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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 o f Commerce and Business  Administration)  We accept t h i s t h e s i s as conforming to the r e q u i r e d  THE  standard  UNIVERSITY OF BRITISH COLUMBIA May 1980  (c)  G e o f f r e y D. Bach, 1980  In presenting this thesis in partial fulfilment of the requirements for an advanced degree at the University of B r i t i s h 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 thesisfor 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 B r i t i s h Columbia 2075 Wesbrook Place Vancouver, Canada V6T 1W5 Date  25 March 1980  ABSTRACT T h i s study e v a l u a t e s a m i n o r i t y i n t e r e s t i n a s i l v e r orebody i n Zacatecas, Mexico, l e a d i n g to a d e c i s i o n i n mid  1979  by a Canadian mining company, whether to s e l l ,  h o l d or develop the orebody i n t o a s i l v e r mine on a j o i n t venture The  basis.  framework employed i n the e v a l u a t i o n emphasizes  the importance  to mining companies of e x p l o r a t i o n to  i d e n t i f y m i n e r a l o r e b o d i e s , and s t r i v e s t o 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 t h a t country by a Canadian c o r p o r a t i o n . A l t e r n a t i v e methods of e v a l u a t i n g an orebody are e s t a b l i s h e d and reviewed  i n c o n j u n c t i o n with the s e l e c t i o n  of what has value to whom, and what i n f l u e n c e s the v a l u e . Success of the Canadian mining investment  i n Mexico  depends on the r e l a t i o n s h i p s between the three  joint  venture p a r t n e r s i n a d d i t i o n to the e x i s t e n c e of an i d e n t i f i e d orebody ready f o r development.  Before measure-  ment of the value of the m i n o r i t y i n t e r e s t i n the orebody i s attempted,  an examination  i s made of the needs of  p a r t n e r s , the s e l e c t i o n of p a r t n e r s and the r e l a t i o n s h i p s between the p a r t n e r s to the j o i n t venture. of  Measurement  the value of the m i n o r i t y i n t e r e s t i s based on a  feasibility  study prepared i n 1975  w r i t e r to e a r l y 1979  conditions.  and up-dated  by the  P r o d u c t i o n data, revenue  f o r e c a s t s and mine c o s t s of c o n s t r u c t i o n and  subsequent  Ill  o p e r a t i o n s are presented and analysed t o p r o v i d e an overview o f the f i n a n c i a l aspects o f the p o t e n t i a l mine. V a l u a t i o n of the m i n o r i t y i n t e r e s t i n the orebody i s achieved a f t e r determining mine cash flow f o r e c a s t s , net earnings f o r e c a s t s and f o r e c a s t s o c i a l b e n e f i t s and c o s t s to Mexico.  The c o n c l u s i o n s of the study are t h a t the  Canadian's investment has a value i n the range US $3 100 000 t o US $3 900 000 and t h a t the orebody w i l l continue t o be h e l d u n t i l circumstances r e t u r n s to the owners o f the orebody.  allow improved  iv TABLE OF CONTENTS PAGE NUMBER i i viii  ABSTRACT LIST OF TABLES CHAPTER  INTRODUCTION 1. 1 1.2 1. 3 1.4 1.5 1. 6 1. 7 1. 8 1. 9  CHAPTER TWO  2.6  Objective of exploration Cost o f e x p l o r a t i o n Resource p o l i c y Process o f e x p l o r a t i o n Path t o a d e c i s i o n on the l o c a t i o n o f exploration e f f o r t Exploration target nations f o r Placer  21 22 28 31 33 35  A MINING VIEW OF MEXICO 3.1 3.2 3.3 3.4 3.5 3.6  CHAPTER FOUR  1 2 4 5 9 11 14 16 18  EXPLORATION 2.1 2.2 2.3 2.4 2.5  CHAPTER THREE  Introduction The purpose o f the study L i m i t a t i o n s o f the study O r g a n i z a t i o n o f the study Background o f P l a c e r Development L i m i t e d Placer's f i n a n c i a l position P l a c e r ' s p r o p e n s i t y toward r i s k P l a c e r ' s strengths and weaknesses Objectives of Placer  An i n t r o d u c t i o n t o Mexico Minerals Mexican p o l i t i c s Mexican economics Government a t t i t u d e s toward mining Why i n v e s t i n Mexico?  43 46 47 50 53 54  The tax comparison Canadian taxes on mining business Canada's f e d e r a l income tax B r i t i s h Columbia's taxes on income Other taxes i n Canada Mexican taxes on mining business Mexico's p r o d u c t i o n taxes Mexico's taxes on income Other taxes i n Mexico  58 59 60 61 63 64 65 67 68  TAXES 4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9  V  CHAPTER FIVE  VALUATION METHODS FOR A POTENTIAL MINE 5.1 5.2 5.3 5.4 5.5 5.6 5.7 5.8 5.9 5.10  CHAPTER SIX  The p a r t n e r s Ownership i n the p o t e n t i a l mine Partnership p o l i c i e s Negotiations The p o t e n t i a l mine i n Mexico Metal revenue f o r e c a s t s Mine c o s t s F e a s i b i l i t y study  111 116 117 119 12 3 128 137 142  PROJECT ECONOMIC RESULTS AND VALUATION 7.1 7.2 7.3 7.4 7.5 7.6 7.7 7.8  CHAPTER EIGHT  72 75 78 83 88 92 96 97 101 105  PARTNERS AND THE POTENTIAL MINE; IN MEXICO 6.1 6.2 6.3 6.4 6.5 6.6 6.7 6.8  CHAPTER SEVEN  What t o value V a l u a t i o n methods Investment and f i n a n c i n g d e c i s i o n s Cost o f c a p i t a l Risk The cash flow method The a s s e t a p p r a i s a l method The earnings c a p i t a l i z a t i o n method The s o c i a l c o s t / b e n e f i t method V a l u a t i o n method: a p r e f e r e n c e  PAGE NUMBER  Cash flow f o r e c a s t s 146 Earnings f o r e c a s t s 150 A l l o c a t i o n o f mine generated cash 152 Sensitivities 159 S o c i a l b e n e f i t s and c o s t s 161 V a l u a t i o n o f the p o t e n t i a l mine 174 V a l u a t i o n o f P l a c e r ' s i n t e r e s t i n the mine 190 P l a c e r ' s next step i n Mexico 197  SUMMARY AND CONCLUSIONS 8.1 8.2 8.3  Summary Conclusions Concluding comments  BIBLIOGRAPHY LIST OF APPENDICES  199 201 202 203  vi  VI  APPENDICES APPENDIX NUMBER 1  PAGE NUMBER P l a c e r Development L i m i t e d - Assumptions made i n pro forma Balance Sheets as a t 31 December 1980  208  2  M e t r i c symbols and i m p e r i a l e q u i v a l e n t s  210  3  Mexican Mining Company S.A. de C.V. Investment d e c i s i o n case cash flow r e s u l t s  211  Mexican Mining Company S.A. de C.V. F i n a n c i n g d e c i s i o n case cash flow r e s