average of US $6 199 000 (US $7 146 000 less $947 000) over the entire mine operating l i f e . A recovery period of almost eight operating years i s a high r i s k factor for a mine with proven ore reserves s u f f i c i e n t for twenty years and steadily r i s i n g operating costs per kilogram of s i l v e r produced as the ore reserves approach exhaustion. A m u l t i p l i e r of two applied to the average annual net earnings for the i n i t i a l f i v e years of operations deter-mines a value for the orebody of US $9 470 000 and a m u l t i p l i e r of f i v e obtains a value of US $23 675 000. The range of these two values delays recoupment of a l l invest-184 ment expenditure by between 0.7 of a year and 1.6 years to 7.2 and 8.1 years operations respectively. Whether the delay i s 0.7 or 1.6 years, the question appears immaterial as the difference i s less than one year and few purchasers of the orebody w i l l be concerned over such a minor extension of the payback period. Greater emphasis w i l l be assigned to the relationship of price to ultimate net earnings of US $180 927 000 (Table XIX, case 101) over the whole mine l i f e . Two years net earnings of US $9 470 000 represents 5%; a m u l t i p l i e r of three represents 8%; four times average net earnings of US $4 735 000 represents 10% and a factor of f i v e raises the percentage of mine l i f e net earnings paid for to 13% (Table XXIX). It has been said above that eight operating years out of a t o t a l mine l i f e of twenty to achieve investment pay-back i s high. A m u l t i p l i e r of four i s accordingly a high value but when viewed i n terms of aggregate net earnings, i t represents a purchase price of ten cents for every d o l l a r of future net earnings expressed i n constant d o l l a r s . I t i s at t h i s point the valuator returns to the rea l world and reintroduces the element of i n f l a t i o n a r y expectations so neatly removed i n a l l previous c a l c u l a -tions. This i s a time of great international economic uncertainty. Price l e v e l i n f l a t i o n i s well entrenched i n the United States of America, Mexico, Canada and many other countries. Anyone who examines the past behaviour TABLE XXIX Value of M u l t i p l i e r 0 2 2.5 3 3.5 4 4.5 5 Note: 1) 2) Mexican Mining Company S.A. de C.V. Orebody Valuations Based on M u l t i p l i e r of Net Earnings (Expressed i n thousands of 1979 constant United States Dollars) US $000 Average annual net earnings (Note 1) US $4 735 Value placed on orebody i n Zacatecas Production Years to Payback (Note 2) US US $ 9 470 11 837 14 205 16 572 18 940 21 307 23 675 6. 7. 7 7 7 7 5 Base 2 3 5 6 8 8.0 8.1 Orebody value as % of 20 year t o t a l net earnings (Note 3) 5% 7% 8% 9% 10% 12% 13% Purchaser 1s Return on Investment (Note 4) 13.0% 12.5% 12.1% 11.7% 11.3% 10.9% 10.5% Net earnings of US $4 735 000 are after loan interest expense (Table XXI) and the 21% withholding tax on dividends to shareholders averaged over the f i r s t f i v e years of production. Production years to payback are based on cash flow case number 101, the base loan case for the financing decision, i . e . , before the dividend withholding tax of 21%. 3) 20 year t o t a l net earnings are per loan cash flow number 101 of US $180 927 000 (Table XIX) i . e . , before the dividend withholding tax of 21%. 4) The purchasers return on investment assumes base equity case number 1 circumstances before the 21% dividend withholding tax. OD U l 186 of s i l v e r and other metal prices w i l l agree that current high prices for s i l v e r w i l l recede i n due course. The areas of disagreement w i l l be the amount of the price f a l l and the timing of the decline. Potential buyers of the Zacatecas property w i l l have in d i v i d u a l ideas on both the effects of i n f l a t i o n on the currencies of Mexico and the USA and the s i l v e r metal price movements. Placer paid Cdn $5.1 m i l l i o n to purchase a 30% in t e r e s t i n a s i l v e r orebody i n central B r i t i s h Columbia (Equity S i l v e r Mine) i n early 1979. The amount when grossed up for a 100% i n t e r e s t fixes an unadjusted value for the orebody of Cdn $17 m i l l i o n (US $14.6 m i l l i o n at p r e v a i l i n g exchange ra t e s ) . The forecast s i l v e r produc-t i o n rates, and t o t a l s of operating costs, income taxes and c a p i t a l expenditures of the two properties suggest the Mexican mine i s better, aided by greater proven re-serves and easier metallurgy. However, production taxes and withholding taxes on dividends to a l l owners re-verses the ranking. The Zacatecas and central B r i t i s h Columbia mines are both large s i l v e r open p i t mines although forecast pro-duction rates i n Zacatecas are approximately f i f t y per-cent greater than Equity's. Higher tax rates and e a r l i e r tax payments eliminate the advantage otherwise held by the Zacatecas orebody and the Canadian property i s fore-cast to be able to achieve greater net earnings over the investment payback years of operations accompanied by a 187 more rapid generation of cash after costs and taxes. The longer l i f e of the Zacatecas property does much to redress i t s p o s i t i o n leaving i t s return on an a l l equity investment a l i t t l e worse, but i t s undiscounted cash flow to owners better than the Equity s i l v e r mine. The p r i n c i p a l differences between the two orebodies d i s -cussed above are t h e i r location, the Canadian orebody's a b i l i t y to generate cash more rapidly early i n the mine l i f e , and the aggregate net earnings. Location d i f f e r -ences a f f e c t p o l i t i c a l and climatic conditions, water a v a i l a b i l i t y , labour supply, equipment a v a i l a b i l i t y and market access. The second difference serves to reduce the r i s k of losses by shortening the period of debt ser-v i c i n g and to improve the a b i l i t y to recover from a pro-longed market metal price down turn as losses for tax purposes i n Canada do not f a l l o ff the shelf after three years as they do i n Mexico. The t h i r d difference favours the Zacatecas orebody as over the entire mine l i f e i t generates more than twice the net earnings. Mine l i f e net earnings equal mine l i f e aggregate net cash flows. During the operating period the two are d i s s i m i l a r owing to timing differences i n recognition of earnings caused p r i n c i p a l l y by depreciation. The longer mine l i f e of the Zacatecas orebody of f e r s prospective purchasers of the property greater p r o f i t opportunities through i n f l a t i o n of price l e v e l s and through the extra price cycle at the end of i t s l i f e when compared with Equity S i l v e r . 188 The Zacatecas orebody i s a viable s i l v e r mine ready to be developed at a time when s i l v e r prices are at record l e v e l s . Expectations of price l e v e l i n f l a t i o n are exaggerated when s i l v e r prices i n 1979 are viewed i n h i s t o r i c a l terms and the metal i s seen worldwide as an investment hedge against i n f l a t i o n . In mid 1979, a prospective purchaser of the Zacatecas orebody knowing the economic results described e a r l i e r i n thi s Chapter, w i l l pay three, but possibly up to four times the i n i t i a l f i v e years average annual net earnings to place a value on the whole orebody based on the earnings c a p i t a l i z a t i o n method of approximately US $14 m i l l i o n with a high value of US $19 m i l l i o n . The value range of US $14 m i l l i o n to US $19 m i l l i o n based on forecast net earnings aft e r loan inter e s t expense provides the purchaser with a return on an a l l equity investment of between 11.3% and 12.1% (Table XXIX). Clearly, the rate of return w i l l not surpass the customary hurdle, rates i n the Canadian mining industry which are generally agreed to be close to f i f t e e n percent on an a l l equity basis. The much improved p o l i t i c a l and economic conditions i n Mexico coupled with a low operating r i s k mine producing a much sought metal renders the orebody an a t t r a c t i v e purchase which demands a premium. The cash flow re s u l t s for base case number 1 (Table XIX) a l l equity funded for investment decision purposes indicates the entire project allows a posit i v e present value of the 189 forecast cash flow aft e r discounting at f i f t e e n percent. However, the present value i s small at US $577 000. If twelve percent i s used the present value i s increased to US $14.6 m i l l i o n . Reasons c i t e d above i n a r r i v i n g at a m u l t i p l i e r of three applied to net earnings are also relevant to a valuation of the orebody based on cash flows. Inflationary increases i n annual net cash flow w i l l permit e a r l i e r payback of bank indebtedness as new d o l l a r s w i l l be used to repay old d o l l a r s . The s i l v e r metal price w i l l undoubtedly f a l l from i t s present height as f a i t h i n the price cycle i s not l o s t . Purchasers of the Zacatecas orebody w i l l i n g to pay a high bid price w i l l do so on the assumption that the s i l v e r price i n constant d o l l a r s w i l l exceed the US $193/kg (US $6/oz) used i n the cash flow, regarding as too conservative the 70% l e v e l of confidence i n that long-term average p r i c e . The mood surrounding s i l v e r i n 1979 suggests that buyers w i l l assign value to the length of the mine l i f e and possible additions to ore reserves as the mine deve-lops. The e f f e c t i s to reduce the investment hurdle rate to the region of twelve percent and place a value on the whole orebody based on the cash flow method of approxi-mately US $14.6 m i l l i o n . The entire orebody i n Zacatecas i s therefore valued i n the range US $14 m i l l i o n to US $19 m i l l i o n i n mid 1979 with a most l i k e l y value of US $14.6 m i l l i o n . 190 7.7 Valuation of Placer's i n t e r e s t i n the mine Placer Development Limited holds a t h i r t y - f o u r per-cent shareholding i n t e r e s t i n Mexican Mining Company S.A. de C.V. which i n turn holds the Zacatecas orebody mining rights free of encumbrance. The pro-rata value of Placer's i n t e r e s t i n the entire orebody ranges from US $4.8. m i l l i o n to US $6.5 m i l l i o n but, as shareholders suffer a twenty-one percent withholding tax on dividends, the value i s reduced to between US $3.8 m i l l i o n and US $5.1 m i l l i o n . The most l i k e l y value i s US $3.9 m i l l i o n . However, Placer's position may vary the pro-rata value re-cognizing special benefits available or p a r t i c u l a r concerns of i t s management. Placer's shareholding car r i e s no r e s t r i c t i o n s on transfer to a t h i r d party; i t may be held by Mexicans or non-Mexicans a l i k e . A maximum dividend policy i s re-quired by the rules of incorporation of Mexican Mining Company S.A. de C.V. and a l l i t s major policy decisions and commitments require sixty-eight percent of share-holder votes before authorization may be given. Partners have s e t t l e d the important p o l i c i e s including the common objective to develop the Zacatecas mine under free enter-prise conditions. Placer has shifted i t s exploration emphasis to Canada since 1977 but s t i l l retains i t s foreign programme, p a r t i c u l a r l y i n the United States of America. The poor experience i n Mexico i n 1976 i s the most l i k e l y cause of that s h i f t but Placer's long-term f a i t h i n the 191 Mexican mining industry was demonstrated p a r t i c u l a r l y when i n 1977 i t s Mexican partners did not contribute cash and Placer paid the corporate and orebody holding costs. Placer does have the w i l l to persevere i n i t s e f f o r t s to develop the Zacatecas property although there may be less incentive to r i s k t h e i r c a p i t a l and good min-ing reputation i f they are not the mine Operator/Manager. The matter of Operator/Manager w i l l become more c r i t i c a l i f completion guarantees and performance guarantees are required of Placer to put the financing package i n place. At t h i s time, o f f Balance Sheet project financing i s anticipated by Placer and the small amount of equity c a p i t a l needed i s forecast to be available out of Placer's present cash balances. If the Zacatecas project goes ahead, Placer i s not expected to experience regret i n making the investment i n Mexico owing to the c a p i t a l needs of subsequent projects. However, advantage may accrue through Placer's operating presence i n Mexico as mining opportunities not otherwise available may be forthcoming. Taxable income earned i n Mexico from the project w i l l serve to reduce the cost of further explora-t i o n i n that country to 38% of expenditure (Table VI) instead of the f u l l outlay. The size of the f i n a n c i a l commitment, by Placer to the e n t i r e l y project financed mine i s not such as to ever place the company i n danger of compulsory l i q u i d a t i o n or receivership. The partners are not forecasting the need 192 for guarantees to lenders by Placer so Placer's t o t a l commitment of funds i s r e s t r i c t e d to i t s t h i r t y - f o u r percent of the equity funds. There are extra r i s k s attributable to a foreign investment i n the ninety m i l l i o n d o l l a r range but, as discussed i n Chapter three, these r i s k s are at an acceptable l e v e l i n 1979. There i s also seen to be a cost attached to Placer withdrawing support for a production decision or s e l l i n g t h e i r i n t e r e s t i n Mexican Mining Company S.A. de C.V. Such a withdrawal w i l l be seen as a lack of resolve to make foreign mining investments and Placer's other foreign exploration ventures w i l l suffer accordingly. I t does not go unnoticed that the l a s t mine developed by Placer outside North America was ten years ago and p r i o r to that one must look back to the 1930's for the previous successful foreign venture. There need be no a i r of desperation for Placer to make a foreign investment. The company does have in t e r e s t i n g domestic mineral prospects i n i t s inventory. It also has an entry into s i l v e r production v i a Equity S i l v e r so has attained a degree of d i v e r s i f i c a t i o n from i t s t r a d i t i o n a l copper and molybdenum products. On the other hand, p o l i t i c s i n Canada and B r i t i s h Columbia i n p a r t i c u l a r have blown cold on mining i n the 1970's and, although a degree of s t a b i l i t y has been restored, i t i s obvious that to spread the mining a c t i v i t y to various nations repre-sents another form of d i v e r s i f i c a t i o n o f f e r i n g some pro-193 tection to Placer against the return of more demanding government i n Canada. Table XX shows that the investment decision base case for Placer has a return on investment of 10.5%, half a point above the expected case r e s u l t of 10%. These res u l t s are much worse than the project returns owing to the twenty-one percent withholding taxes on dividends. Table XX also shows returns which are improved by large tax incentives but even those results are not impressive and t h e i r p r o b a b i l i t y of occurrence i s small. In addition, i t i s not Placer's p o l i c y to accept special subsidies and tax incentives which convert uneconomic projects to economic ones at the stroke of a pen. Subsidies and tax incentives can be withdrawn leaving the investor i n f i n a n c i a l trouble. The returns to Placer are at least above the company's cost of c a p i t a l forecast to be eight percent (Table VIII) at 31 December 1980 recording a forecast present value i n early 1979 of US $5 764 000 or an expected US $4 498 000 (Table XX). However, the values are so unattractive keeping i n mind r i s k s inherent i n mining as to prevent any value, other than a nominal half m i l l i o n d o l l a r s , being assigned to the minority i n t e r e s t i n Mexican Mining Company S.A. de C.V. at the 70% c e r t a i n l e v e l of s i l v e r priced at an average US $193/kg on a long-term basis. 1979 i s an unusual year for s i l v e r metal prices and a nominal value for a senior minority i n t e r e s t i n a poten-194 t i a l s i l v e r producer i n 1981, when prices are presently more than double the forecast long-term p r i c e , i s un-r e a l i s t i c . Optimists might look favourably upon a long-term average of US $257/kg (US $8.00/oz) which after taxes leaves incremental net cash flow of US $29.12 per kilogram of s i l v e r produced when compared with the fore-cast price of US $193/kg. The cash flow from a US $257/kg s i l v e r price under otherwise a l l equity base case number 1 circumstances provides the following: 100% 34% Production years for investment payback 4.2 5.2 Cash flow over the mine l i f e -undiscounted US $284 798 000 70 674 000 Present values - March 1979 - 8% 81 747 000 15 611 000 - 12% 39 884 000 4 298 000 * - 15% 20 888 000 ( 1 .044 000) - 20% 0 ( 6 836 000) A further point to appreciate i s that many mining com-panies may spend say ten m i l l i o n d o l l a r s on exploration without i d e n t i f y i n g an economically viable orebody. The Zacatecas property has been i d e n t i f i e d and to pay a few m i l l i o n for i t makes good exploration sense even i f future cash flows from the acquired property only just surpass the hurdle rate. Exploration expenses are always sunk costs when i t s time to conclude the f e a s i b i l i t y study and to pay for an i d e n t i f i e d orebody and l a b e l the payment an exploration cost recognizes that s i t u a t i o n . The optimist w i l l i n g to invest on the basis of a US $257/kg price w i l l probably reach for a twenty percent 195 return on investment to allow for the combination of r i s k s associated with the high long-term s i l v e r price and the location of the orebody. Inflationary expectations are running high i n mid 1979 and i t can be foreseen that hurdle rates w i l l be lowered i f , as i n the case of s i l v e r , the hedge against i n f l a t i o n i s perceived to be strong. The cautious mining investor having prepared a f e a s i b i l i t y on a s i l v e r price of US $193/kg (US $6/oz) which i s 70% cer t a i n of being equalled or bettered w i l l have to compete for the orebody against the more optimistic viewers of s i l v e r . If 15% i s to be the hurdle rate of the cautious investor, the orebody w i l l not be acquired as 1979 market conditions have brought out the s i l v e r b u l l s and the optimists w i l l p r e v a i l . Placer f i t s the conservative mould and w i l l choose the combination of a 70% cer t a i n price and 15% hurdle rate which sets the value of i t s t h i r t y - f o u r per-cent i n t e r e s t i n Mexican Mining Company S.A. de C.V., on a cash flow basis, at zero as the present value i s a negative US $6 499 000 (Table XX, case 1). At the same time, Placer w i l l appreciate that, to others, the optimis-t i c s i l v e r price w i l l provide cash flows discounted at 20% of a s i m i l a r negative value (US $6 836 000). It w i l l be r e c a l l e d that the unadjusted pro-rata most l i k e l y value of the minority inte r e s t i s US $3.9 m i l l i o n . That value i s attributed to the presence of three factors. The length of the mine l i f e and the p o s s i b i l i t y of additions 196 to ore reserves; i n f l a t i o n a r y expectations and the posi-t i v e net e f f e c t i n f l a t i o n w i l l have on net cash flows and the period of investment payback; and, the pre v a i l i n g high s i l v e r p r i c e s . Add to those items the view of the mineral explorer who anticipates before-tax expenditure of say ten m i l l i o n d o l l a r s (were i t not for optimism, i t would be the twenty-seven m i l l i o n (1977 Canadian dollars) d o l l a r s previously quoted i n Chapter 2.2) without much hope of discovering an orebody. Include the prospect of new opportunities i n Mexico and the zero value i s seen to be u n r e a l i s t i c . The position of the minority shareholder in Mexican Mining Company S.A. de C.V. i s well protected through i t s voting, dividend and commitment veto r i g h t s , and the na t i o n a l i z a t i o n with compensation precedents i n Mexico are comforting to the investor. The shareholder's l i a b i l i t y i s limited owing to the forecast project f i n -ancing of the mine free of guarantees for completion and performance as far as Placer i s concerned, although that may not be the case i f Placer i s appointed Operator of the project. These points demonstrate that the e a s i l y trans-f e r a b l e minority shareholding needs l i t t l e discount from i t s pro-rata share of the value of the entire orebody. The optimists US $4 298 000 present value i n March 1979 of cash flows expressed i n constant 1979 do l l a r s d i s -counted at 12%, places a value on the notional exploration expenditure of US $11 134 000 ($6 836 000 plus $4 298 000) which i s both before and af t e r taxes as there i s no deduc-197 ti o n i n Canada for non-Canadian successful exploration costs. Here an arbi t r a r y ten m i l l i o n of notional ex-ploration i s used which turns the negative present value of US $6 836 000 aft e r discounting cash flows by 20% into a pos i t i v e value*7 of US $3 164 000 regarding the ten m i l l i o n dolars the same way as sunk costs. Placer's t h i r t y - f o u r percent shareholding i n t e r e s t i n Mexican Mining Company S.A. de C.V. i s therefore valued i n the range US $3 100 000 to US $3 900 000 i n mid 1979 with a preference for US $3 500 000 as i t i s the mid point. 7.8 Placer's next step i n Mexico A value of US $3 500 000 for Placer's investment i n . Mexico i s the sale value but there are two other courses of action a v a i l a b l e : to hold the investment and vote to delay major expenditure on the property pending improved economic conditions; and to hold the investment and support the development of the orebody into a mine. Placer's long-term aim i n Mexico i s to become active i n mining and, providing no further serious problems arise between the partners, sale of the minority i n t e r e s t i s not foreseen. Results of the forecast cash flows to Placer Development Limited under base case conditions 'for invest-ment decision purposes (Table XX, case number 1) show the investment of further resources into the Zacatecas mine at t h i s time to be unwise. The 10.5% return on investment 198 i s inadequate compensation for the r i s k s involved i n the project. Base case assumptions are those considered most l i k e l y to occur and unless and u n t i l they a l t e r for the betterment of forecast cash flows, the development of the orebody ought to be delayed. Placer's next step i s to r e t a i n the minority i n t e r e s t i n Mexican Mining Company S.A. de C.V. and vote to hold the Zacatecas orebody for periodic review of i t s economic value. 199 CHAPTER EIGHT  SUMMARY AND CONCLUSIONS 8.1 Summary This study examines the circumstances leading to a valuation of a Mexican s i l v e r mining investment by the Canadian mining company, Placer Development Limited. The valuation forms a major part of the company's decision whether to commit additional corporate resources to the j o i n t venture i n the State of Zacatecas, Mexico. The basic project data i s taken from a 1975 Placer f e a s i b i l i t y study amended by the writer i n an attempt to allow for changes a f f e c t i n g the project during the subse-quent four years. An understanding of the events and c i r -cumstances leading to the current s i t u a t i o n where Placer holds a minority t h i r t y - f o u r percent shareholding i n Mexican Mining Company S.A. de C.V. i s considered essen-t i a l for a thorough assessment of Placer's p o s i t i o n . The need for exploration e f f o r t to i d e n t i f y economically viable orebodies i s linked to the su r v i v a l of Placer as a mining company and i t s importance to the company's management i s stressed. The choice of Mexico as a target country for mineral exploration demands a t h i r t y year horizon of s a t i s f a c t o r y investment conditions i n that country i f the company Is to achieve a successful explora-t i o n and mine investment programme. Such a lengthy period in the future i s impossible to foresee i n any meaningful 200 d e t a i l and a l l that i s available i s an h i s t o r i c a l mining perspective to guide the potential investor. A major influencing factor i n both the value of Placer's investment and the decision to develop the pro-perty i s that of the Mexican partners i n the j o i n t ven-ture. A workable long-term partnership i s v i t a l to the e f f i c i e n t e x ploitation of the orebody and the objectives of the partners must be s u f f i c i e n t l y i n harmony to allow a good re l a t i o n s h i p . The objectives of the partners i n the j o i n t venture have a strong bearing on t h e i r methods of project evaluation and t h i s area i s considered i n d e t a i l , p a r t i c u l a r l y as regards ownership by an agency of the Mexican federal government. It i s only since late 1978 that the three parties to the j o i n t venture have reached agreement on fundamental matters of partnership policy and a new wave of enthusiasm emerged toward develop-ment of the orebody. The study concludes with a review of the f i n a n c i a l forecasts and a valuation of both the orebody i t s e l f and t h i r t y - f o u r percent shareholding i n the Mexican corpora-tion which owns the mineral rights to the orebody. The valuation i s subject to a number of l i m i t a t i o n s i n the data which have been referred to throughout the text of the study. The most important are the size of ore reserves and the annual rate of m i l l i n g the ore, which are both determined on the basis of 1975 economic conditions, and estimates of the cost of mine construction i n 1979. 201 8.2 Conclusions Findings indicate that the t h i r t y - f o u r percent minor-i t y shareholding i n Mexican Mining Company S.A. de C.V. has a value i n mid-1979 i n the range US $3 100 000 to US $3 900 000 and i f a sale were to occur, that the mid point of US $3 500 000 would be the l i k e l y p r i c e . The stream of income expressed i n constant d o l l a r s forecast to ar i s e from new investment outlays does not, on i t s own, j u s t i f y the value. Future long-term s i l v e r price trends are expected by many i n 1979 to increase with accompanying increases i n the Zacatecas ore reserves. When combined with the ef f e c t s of anticipated general p r i c e l e v e l i n f l a -t i o n , the investment i s regarded as a good hedge against i n f l a t i o n . The mining industry i n 1979 i s b u l l i s h on the future of s i l v e r and, for an i d e n t i f i e d orebody, w i l l pay a sum i n l i e u of actual exploration e f f o r t even i f i t means lowering customary hurdle rates. Ten million: d o l l a r s i s the assumed sum which allows the minority holding to be valued at US $3 500 000. The second conclusion i s that Placer w i l l continue to hold the investment u n t i l circumstances allow improved returns to the owners of the orebody. Placer's long-term objective of establishing a mining presence i n Mexico i s s t i l l i n evidence and continued e f f o r t s to achieve better economic terms, for example i n smelter charges and length of mine l i f e , w i l l , i n the foreseeable future, lead to the successful development of the orebody. 202 8.3 Concluding comments The study has shown the project to be very sensitive to the price of s i l v e r ; a factor well understood i n the mining industry. The current extremely high s i l v e r prices are regarded as a short term phenomenon not anticipated to l a s t the two years of mine construction. It i s the long-term s i l v e r price trend that i s of greatest i n t e r e s t to the potential investor i n the Mexican mine although the current market price plays a s i g n i f i c a n t role i n establishing the lar g e l y subjective value of the minority investment i n the corporate vehicle for the orebody. An obvious way to improve cash flow results i s to speed up the rate of production and no doubt t h i s avenue i s s t i l l being examined by the j o i n t venture partners. 203 BIBLIOGRAPHY 1. R.N. Anthony, "Accounting for the cost of in t e r e s t " Lexington Books, Mass., U.S.A., 1975, Pages 18, 69 and 76. 2. W.F. Atkins, "Fair Market Value of a Mining Property", CIM B u l l e t i n , September 1977, pp. 113-115. 3. G.O. A r g a l l , J r . , "Guanajuato Group Revives Mexican S i l v e r D i s t r i c t " , World Mining, September 1977, pp. 78-84. 4. G.O. A r g a l l , J r . , "La Caridad - World's Largest New Open P i t Copper Mine", World Mining, November 1977, pp. 42-44. 5. M.R.L. Blackwell, "Some Aspects of the Evaluation and Planning of the Bougainville Copper Project", Decision- Making i n the Mineral Industry, CIM Special Volume No. 12, 1971, pp. 261-269. 6. "The B r a z i l i a n Gamble", Business Week, 5 December 1977, pp. 72-81. 7. D.G. 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Lewis, "Determination of Optimum Ore Reserves and Plant Size by Incremental Finan-c i a l Analysis", I n s t i t u t i o n of Mining and Metallurgy  Transactions, Volume 78, 1969, Part A, pp. 20-26. 28. D.B. Hertz, "Risk Analysis i n Capital Investment", Harvard  Business Review, January-February 1964, pp. 95-106. 205 29. Investing, Licensing and Trading Conditions Abroad: Mexico, Business International Corp., 1978 (Updated to 1 March, 1978) . 30. D.G. Krige, "The Impact of Taxation Systems on Mine Economics", Decision-Making i n the Mineral Industry, CIM Special Volume No. 12, pp. 283-288. 31. R.H. Lesemann, "Commercial and Price Considerations i n Mine F e a s i b i l i t y and Cost Studies: Smelting and Refining Charges", Mineral Industry Costs, Northwest Mining Association, 1977, Chapter 12, pp. 200-204. 32. A. McQuire, " S i l v e r " , unpublished memo dated 2 May 1978, Placer Development Limited. 33. A.A. Meitz, B.B. 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Wells, J r . , "Negotiating with Third World Governments", Harvard Business Review, January-February 1977, pp. 72-80. 67. L.T. Wells, J r . , "Social Cost/Benefit Analysis for MNCs", Harvard Business Review, March-April 1975, pp. 40-48, 150-152. 68. World Metal S t a t i s t i c s , World Bureau of Metal S t a t i s t i c s , London, January 1979, pp. 9-10. 69. L. Wynant, "Project Financing for Extractive Ventures", Management Accounting, October 1978. 208 APPENDIX 1 Placer Development Limited  Assumptions made i n Pro-Forma Balance Sheets  as at 31 December 1980 (See Table III) Forecasts  1979 1980 Present operations (Cdn $) Notes Net earnings 1 Non-cash charges, net 2 Non-cash gain on exchange of Mattagami shares for Noranda shares 3 Dividends Capital expenditure $45 000 000 10 000 000 $51 000 000 15 300 000 38 600 000 12 000 000 20 000 000 12 000 000 20 000 000 Equity S i l v e r Mines Limited(Cdn Estimated costs Construction (cumulative) Working c a p i t a l (net) Net earnings (est.) Non cash charges, net (est.) $ ) 4 40 000 000 80 000 000 5 - 15 000 000 - 4 000 000 12 000 000 Mexican Mining Company S.A. de C.V. (Base case) cumulative  Estimated costs Construction 7 US39 500 000 US80 000 000 Working c a p i t a l (net) US 500 000 US 2 500 000 Net earnings 8 - -Non cash charges , net 8 US10 200 000 US10 200 000 Placer share of investment i n Mexican Mine S.A. de C.V. 9 US10 200 000 US10 200 000 Notes 1 Forecast by Alf r e d Bunting & Co. Limited P.J. Mars, Monthly Metals and Mining Review, Toronto, March 1979. 2 Based on 1978 consolidated statement of changes i n 1 f i n a n c i a l position i n Annual Report of Placer Development  Limited 1979 1980 Depreciation and depletion 14 500 000 15 000 000 Equity i n excess of dividends from associated companies (7 500 000) (2 700 000) Other items 3 000 000 3 000 000 Cdn $10 000 000 15 300 000 209 Notes 3 Omitted by Buntings (see note 1 above), per Placer f i r s t quarter 1979 report to shareholders. 4 New mine construction near Houston, B.C. announced March 19 79. 5 Receivables and inventory, $18 000 000 less accounts payable $3 000 000. 6 No new business, and no assets d i s t r i b u t i o n , of Craigmont Mines Ltd. i s assumed. 7 Assumes construction begins f a l l . 1979 and ends 31 December 1980. 8 Assumes production begins 1 January 1981. 9 34% of cost of assets less loans of Mexican Mining Co. S.A. de C.V. APPENDIX 2  Metric Symbols and Imperial Equivalents Metric Symbol Tonne t Kilogramme k Grams per tonne g/t Metre m Imperial Equivalent 1 t approximates 1.1 tons 1 kg approximates 2.2 lbs. 1 kg approximates 32.15 troy 100 g/t approximates 2.9 troy oz/ton 1 m approximates 3.25 feet APPENDIX 3  Mexican Mining Company S.A. de C.V. Investment Decision Case Cash Flow Results Case Production Return on Net Present Values.discounted at Number Years to Investment (US $000) Payback After Tax i 01 15% 20% 1 BASE 5.2 15.2% 196 726 577 (14 424) 2 - 10 year l i f e 5.2 11.2% 64 291 (10 571) (19 855) 3 - minus 10% of metal prices 6.4 12.2% 147 817 (10 585) (22 340) 4 - minus 20% of s i l v e r price 6.6 11.8% 143 716 (11 857) (23 278) 5 - plus 10% construction costs 5.7 14.0% 192 676 ( 4 200) (19 173) 6 - plus 10% operating costs 5.7 13.9% 177 275 ( 4 144) (17 825) 7 - accelerated tax depreciation-20% 4.0 16.9% 200 175 6 846 ( 8 587) 8 - accelerated tax depreciation-33 1/3% 4.0 17.0% 200 226 .7 183 ( 8 286) 9 - accelerated tax depreciation-100% for pre-production c a p i t a l 4.0 16.8% 199 333 6 645 ( 8 687) 10 accelerated tax depreciation-100% for pre-production c a p i t a l and 20% afte r 4.0 16.9% 200 175 6 999 ( 8 427) 11 - 50% taxes remission for 3 years 4.6 16.4% 205 857 5 535 (10 302) 12 50% taxes remission for 3 years and 20% accelerated tax depre-c i a t i o n 4.0 17.0% 201 145 7 339 ( 8 185) 13 — 10 year l i f e , 5 0 % taxes remis-sion for 3 years and 20% accelerated tax depreciation 4.0 13.6% 71 246 ( 3 578) (13 501) 14 no production tax for 5 years and 20% accelerated tax de-preciation 3.6 18.6% 210 297 12 469 ( 3 845) 15 no production tax and income tax for 5 years 3.3 22.7% 251 904 27 723 7 569 16 no production tax and income tax for 5 years and $10 m i l l i o n con-str u c t i o n cost reduction/subsidy3.0 26.5% 259 844 35 870 15 590 17 minus 10% of metal prices,50% taxes remission for 3 years and 20% accelerated tax depreciations.4 13.0% 146 661 i 7 040) (18 824) EXPECTED (see Appendix 11) 5.1 14.9% 176 537 305) (14 2 94) APPENDIX 4  Mexican Mining Company S.A, de C.V. Financing Decision Case Cash Flow Results Case Number 101 BASE 102 10 year l i f e 103 minus 10% of metal prices 104 minus 20% of s i l v e r price 105 plus 10% construction costs 106 plus 10% operating costs 107 accelerated tax depreciation-20% 109 accelerated tax depreciation-100% for pre-production c a p i t a l 110 accelerated tax depreciation-100% for pre-production c a p i t a l and 20% accelerated tax depreciation aft e r 111 50% taxes remission for 3 years 112 50% taxes remission for 3 years and 20% accelerated tax depreciation 113 10 year l i f e , 5 0 % taxes remission for 3 years and 20% accelerated tax depreciation 114 no production tax for 5 years and 20% accelerated tax depreciation 115 no production tax and income tax for 5 years 116 no production tax and income tax for 5 years and $10 m i l l i o n con-str u c t i o n cost reduction/subsidy 117 minus 10% of metal prices,50% taxes remission for 3 years and 20% accelerated tax depreciation 118 Canadian Investor US $8.5 m i l l i o n Production Years to Return on Investment Net Present Values discounted at (US $000) ayback After Tax 0% 15% 20% 6.5 17.2% 180 927 6 060 ( 5 592) 6.5 12.1% 48 491 ( 5 088) (11 023) 7.8 13.4% 130 457 ( 4 279) (12 470) 8.1 12.9% 126 028 ( 5 416) (13 239) 7.1 16.1% 173 357 2 977 ( 7 921) 7.0 15.6% 160 771 1 741 ( 8 486) 5.7 18.2% 180 601 8 327 ( 3 505) 5.5 18.5% 182 348 9 262 ( 2 779) 5.2 18.9% 184 787 10 197 ( 2 029) 5.1 19.1% 185 629 10 552 ( 1 769) 6.1 18.1% 186 900 8 403 ( 3 829) 5.7 18.2% 180 601 8 327 ( 3 505) 5.7 13.5% 50 702 ( 2 591) ( 8 822) 4.4 21.1% 196 543 15 441 2 065 3.9 25.7% 231 601 27 564 10 985 3.5 28.9% 244 437 34 426 16 628 8.0 13.1% 124 825 ( 4 712) (12 563) 6.5 17.2% 180 927 6 060 ( 5 592) t o APPENDIX 4 (Cont'd) Mexican Mining Company S.A. de C.V. Financing Decision Case Cash Flow Results Case Number Production Years to Payback Return on Investment After Tax Net Present Values discounted at (US $000) $8.5 m i l l i o n , for 3 years tax depre-119 Canadian Investor US 50% taxes remission and 20% accelerated c i a t i o n 120 in t e r e s t 14% 121 Mexican investment tax c r e d i t for 2 years EXPECTED (see Appendix 12) 1 .6 6.2 6.5 15% 18 17 186 179 900 358 8 5 403 457 17.8% 16.7 185 563 163 338 7 844 4 570 20% 829) 043) ( 4 258) ( 6 173) APPENDIX 5  Mexican Mining Company S.A. de C.V. Investment Decision Base Case Cash Flow' Results and S e n s i t i v i t i e s Case Production %Return on Net Present Values discounted at Number Years to Investment (US $000) Payback After Tax 0% 15% 20% 1 BASE case r e s u l t s (Appendix 13) SENSITIVITIES better (worse) 5.2 15.2 196 726 577 (14 424) 2 10 year base 0 (4.0) (132 435) (11 148) ( 5 431) 3 minus 10% of metal prices (0.8) (3.0) ( 48 909) (.11 162) ( 7 916) 4 minus 20% of s i l v e r price (1.4) (3.4) ( 53 010) (12 434) ( 8 854) 5 plus 10% construction costs (0.5) (1.2) ( 4 050) ( 4 777) ( 4 749) 6 plus 10% operating costs (0.5) (1.3) ( 19 451) ( 4 721) ( 3 401) 7 accelerated tax depreciation-20% 1.2 1.7 3 449 6 269 5 837 8 accelerated tax depreciation-33-1/3% 1.2 1.8 3 500 6 606 6 138 9 100% for pre-production c a p i t a l 1.2 1.6 2 607 6 068 5 737 10 accelerated tax depreciation-100% for pre-production c a p i t a l and 20% accelerated a f t e r 1.2 1.7 3 449 6 422 5 997 11 50% taxes remission for 3 years 0.6 1.2 9 131 4 958 4 122 12 50% taxes remission for 3 years and 20% accelerated tax depre-c i a t i o n 1.2 1.8 4 419 6 762 6 239 13 10 year l i f e , 50% taxes remission and 20% accelerated tax depre-c i a t i o n 1.2 (1.6) (125 480) ( 4 155) 923 14 no production tax for 5 years and 20% accelerated tax depreciation 1.6 3.4 13 571 11 892 10 579 15 no production tax and income tax for 5 years 1.9 7.5 55 178 27 146 21 993 16 no production tax and:'Income tax for 5 years and $10 m i l l i o n con-str u c t i o n cost reduction/subsidy 2.2 11.3 63 118 35 293 30 014 17 minus 10% of metal prices,50% taxes remission for 3 years and 20% accelerated tax depreciation (0.2) (2.2) ( 50 065) ( 7 617) ( 4 400) APPENDIX 6  Mexican Mining Company S.A. de C.V. TFinancing. Decision Base Case Cash Flow Results and S e n s i t i v i t i e s Production ',%Return on Net Present Values discounted at Case Years to Investment (US $000) Number Payback After • Tax 0% 15% 2C )% 101 BASE case re s u l t s (Appendix 14) SENSITIVITIES better (worse) 6. 5 17. 2 180 927 6 060 ( 5 592) 102 10 year base [ (5. 1) (132 436) (11 148) ( 5 431) 103 minus 10% of metal prices (1. .3) (3. 8) ( 50 470) (10 339) ( 6 878) 104 minus 20% of s i l v e r price (1. 6) (4. 3) ( 54 899) (11 476) ( 7 647) 105 plus 10% construction costs (0. 6) (1. 1) ( 7 570) ( 3 083) ( 2 329) 106 plus 10% operating costs (0. 5) (1. 6) ( 20 156) ( 4 319) ( 2 894) 107 accelerated tax depreciation-20% 0. 8 1. 0 ( 326) 2 267 2 087 108 accelerated tax depreciation-33-1/3% 1. 0 1. 3 1 421 3 202 2 813 109 accelerated tax depreciation-100% for pre-production c a p i t a l 1. 3 1. 7 3 860 4 137 3 563 110 accelerated tax depreciation-100% for pre-production c a p i t a l and 20% accelerated tax depre-c i a t i o n a f t e r 1. 4 1. 9 4 702 4 492 3 823 111 50% taxes remission for 3 years 0. 4 0. 9 5 973 2 343 1 763 112 50% taxes remission for 3 years and 20% accelerated tax depre-c i a t i o n 0. 8 1. 0 ( 326) 2 267 2 087 113 10 year l i f e , 5 0 % taxes remission for 3 years and 20% accelerated tax depreciation 0. 8 (3. 7) (130 225) ( 8 651) ( 3 230) 114 no production tax for 5 years and 20% accelerated tax depreciation 2. 1 3. 9 15 616 9 381 7 657 115 no production tax and income tax for 5 years 2. 6 8. 5 50 674 21 504 16 577 116 no production tax and income tax for 5 years and $10 m i l l i o n con-struction cost reduction/subsidy 3. 0 11. 7 63 510 28 366 22 220 APPENDIX 6 (Cont'd) Mexican Mining Company S.A. de C.V. Financing Decision Base Case Cash Flow Results and S e n s i t i v i t i e s Case Number Production Years to Payback 117 118 119 120 121 minus 10% of metal prices, 50% taxes remission for 3 years and 20% accelerated tax depre-c i a t i o n Canadian Investor US Canadian Investor US 50% taxes remission and 20% accelerated c i a t i o n i n t e r e s t 14% Mexican investment tax for 2 years $8.5 m i l l i o n $8.5 m i l l i o n , for 3 years tax depre-c r e d i t (1.5) 0 0, (0, 4 1) %Return on Investment After Tax (4.1) 0 0 (0 9 2) Net Present Values discounted at (US $000) 0% 56 102) 0 5 1 973 569) 15% 0.3 0.6 4 6 36 (10 772) 0 2 343 603) 1 784 20! 6 971) 0 1 763 451) 1 334 APPENDIX 7  Placer Development Limited  Investment Decision Case Cash Flow Results to Shareholder i n Mexican Project Production Return on Net Present Values discounted at Case Years to Number Payback Investment After Tax 0% (US 8% $000) 15% 20% 1 BASE 6. 9 10. 5% 47 018 5 764 (6 499) (10 684) 2 10 year l i f e 6. 9 5. 7% 11 446 (3 146) (9 494) (12 143) 3 minus 10% of metal prices 8. 2 8. 2% 33 881 357 (9 497) (12 811) 4 minus 20% of s i l v e r price 8. 4 7. 9% 32 780 ( 202) (9 839) (13 063) 5 plus 10% construction costs 7. 4 9. 6% 45 448 3 991 (.8 324) (12 513) 6 plus 10% operating costs 7. 4 9. 5% 41 694 3 440 (7 856) (11 684) 7 accelerated tax depreciation-20% 5. 9 11. 5% 47 945 7 451 (4 816) ( 9 117) 8 accelerated tax depreciation-33 1/3% 5. 9 11. 5% 47 958 7 546 (4 725) ( 9 036) 9 accelerated tax depreciation-100% for pre-production c a p i t a l 6. 0 11. 5% 47 719 7 335 (4 870) ( 9 143) 10 accelerated tax depreciation-100% for pre-production c a p i t a l and 20% a f t e r 5. 9 11. 5% 47 945 7 482 (4 774) ( 9 074) 11 50% taxes remission for 3 years 6. 3 11. 4% 49 471 7 515 (5 168) ( 9 577) 12 50% taxes remission for 3 years and 20% accelerated tax de-preciation 5. 8 11. 6% 48 205 7 6 30- (4 683) ( 9 009) 13 10 year l i f e , 5 0 % taxes remission for 3 years and 20% accelerated tax depreciation 5. 8 7. 2% 13 314 (1 102) (7 615) (10 437) 14 no production tax for 5 years and accelerated tax depreciation 4. 9 12. 5% 50 663 9 407 (3 305) ( 7 843) 15 no production tax and income tax for 5 years 3. 9 15. 6% 61 839 15 759 792 ( 4 777) 16 no production tax and income tax for 5 years and $10 m i l l i o n con-str u c t i o n cost reduction/subsidy 3. 6 17. 9% 64 686 18 634 3 616 ( 2 009) 17 minus 10% of metal prices,50% taxes remission for 3 years and 20% accelerated tax depreciation 8. 0 8. 6% 33 571 1 117 (8 545) (11 866) EXPECTED (see Appendix 11) 6 . 8 10. 0% 41 583 4 498 (6 751) (10 665) APPENDIX 8  Placer Development Limited  Financing Decision Case Cash Flow Results to Shareholder i n Mexican Project Production Return on Net Present Values discounted at Case Years to Investment (US $000) Number Payback After Tax 0% 8% 15% 20% 101 BASE 6 .7 15. 3% 47 788 10 427 234; (2 959) 102 10 year l i f e 6 .7 10. 0% 12 216 1 517 (2 760) (4 417) 103 minus 10% of metal prices 8 .3 11. 5% 33 537 4 628 (2 842) (5 036) 104 minus 20% of s i l v e r price 8 .3 11. 4% 33 042 4 452 (2 915) (5 076) 105 plus 10% construction costs 7 .3 14. 3% 45 755 9 180 ( 594) (3 584) 106 plus 10% operating costs 7 .2 13. 9% 42 374 8 222 ( 926) (3 736) 107 accelerated tax depreciation-20% 6 .0 16. 1% 47 700 11 053 920 (2 321) 108 accelerated tax depreciation-33-1/3% 5 .8 16. 4% 48 170 11 407 1 171 (2 126) 109 accelerated tax depreciation-100% for pre-production c a p i t a l 5 .5 16. 8% 48 825 11 768 1 422 (1 925) 110 accelerated tax depreciation-100% for pre-production c a p i t a l and 20% accelerated tax de-preciation a f t e r 5 .5 16. 9% 49 051 11 915 1 518 (1 855) 111 50% taxes remission for 3 years 6 .3 16. 1% 49 392 11 448 940 (2 408) 112 50% taxes remission for 3 years and 20% accelerated tax de-preciation 6 .0 16. 1% 47 700 11 053 920 (2 321) 113 10 year l i f e , 50% taxes remission for 3 years and 20% accelerated tax depreciation 6 .0 11. 2% 12 810 2 321 (2 012) (3 749) 114 no production tax for 5 years and 20% accelerated tax de-preciation 4 .6 18. 7% 51 982 13 865 2 919 ( 733) 115 no production tax and income tax for 5 years 4 .0 22. 7% 61 399 19 033 6 161 1 648 116 no production tax and income tax for 5 years and $10 m i l l i o n construction cost reduction/ subsidy 3 .4 29. 0% 66 547 23 089 9 530 4 637 APPENDIX 8 (Cont'd) Placer Development Limited  Financing Decision Case Cash Flow Results to Shareholder i n Mexican Project Production Return on Net Present Values discounted at Case Years to Investment (US $000) Number Payback After Tax 0% 8% 15% 20% 117 minus 10% of metal prices,50% taxes remission for 3 years and 20% accelerated tax de-prec i a t i o n 8.3 11.5% 32 719 4 641 (2 659) (4 831) 118 Canadian Investor US $8.5 m i l l i o n 6.3 17.3% 49 488 12 022 1 747 (1 498) 119 Canadian Investor US $8.5 m i l l i o n , 50% taxes re-mission for 3 years and 20% accelerated tax de-preciation 5.8 18 .3% 51 092 13 043 2 454 ( 948) 120 int e r e s t 14% 6.8 15.1% 47 367 10 178 72 (3 080) 121 Mexican investment tax c r e d i t for 2 years 6.5 15.7% 48 739 11 026 644 (2 641) EXPECTED (see Appendix 12) 6.7 15.0 43 147 9 296 ( 13) (2 956) I— vo APPENDIX 9  Placer Development Limited Investment Decision Base Case Cash Flow Results to Shareholder in Mexican Project and S e n s i t i v i t i e s Production %Return on Net Present Values discounted at Case Years to Investment (US $000) Number Payback After Tax 0% 8% 15% 20% 1 BASE case results (Appendix 15) 6.9 10. 5 47 018 5 764 (6 499) (10 684) SENSITIVITIES better (worse) 2 10 year base 0 (4. 8) (35 572) (8 910) (2 995) ( 1 459) 3 minus 10% metal prices (1.3) (2. 3) (13 137) (5 407) (2 998) ( 2 127) 4 minus 20% of s i l v e r price (1.5) (2. 6) (14 238) (5 966) (3 340) ( 2 379) 5 plus 10% construction costs (0.5) (0. 9) ( 1 570) (1 773) (1 825) ( 1 829) 6 plus 10% operating costs (0.5) (1. 0) ( 5 324) (2 324) (1 357) ( 1 000) 7 accelerated tax depreciation-20% 1.0 1. 0 927 1 687 1 683 1 567 8 accelerated tax depreciation-33-1/3% 1.0 1. 0 940 1 782 1 774 1 648 9 100% for pre-production c a p i t a l 0.9 1. 0 701 1 571 1 629 1 541 10 accelerated tax depreciation-100% for pre-production c a p i t a l and 20% accelerated af t e r 1.0 1. 0 927 1 718 1 725 1 610 11 50% taxes remission for 3 years 0.6 0. 9 2 453 1 751 1 331 1 107 12 50% taxes remission for 3 years and 20% accelerated tax depre-c i a t i o n 1.1 1. 1 1 187 1 866 1 816 1 675 13 10 year l i f e , 5 0 % taxes remission and 20% accelerated tax depre-c i a t i o n 1.1 (3. 3) (33 704) (6 866) (1 116) 247 14 no production tax for 5 years and 20% accelerated tax depreciation 2.0 2. 0 3 645 3 643 3 194 2 841 15 no production tax and income tax for 5 years 3.0 5. 1 14 821 9 995 7 291 5 907 16 no production tax and income tax for 5 years and $10 m i l l i o n con-struction cost reduction/subsidy 3.3 7. 4 17 668 12 870 10 115 8 675 17 minus 10% of metal prices,50% taxes remission for 3 years and 20% accelerated tax depreciation(1.1) (1. 9) (13 447) ( 4 : 647) (2 046) ( 1 182) APPENDIX 10 Placer Development Limited Financing Decisio to Shareholder i n Me n Base Case Cash Flow Results xican Project and S e n s i t i v i t i Case Number Production Years to Payback 101 BASE case re s u l t s (Appendix 16) SENSITIVITIES better (worse) 102 10 year base 103 minus 10% of metal prices 104 minus 20% of s i l v e r p rice 105 plus 10% construction costs 106 plus 10% operating costs 107 accelerated tax depreciation-20% 108 accelerated tax depreciation-33-1/3% 109 accelerated tax depreciation-100% for pre-production c a p i t a l 110 accelerated tax depreciation-100% for pre-production c a p i t a l and 20% accelerated tax depre-c i a t i o n a f t e r 111 50% taxes remission for 3 years 112 50% taxes remission for 3 years and 20% accelerated tax depre-c i a t i o n 113 10 year l i f e , 5 0 % taxes remission for 3 years and 20% accelerated tax depreciation 114 no production tax for 5 years and 20% accelerated tax depreciation 115 no production tax and income tax for 5 years 116 no production tax and income tax for 5 years and $10 m i l l i o n con-struction cost reduction/subsidy 6.7 0 (1.6) (1.6) (0.6) (0.5) 0.7 %Return on Net Present Value Investment (US $0 After Tax es s discounted at 00) 0% 8% 15'-15.3 47 788 10 427 (5. (3. (3, (1. 3) 8) 9) 0) (1.4) 0.8 (35 (14 (14 ( 2 ( 5 ( 572) 251) 746) 033) 414) 88) (8 (5 (5 (1 (2 910) 799) 975) 247) 205) 626 234 (2 994) (3 076) (3 149) ( 828) (1 160) 686 20% (2 959) (1 458) (2 077) (2 117) ( 625) ( 777) 638 0.9 1.1 382 980 936 833 1.2 1.5 1 037 1 341 1 188 1 034 1.2 1.6 1 263 1 488 1 284 1 104 0.4 0.8 1 604 1 021 706 551 0.7 0.8 ( 88) 626 686 638 0.7 (4.1) (34 978) (8 106) (2 246) ( 790) 2.1 3.2 4 194 3 438 2 685 2 226 2.7 7.4 13 611 8 606 5 927 4 607 3.3 13.7 18 759 12 662 9 296 7 596 APPENDIX 10 (Cont'd) Placer Development Limited Financing Decision Base Case Cash Flow Results to Shareholder in Mexican Project and S e n s i t i v i t i e s Case Number 117 minus 10% of metal prices,50% taxes remission for 3 years and 20% accelerated tax depreciation 118 Canadian Investor US $8.5 m i l l i o n 119 Canadian Investor US $8.5 million,50% taxes remission for 3 years and 20% acce-lerated tax depreciation 120 i n t e r e s t 14% 121 Mexican investment tax c r e d i t for 2 years Production Years to Payback (1.6) 0.4 0, (.0. 9 1) %Return on Investment After Tax (.3.8) Net Present Values discounted at (US $000) 151 2.0 3. CO 0 2) 0.2 0.4 1 700 304 421) 951 1 595 616 249) 599 1 513 220 162) 410 20? (15 069) (.5 786) (2 893) (1 872) 1 461 011 121) 318 t o C a i i Number • ' A P P E N D I X 11. . M E X I C A N M I N I N G C O M P A N Y S A d e C V I N V E S T M E N T D E C I S I O N C A S E S : P R O B A B I L I T Y O F O C C U R R E N C E C w r r e M MMICM tax law with/without c o n e * t i i o r a (0.8) b b t « opar./cont'r. coir . 20 vr. (0.81 \ 1 0 , r . 1-2) b a i t o p t r . c o i t / 1 1 0 * / . cor.it. 2 0 % (.3) 3 3 ' * % ( .41 \ \ 100 % 1 2 ) \ •  100% • 2 0 % (.11 I.JI /•VII. tan dopr. 20 m . I I I (-5) 10 r n . (-2) . ( . 1 1 * 2 0 % roi dopr. $10 m i l l i o n l u b i l d y othorwiio b c i a 3 r r . 3 0 % tw* r o i ' l l l o n o n d 2 0 % t o i d » p r . or t to rwl i i bo io ML _L2L i i 12 13 U IS 3 17 Probability of o c c u r o n c r> . 2 24 • 0 3 6 . 0 3 5 . 0 3 5 •04 2 • 0 5 6 •028 .014 •033 • 0 2 1 • 0 0 7 .112 .017 .011 •160 • 0 4 0 .100 1 . 0 0 0 N o l o 1 • r o b o b i l i r i o t for . a c h ovont (iriown m b r o t k o M ) oro a l d o t a r a t o . d b f t t i o o » r b o » t o to U) APPENDIX 12. MEXICAN MINING COMPANY SA da CV FINANCING DECISION CASES :• PROBABILITY OF OCCURRENCE (.5) b e l t t o « t i o c c o l . r o i dtpr. L 3yr.50%te> r t m i u i o n (••> I.S) /•70V. t o i d t o r . ( J ) C o l t Numbtr 1 A p p t n j i K A.) i n v t i t c r t d i t Ml 2 0 % 1.3) 121 107 I 0 « ' 0 0 % < . 2 > , 0 9 110 I 0 0 % * 2 0 % | . l | .21 5yr. no Prodn.Toa | . » > » 2 0 % Ion d t p r . o r h t r w l M b o l t 3yr. 5 0 % r o » f t m i n i o n ond 2 0 % t o » d t p r . othorwiio b o M o t h t r w i u b o l t 3yr. 5 0 % t o i r t m l n l o n ond 2 0 % t o « d t p r . 2 0 y r » . ( . 8 ) I 0 r r t . ( . 2 ) 12) 5 y r i . no inc. l o a \ (.21 1-7) JUL 112 115 116 103 117 104 111 I I * Probability, of OCCUrrtn'ct 0.1613 0 . 0 4 0 3 0 . 0 2 5 2 0 . 0 2 5 2 0 . 0 6 3 0 0 . 0 1 2 6 0 . 0 3 7 8 0 . 0 3 7 1 0 . 0 2 5 2 0 . 0 1 2 6 0 . 0 3 1 5 0 . 0 2 5 2 0 . 0 0 6 3 0 . 1 0 0 1 aoisi 0.0101 0 . 1 4 4 0 0 . 0 3 6 0 ao»oo 0 . 0 7 0 0 0 . 0 3 0 0 N o t * : P r o b o b l l l t l t i for t « h t y t n l (ihown In b reckon ) a r « o i do lor min t d by tho a u t h o r . 1. 0 0 0 0 t o to PRODUCTION YEAH SALES SALES RECEIPTS OPERATING COSTS EXPLORATION EXPENSES WAREHOUSE INVENTORY STATE PROPERTY TAX OPERATING CASH PROFIT INTEREST EXPENSE CASH EARNINGS BEFORE TAXES PRODUCTION TAXES INCOME TAXES EMPLOYEE SHARING TAX CASH EARNINGS AFTER TAX CAPTIT AL EXPENDITURES - ACQUISITIONS - TAX AND OUT Y ADDED - PREPRODUCTlON INTEREST TOTAL CAP11AL EXPENDITURES CASH FLOW IIEFURE LOAN PAYMENT LOAN PAYMENT-100 PCT CASH FLOW PROJECT NET CASH FLOW -100PCT PROJECT CUM NLT CASH FLOW LOAN BALANCE REMAINING TOTAL TAXES AND DUTY CUMULATIVE TOTAL TAXES « DUTY PRESENT VALUE MAR.1979- H PC I -15 per -20 PCT INTERNAL RATE OF RETURN (PCT.) YEARS TO PAYbACK (PRODN YRS) MEXICAN MINING CO. SA DE CV (S000 1979 UNITED STATES CONSTANT DOLLARS I MARCH 1979 - CASE! EQUITY - BASE - 20 YEARS PRODUCT PR I C E S : RASE AG US$ 193/KG (US 16.00/OZ) ZN US* 882/T PR USS 750/T CD US$ 4.05/KG APPENDIX 13 CAPITAL COST WAREHOUSE INVENTORY I N I T I A L OPERATING COSTS - 3 MONTHS MAXIMUM INVESTMENT - PROJECT PROJECT CASH FLOW 75 105 000 2 500 000 >T 505 000 US $ 82 110 000 -2 -1 500 -500 -500 38 175 700 700 7U0 4 5 1)90 577 -14 424 15.2 5.2 2 000 -2 000 -2 000 -500 -2 000 31 650 1 272 39 175 35 930 -39 675 -37 930 -39 675 -77 605 1 272 1 972 1 2 3 4 5 6 7 8 9 ' I l 532 19 307 56 4 45 50 043 46 716 49 704 40 626 50 675 53 370 31 149 17 423 54 601 57 644 49 548 49 017 40 916 50 163 52 696 10 019 18 322 18 550 10 614 18 262 20 194 21 058 20 904 21 000 - 230 479 51 - - - - -400 300 200 100 - - - - -350 350 350 350 350 350 350 350 350 12 380 28 214 35 102 30 529 30 936 20 473 27 508 28 029 31 266 12 380 28 214 35 102 38 529 30 936 28 473 27 500 28 029 31 266 3 379 3 979 4 504 4 634 3 748 3 979 3 801 4 029 4 230 175 7 786 10 300 11 001 7 290 7 4 74 6 509 7 283 9 721 33 1 403 1 962 2 095 1 389 1 424 1 240 1 307 1 052 8 792 14 965 10 336 . 20 790 I B 509 15 596 15 078 16 129 15 456 ,015 750 650 1 110 1 9 5 5 3 680 2 235 1 110 1 250 1 333 - - _ _ _ _ _ -2 170 750 650 1 110 1 955 3 680 2 235 1 110 1 250 6 614 14 2 1 5 17 606 19 600 16 554 11 916 13 643 15 019 14 206 6 614 1M 215 17 606 19 680 16 554 11 916 13 643 15 019 14 206 70 991 -56 776 - 3 9 090 - 1 9 401 -2 048 9 069 22 711 37 731 51 936 3 930 13 599 17 115 in onn 12 777 13 227 11 900 13 049 16 161 5 910 19 500 36 624 54 704 67 401 00 700 92 600 105 737 121 898 APPFMDTX 1 3 MEXICAN MINING CO. SA OE CV U 0 0 0 1^79 UNITED STATES CONSTANT DOLLARS) MARCH 1979 - CASE'• EQUITY - BASE - 2Q YEARS PRODUCT P R I C E S : RASE AG USJ> 193/KG (US 1 6 . 0 0 / 0 Z ) ZN USt B82/T Pn USt 750/T CD USS 4.85/KG C A P I T A L COST 75 105 0 0 0 WAREHOUSE INVENTORY 2 500 000 I N I T I A L OPERATING COSTS - 3 MONTHS 4 5 0 5 000 MAXIMUM INVESTMENT - PROJECT US S 02 110 000 PROJECT CASH FLOW PRODUCTION YEAR 10 11 12 13 14 15 16 17 10 19 20 SALES 50 560 43 720 43 669 46 073 44 034 40 291 55 143 48 144 43 976 45 009 60 971 SALES RECEIPTS 51 263 45 430 43 682 45 472 44 544 47 227 53 430 49 B94 45 010 44 751 72 223 OPERATING COSTS 20 057 20 645 20 798 20 071 20 153 10 430 18 054 17 843 17 609 17 970 21 217 EXPLORATION EXPENSES - - - - - - - - - 705 1 089 WAREHOUSE INVENTORY - - - - - - - - - - -3 500 STATE PROPERTY TAX 350 350 350 350 350 350 350 350 350 350 350 OPERATING CASH PROFIT 30 056 24 235 22 534 25 051 24 041 20 447 35 026 31 701 26 979 25 726 53 067 INTEREST EXPENSE - - - - - - - - - - -CASH EARNINGS BEFORE TAXES 30 056 24 235 22 534 25 051 24 041 28 447 35 026 31 701 26 979 25 726 53 067 PRODUCTION TAXES 4 007 3 499 3 406 3 680 3 537 3 060 4 370 3 844 3 510 3 623 4 889 INCOME TAXES 9 62b 6 800 6 849 8 028 7 211 9 590 12 541 10 027 0 493 8 51 1 13 330 EMPLOYEE SHARING TAX 1 033 1 310 1 305 1 529 1 374 1 827 2 309 1 910 1 618 1 621 2 539 CASH EARNINGS AFTER TAX 14 590 12 546 10 094 11 014 11 919 13 170 15 726 15 919 13 358 11 971 32 309 CAPT ITAL EXPENDITURES - ACQUISITIONS 2 235 4 010 2 020 2 165 935 1 825 2 100 1 680 1 330 195 130 - TAX AND DUTY ADDED - - - - - - - - - - -- PREI'ROUUCTION INTEREST - - - - - - - - - - — TOTAL CAPITAL EXPENDITURES 2 235 4 010 2 020 2 165 935 1 825 2 100 1 600 1 330 195 130 CASH FLOW BEFORE LOAN PAYMENT 12 355 8 536 0 074 9 649 10 904 11 345 13 626 14 239 12 028 11 776 32 179 LOAN PAYMLNT-100 PCT CASH FLOW - - - - - - - — ~ *** PROJECT NET CASH FLOW -100PC1 12 355 0 536 0 074 9 649 10 904 11 34 5 13 626 14 239 12 028 11 776 32 179 PROJECT CUM NET CASH FLOW 64 291 72 827 00 900 90 549 101 534 112 079 126 505 140 744 152 772 164 540 196 726 LOAN BALANCE REMAINING - - - - - - - - - - -TO 1AL TAXES AND DUTY 15 016 12 039 11 990 13 507 12 471 15 627 19 650 16 131 13 971 14 105 21 108 CUMULATIVE TOTAL TAXES « DUTY 137 713 149 753 161 743 175 33(1 107 (101 203 428 223 078 239 209 253 180 267 285 280 393 APPENDIX 13 MEXICAN MIMING CO. SA OE CV ( S 0 0 0 1 9 7 9 UNITED STATES CONSTANT DOLLARS) MARCH 1979 - CASE! E O U l ft - UASF. - 20 YEARS PRODUCT P R I C E S : BASE AG US* 193/KG (US Sb.OO/OZ) 2M US1 802/T PU US'J. 750/T CP U S J <».85/KG C A P I T A L COST 7 5 105 000 WAREHOUSE INVENTORY 2 500 000 I N I T I A L OPERATING COSTS - 3 MONTHS 14 505 000 MAXIMUM INVESTMENT - PROJECT US $ 82 110 000 PRODUCTION YEAR TOTALS PROJECT CASH FLOW S A L E S 9 8 4 168 S A L E S R E C E I P T S OPERATING COSTS EXPLORATION EXPENSES WAREHOUSE INVENTORY STATE PROPERTY TAX OPERATING CASH P R O F I T IhlEREST EXPENSE CASH EARNINGS UEFORE TAXES PRODUCTION TAXES INCOME TAXES EMPLOYEE SHARING TAX CASH EARNINGS AFTER TAX 98<4 16B 3 8 9 0 1 0 2 562 7 000 5 8 5 5 9 6 585 596 78 676 168 626 32 119 306 17q C APT H A L EXPENDITURES - A C Q U I S I T I O N S 106 1 4 3 - TAX AND DUTY ADDED 1 9 7 2 - PRLPRUUUCTION INTEREST 1 3 3 3 TOTAL C A P I T A L EXPENDITURES 109 <i'.H CASH FLOU BEFORE LOAN PAYMENT 27<* 3 3 1 LOAN PAYMENI-100 PCI CASH FLOW PROJECT NET CASH FLOW - J 0 0 P C T 196 7 2 6 PROJECT CUM NET CASH FLOW LOAN BALANCE REMAINING TOTAL TAXES AND DUTY CUMULATIVE TOTAL TAXES S DUTY 288 3 9 3 to to MEXICAN MINING CO. SA DE CV (SOOO 1979 UNITED STATES CONSTANT DOLLARS! APPENDIX 14 MARCH 1 9 7 9 - CASE: LOAN PROOUCT PRICES." BASE AG USS 193/KG (US *6.OO/OZ) PH USS 750/T BASE - 2 0 YEARS ZN CO USJ 882/T USS 4.85/KG C A P I T A L COST PREPRODUCTION INTEREST WAREHOUSE INVENTORY I N I T I A L OPERATING COSTS 3 MONTHS 75 105 000 4 975 000 2 500 000 4 505 000 MAXIMUM INVESTMENT - PROJECT US S 87 085 000 PROJECT CASH FLOW PRODUCTION YEAR SALES SALES R E C E I P T S OPERATING COSTS EXPLORATION EXPENSES WAHEHOUSE INVENTORY STATE PROPERTY TAX OPERATING CASH PROFIT INTEREST EXPENSE CASH EARNINGS BEFORE TAXES PRODUCTION TAXES INCOME TAXES EMPLOYEE SHARING TAX CASH EARNINGS AFTER TAX CA P T I T A L EXPENDITURES - ACQUISITIONS - TAX AND DUTY AOOED - PREPRODUCTION INTEREST TOTAL C A P I T A L EXPENDITURES CASH FLOW BEFORE LOAN PAYMENT LOAN PAYMENT—100 PCT CASH FLOW PROJECT NET CASH FLOW -100PCT PROJECT CUM NET CASH FLOW LOAN BALANCE REMAINING TOTAL TAXES AUG OUTY CUMULATIVE TOTAL TAXES 8 OUTY PRESENT VALUE MAR.1979- 8 PCT -15 PCT - 2 0 PCT 500 -500 -500 38 <»75 700 325 39 500 INTERNAL HATE OF RETURN (PCT.) YEARS TO PAYBACK (PRoON YRS) -30 000 -30 000 10 000 700 700 13 367 6 060 -5 592 17.2 6.5 2 000 -2 000 -500 -2 000 -2 000 31 658 1 2 7 2 4 650 tO 580 -10 000 -42 580 -30 000 52 5flO 1 272 1 972 1 2 3 1 5 6 7 8 9 11 532 19 387 56 115 58 013 16 716 19 781 18 626 50 675 53 370 31 1<»9 17 123 51 681 57 611 19 518 19 017 " 18 916 50 163 52 696 18 019 18 322 in 550 18 611 18 262 20 191 21 058 20 984 21 080 - 238 179 51 — - _ <|00 300 200 100 - - - _ _ 350 350 350 350 350 350 350 350 350 12 380 28 211 35 102 38 529 30 936 28 173 27 508 28 829 31 266 6 835 6 661 1 832 2 817 172 _ 5 5<»5 21 550 30 270 35 682 30 161 28 173 27 50B ?8 829 31 266 3 379 3 979 1 501 1 631 3 718 3 979 3 881 4 02" 4 238 - 2 292 8 270 • 9 805 7 092 7 171 6 509 7 283 9 721 — 137 1 575 1 868 1 351 1 124 1 210 1 387 1 852 2 166 11 812 15 920 19 375 18 273 15 596 15 878 16 129 15 456 8<»5 750 650 1 110 1 955 3 680 2 235 1 110 1 250 - - - _ 1 333 _ _ 815 750 650 1 110 3 288 3 680 2 235 1 110 1 250 1 321 11 092 15 270 18 265 11 985 11 916 13 613 15 019 14 206 1 321 11 092 15 270 lfl 265 3 632 - - - -- - - - 11 352 11 916 13 643 15 019 14 206 •30 000 -30 000 -30 000 -30 000 -18 618 -6 731 6 911 21 931 36 136 51 259 37 167 21 897 3 632 - - - - -3 729 7 05B 11 700 16 657 12 511 13 227 11 980 13 049 16 161 5 701 12 759 27 158 11 115 56 657 69 883 81 863 94 912 111 073 to to CO APPENDIX 14 MEXICAN MINING CO. SA DE CV (SOOO 1979 UNITED STATES CONSTANT DOLLARS) MARCH 1979 - CASE! LOAN - RASE - 20 YEARS PRODUCT PRICES'. BASE AG US$ 193/KG (US $6.00/02) ZN US$ 882/T Pn USt 750/T CD US* 4.85/KG CAPITAL COST 75 105 000 PREPRODUCTION INTEREST 4 975 000 WAREHOUSE INVENTORY 2 500 000 INITIAL OPERATING COSTS - 3 MONTHS 4 505 000 MAXIMUM INVESTMENT - PROJECT US $ 87 005 000 PROJECT CASH FLOW PRODUCTION YEAR 10 11 12 13 14 15 16 17 18 19 20 SALES 50 560 43 720 43 669 46 073 44 034 48 291 55 143 48 144 43 976 45 009 60 971 SALES RECEIPTS 51 263 45 430 43 682 45 472 44 544 47 227 53 430 49 894 45 bin 44 751 72 223 OPERATING COSTS 20 857 20 845 20 790 20 071 20 153 18 430 18 054 17 043 17 689 17 970 21 217 EXPLORATION EXPENSES - - - - - - - - - 705 1 009 WAREHOUSE INVENTORY - - - - - - - - -3 500 STATE PROPERTY TAX 350 350 350 350 350 350 350 350 350 350 350 OPERATING CASH PROFIT 30 056 24 235 22 534 25 051 24 041 20 447 35 026 31 701 26 979 25 726 53 067 INTEREST EXPENSE _ - _ - _ _ _ • _ — CASH EARNINGS BEFORE TAXES 30 056 24 235 22 534 25 051 24 041 20 447 35 026 31 701 26 979 25 726 53 067 PRODUCTION TAXES 4 007 3 499 3 486 3 680 3 537 3 860 4 370 3 844 3 510 3 623 4 889 INCOME TAXES 9 625 6 880 6 049 8 020 7 211 9 590 12 541 10 027 8 493 0 511 13 330 EMPLOYEE SHARING TAX 1 833 1 310 1 305 1 529 1 374 1 027 2 389 1 910 1 618 1 621 2 539 CASH EARNINGS AFTER TAX 14 590 12 546 10 094 11 814 11 919 13 170 15 726 15 919 13 358 11 971 32 309 CAPTITAL EXPENDITURES' - ACQUISITIONS 2 235 4 010 2 020 2 165 935 1 825 2 100 1 680 1 330 195 130 - TAX AND DUTY ADDED - - - - - - - - - - -- PREPRODUCTION INTEREST - - - - - - - - - -TOTAL CAPITAL EXPENDITURES 2 235 4 010 2 820 2 165 935 1 825 2 100 1 680 1 330 195 130 CASH FLOW BEFORE LOAN PAYMENT 12 355 0 536 0 074 9 649 10 904 11 345 13 626 14 239 12 028 11 776 32 179 LOAN PAYMENT-100 PCT CASH FLOW - - - - - - - - - - -PROJECT NET CASH FLOW -100PCT 12 355 a 036 8 074 9 649 )0 904 11 345 13 626 14 239 12 028 11 776 32 179 PROJECT CUM NET CASH FLOW 40 491 57 027 65 100 '74 749 85 734 97 079 110 705 124 944 136 972 140 748 100 927 LOAN BALANCE REMAINING - - _ - _ _ - • _ _ - -TOTAL TAXES AND DUTY 15 016 12 039 11 990 13 507 12 471 15 627 19 650 16 131 13 971 14 105 21 108 CUMULATIVE TOTAL TAXES 8 DUTY 126 BH9 138 920 150 910 164 505 176 977 192 603 212 253 220 305 242 356 256 460 277 569 APPENDIX 14 PRODUCTION YEAR MEXICAN MINING CO. SA DE CV (lOOl) 1979 UNITED STATES CONSTANT DOLLARS) MARCH 1979 - CASE I LOAN - BASE - 20 YEARS PRODUCT P R I C E S : UASE AG USl 193/KG (US 1 6 . 0 0 / 0 2 ) 2N USJ. BB2/T PO USl 750/T CD USl 4.B5/KG C A P I T A L COST PREPRODUCTION INTEREST WAREHOUSE INVENTORY I N I T I A L OPERATING COSTS - 3 MONTHS MAXIMUM INVESTMENT - PROJECT PROJECT CASH FLOW 7 5 105 000 4 9 7 5 000 2 500 000 4 5 0 5 000 US 1 87 005 000 TOTALS S A L E S S A L E S R E C E I P T S OPERATING COSTS EXPLORATION EXPENSES WAREHOUSE INVENTORY STATE PROPERTY TAX OPERATING CASH P R O F I T 98 ' l 168 984 166 389 010 2 562 7 000 585 59b INTEREST EXPENSE CASH EARNINGS UEFORE TAXES 21 6 5 0 5 6 3 9 4 6 PRODUCTION TAXES INCOME TAXES EMPLOYEE SHARING TAX CASH EARNINGS AFTER TAX 7 8 6 7 6 159 5 3 3 30 387 2 9 5 350 CAPT1TAL EXPENDITURES - A C Q U I S I T I O N S 106 143 - TAX AND DUTY ADDED 1 9 7 2 - PREPRODUCTION INTEREST 6 3 0 8 TOTAL C A P I T A L EXPENDITURES 114 4 2 3 CASH FLOW BEFORE LOAN PAYMENT 2 6 3 507 LOAN PAYMENT-100 PCT CASH FLOW PROJECT NET CASH FLOW -100PCT PROJECT CUM NET CASH FLOW 180 9 2 7 LOAN BALANCE REMAINING TOTAL TAXES AND DUTY CUMULATIVE TOTAL TAXES & DUTY 277 5 6 9 to CO APPENDIX 15 MEXICAN MINING CO. SA DE CV (SOOO 1979 UNITED STATES CONSTANT DOLLARS I MARCH 1979 - CASE! EQUITY -PRODUCT PRICES! BASE AG USS 193/KG (US $6.00/02) PB USS 750/T CAPITAL COST WAREHOUSE INVENTORY INITIAL OPERATING COSTS - 3 MONTHS MAXIMUM INVESTMENT - PROJECT BASE - 20 YEARS ZN CD 05$ 002/T USS 4.85/KG 75 105 000 2 500 000 4 505 000 US S 02 110 000 PRODUCTION YEAR -1 CANADIAN CASH FLOW 1 2 3 PROJECT CASH fLOW TO CANADIAN EXPLORATION COSTS RECOVERED MEXICAN WITHHOLDING TAX NET DISTRIBUTION TO CANADA PROJECT FUNDS INVESTED 1NTEKEST-1NV FUNDS-AFTER TAX NET CASH FLOW TO CANADIAN CUM MET CASH FLOW TO CANADIAN 28 000 -28 000 -20 000 -28 000 2 249 4 833 1 333 472 1 015 3 110 3 818 6 013 6 694 5 628 1 263 1 406 1 182 4 751 5 288 4 446 4 052 4 639 851 974 3 20i 3 664 3 110 3 818 -24 890 -21 072 4 751 5 288 4 446 -16 322 -11 034 -6 587 3 201 3 664 -3 386 270 5 107 4 830 1 072 1 014 4 034 3 816 4 034 4 312 3 816 8 128 PRESENT VALUE MAR.1979- 8 PCT 5 764 -15 PCT -6 499 -20 PCT -10 684 INTERNAL RATE OF RETURN (PCT.) 10.5 PV PER INVESTMENT DOLLAR YEARS TO PAYBACK (PRODN YRS) .21 6.9 APPENDIX 15 PRODUCTION YEAR MEXICAN MINING CO. SA DE CV ( $ 0 0 0 1979 UNITED STATES CONSTANT OOLLARS) MARCH 1979 - CASE: EQUITY PRODUCT P R I C E S ! RASE AG US$ 193/KG (US S6.00/OZ) PR US$ 750/T BASE - 2 0 YEARS ZN CD USS B82/T USS 4.85/KG C A P I T A L COST WAREHOUSE INVENTORY I N I T I A L OPERATING COSTS MAXIMUM INVESTMENT 10 11 3 MONTHS - PROJECT CANADIAN CASH FLOW 12 13 14 7 5 105 000 2 5 0 0 0 0 0 4 5 0 5 000 US S 82 110 0 0 0 15 16 17 18 1 9 20 PROJECT CASH FLOW TO CANADIAN EXPLORATION COSTS RECOVERED MEXICAN WITHHOLDING TAX NET D I S T R I B U T I O N TO CANAUA PROJECT FUNDS INVESTED I N 1 E R E S T - I N V FUNDS-AFTER TAX NET CASH FLOW TO CANADIAN CUM NET CASH fLOW TO CANADIAN 4 201 2 9 0 2 2 7 4 5 3 281 3 7 3 5 882 6 0 9 5 7 6 6 0 9 784 3 3 1 8 2 2 9 3 2 169 2 592 2 950 3 8 5 7 4 6 3 3 8 1 0 9 7 3 3 047 3 6 6 0 4 841 4 090 1 0 1 7 8 5 9 3 8 2 5 3 2 3 1 4 004 10 9 4 1 841 2 2 9 8 3 163 8 6 4 3 3 3 1 8 2 2 9 3 2 169 2 5 9 2 2 9 5 0 3 047 3 6 6 0 3 8 2 5 3 231 3 163 8 6 4 3 11 4 4 6 13 739 1 5 9 0 8 18 4 9 9 21 4 5 0 24 4 9 7 2 8 157 31 9 8 2 3 5 2 1 2 38 3 7 5 4 7 0 1 8 to Co to APPENDIX 15 MEXICAN MINING CO. SA DE CV (*O0O 1979 UNITED STATES CONSTANT DOLLARS) MARCH 1979 - CASE! EQUITY - BASE - 20 YEARS PRODUCT PRICES: RASE AG US* 193/KG (US *6.00/OZ> ZN USt 8B2/T PB US$ 750/T CO US* 4.85/KG CAPITAL COST 75 105 000 WAREHOUSE INVENTORY 2 500 000 INITIAL OPERATING COSTS - 3 MONTHS 1 505 000 MAXIMUM INVESTMENT - PROJECT US S 82 110 000 PRODUCTION YEAR CANADIAN CASH FLOW TOTALS PROJECT CASH FLOW TO CANADIAN 93 273 EXPLORATION COSTS RECOVERED 1 333 MEXICAN WITHHOLDING TAX 19 587 NET DISTRIBUTION TO CANADA 75 018 PkOJECT FUNDS INVESTED 2B 000 INTEREST-1NV FUNDS-AFTER TAX NET CASH FLOW TO CANADIAN 47 018 CUM NET CASH FLOW TO CANADIAN BBRKPT PRINT* APPENDIX 16 MEXICAN MINING CO. SA DE CV UOOf! 1979 UNITED STATES CONSTANT DOLLARS > MARCH 1 9 7 9 - CASE: LOAN - BASE - 20 YEARS PRODUCT P R I C E S : BASE A6 US$ 193/K.G ( U S $ 6 . 0 0 / 0 2 ) ZN US$ 882/T PB US$ 750/T CO US$ <«.B5/KG C A P I T A L COST PREPRODUCTION INTEREST WAREHOUSE INVENTORY I N I T I A L OPERATING COSTS 3 MONTHS MAXIMUM INVESTMENT - PROJECT 7 5 105 0 0 0 4 9 7 5 0 0 0 2 500 0 0 0 1 5 0 5 000 US $ 87 0 8 5 000 PRODUCTION YEAR - 2 -1 CANADIAN CASH FLOW 1 2 3 PROJECT CASH FLOW TO CANADIAN EXPLORATION COSTS RECOVERED MEXICAN WITHHOLDING TAX NET D I S T R I B U T I O N TO CANADA PROJECT FUNDS INVESTED INTE R E S T - I N V FUNDS-AFTER TAX NET CASH FLOW TO CANADIAN CUM NET CASH FLOW TO CANADIAN 10 2 0 0 3 860 1 3 3 3 811 4 3 8 2 4 052 4 6 3 9 8 5 1 974 3 201 3 664 5 107 4 8 3 0 1 0 7 2 1 0 1 4 4 034 3 8 1 6 -10 2 0 0 - - - 4 3 8 2 3 201 3 664 4 0 3 4 3 8 1 6 -10 2 0 0 - 1 0 2 0 0 - 1 0 2 0 0 - 1 0 200 -10 200 - 1 0 2 0 0 -5 8 1 8 -2 6 1 7 1 047 5 0 8 2 8 8 9 7 PRESENT VALUE MAR.1979- 8 PCT 10 4 2 7 - 1 5 PCT 234 - 2 0 PCT -2 9 5 9 INTERNAL RATE OF RETURN (P C T . ) 15.3 PV PER INVESTMENT DOLLAR YEARS TO PAYBACK (PROON YRS) 1.02 6.7 APPENDIX 16 MEXICAN MINING CO. SA DE CV (1,000 1 9 7 9 UNITED STATES CONSTANT DOLLARS! MARCH 1 9 7 9 - CASE: LOAN - RASE - 20 YEARS PRODUCT P R I C E S : RASE AG ItSS 193/KG (US S 6 . 0 0 / 0 Z ) ZN USS 802/T PO USt 750/T CD USS '4.85/KG C A P I T A L COST 75 105 000 PREPRODUCTION INTEREST 4 9 7 5 000 WAREHOUSE INVENTORY 2 5 0 0 0 0 0 I N I T I A L OPERATING COSTS - 3 MONTHS 4 505 0 0 0 MAXIMUM INVESTMENT - PROJECT US $ 07 085 000 CANADIAN CASH FLOW PRODUCTION YEAR 10 11 12 13 14 15 16 17 18 19 20 PROJECT CASH FLOW TO CANADIAN 4 201 2 9 0 2 2 7 4 5 3 281 3 7 3 5 3 8 5 7 4 6 3 3 4 0 4 1 4 090 4 004 10 9 4 1 EXPLORATION COSTS RECOVERED - - - - _ _ MEXICAN WITHHOLDING TAX 8 0 2 6 0 9 5 7 6 6 8 9 784 8 1 0 9 7 3 1 0 1 7 8 5 9 841 2 2 9 8 NET D I S T R I B U T I O N TO CANADA 3 3 1 0 2 2 9 3 2 169 2 5 9 2 2 9 5 0 3 047 3 6 6 0 3 8 2 5 3 2 3 1 3 163 0 6 4 3 PROJECT FUNDS INVESTED _ _ _ _ _ INTEKEST-IMV FUNDS-AFTER TAX - - - - - - - . • - - - -NET CASH FLOW TO CANADIAN 3 3 1 8 2 2 9 3 2 169 2 5 9 2 2 9 5 0 3 047 3 660 3 0 2 5 3 2 3 1 3 163 8 6 4 3 CUM NET CASH FLOW TO CANADIAN 12 2 1 6 14 5 0 8 1 6 6 7 7 19 2 6 9 22 2 1 9 2 5 2 6 6 2 8 9 2 6 32 7 5 1 35 9 0 2 39 145 4 7 788 APPENDIX 16 MEXICAN MINING CO. SA OE CV (SOOO 1979 UNITED STATES CONSTANT DOLLARS) MARCH 1979 - CASE! LOAN - BASE - 20 YEARS PRODUCT PRICES! BASE AG USS 193/KG (US S6.00/OZ) ZN USS 882/T PB USS 750/T CD USS 1.85/KG CAPITAL COST 75 105 000 PREPRODUCTION INTEREST 1 975 000 WAREHOUSE INVENTORY 2 500 000 INITIAL OPERATING COSTS - 3 MONTHS <4 505 000 MAXIMUM INVESTMENT - PROJECT US S 87 085 000 PRODUCTION YEAR CANADIAN CASH FLOW TOTALS PROJECT CASH FLOW TO CANADIAN 71 715 EXPLORATION COSTS RECOVERED 1 333 MEXICAN WITHHOLDING TAX 15 060 NET DISTRIBUTION TO CANADA 57 908 PROJECT FUNDS INVESTED 10 200 INTEREST-1NV FUNDS-AFTER TAX NET CASH FLOW TO CANAOIAN 47 788 CUM NET CASH FLOW TO CANADIAN BBRKPT PRINTS 237 APPENDIX 17 Social Benefits and Costs - Foreign Currency Inflow and Outflow (Expressed i n thousands of 1979 constant United States dollars) 1. Foreign exchange earnings (a) Assume a l l lead and s i l v e r i n lead concentrate exported by the Mexican smelter. Note that smelter charge income remains: i n Mexico. However some of smelters marginal costs w i l l r e l a t e to imported materials used i n Its processing. Smelters marginal costs represent an estimated 75% of smelter charges as follows: Labour 25% Materials - domestic 35% - imported 15% 75% P r o f i t content - before tax 25% Smelter charge 100% Lead concentrate net smelter return (.NSR) 797 396 add back smelter and r e f i n i n g charges 147 601 944 997 less 15% of lead concentrate smelter charge for cost of imported materials 17 12 3 927 874 (b) Zinc concentrate exported - NSR value 186 77 3 1 114 647 (c) Placer's investment as shareholder -Appendix 16 10 200 (d) Non shareholder loan funds Invested -Appendix 14 57 085 Total Inflow US $1 181 932 238 APPENDIX 17 (Cont'd) Social Benefits and Costs - Foreign Currency Inflow and Outflow (Expressed i n thousands of 1979. constant United States dollars) 2. Foreign exchange costs (a) Capital costs (i) I n i t i a l construction years - Material imported d i r e c t Domestic Suppliers im-ported material content 32% of US $11 733 - Equipment, including domestic suppliers im-ported content,estimate 70% of US $25 155 - Warehouse inventory - Indirect costs 50% including foreign contractors p r o f i t and foreign personnel remittanced 20% 12% 3 755 17 608 1 500 ( i i ) Production years - Estimated at 40s of US $33 010 6 000 28 863 13 204 (b) Operating costs 21% of $389 010 Domestic Foreign Total Transportation 7% 5% 12% Materials 34% 16% 50% Labour 38% 0% 38% 21% 1 0 0 * (c) Interest expense, including preproduction inter e s t of $4 975 (d) Loan funds repaid, other than Canadian shareholder (e) Distributions to Canadian Investor-Placer - Preproduction corporate costs recouped 1 333 - Dividends less withholding taxes 56 655 - Return of i n i t i a l investment (see note below) 10 200 42 067 81 692 26 625 57 085 68 188 Total Outflow Note: The c a p i t a l i s assumed to be available out of proceeds of d i s p o s i t i o n of mine assets at the end of the mine l i f e which may i n -clude new potential mine prospects located through exploration. I. Net foreign currency inflow US $275 657 US $906 275 APPENDIX 18 239 Hurdle Rate The hurdle rate i s a s p e c i f i e d percentage discount rate used by an investment decision maker as a p r o f i t a b i l i t y d e c i -sion t o o l to screen out f i n a n c i a l l y unattractive investment projects. In order to pass the p r o f i t a b i l i t y t est, the f i n a n c i a l i n t e r n a l rate of return forecast to be generated from a proposed investment, which i s assumed to be funded on an a l l equity basis, has to exceed the hurdle percentage rate of return or, a l t e r n a t i v e l y , the project's stream of cash has to provide a p o s i t i v e net present value when discounted at the hurdle rate. The hurdle rate i s set by an investment decision maker at such a number which, i n his opinion, w i l l provide future cash flows from the investment s u f f i c i e n t to recover both the opportunity cost of making the investment, and a reward commen-surate with the r i s k of l o s i n g the value invested assumed at the time the investment i s to be made. In the mining industry, a complication arises i n setting a hurdle rate. Most mine invest-ments must carry a share of the cost of a project-unrelated future exploration programme undertaken to i d e n t i f y new mines. The mining investment decision maker knows that explora-t i o n expenditure i s discretionary and that any contribution by a project towards the recoupment of general exploration expen-diture i s valuable. The a l l o c a t i o n to a proposed mine of a fixed amount or portion of a general exploration budget, without 240 APPENDIX 18 (cont'd) regard to that mine's size and location, ore grade and the pro-duct involved, could lead to unreasonably high or low charges assigned to the project- The factors of mine size and location can be captured i n the magnitude of c a p i t a l expenditures. The factors of ore grade and product can be captured i n sales revenue amounts. A l l four factors mentioned can therefore be captured i n the net cash flows. Accordingly, an appropriately sized contribution to future exploration costs can be achieved by setting aside "x" percentage points of the i n t e r n a l rate of return, or allowing for "x" i n the discount rate used to obtain a net present value of the forecast cash flow. The percentage amount to be Incorporated i n the hurdle rate for exploration i s assessed by considering the d o l l a r va-lue and r e l a t i v e size.of forecast exploration programmes, the degree of success achieved i n the past and forecast for the future i n locating viable mines, and the anticipated size of such future mines, a l l as perceived by the decision maker. The author believes the mining investment decision maker has to draw on past experience to e s t a b l i s h an exploration factor within the hurdle rate and suggests f i v e percentage points as a l i k e l y value. 

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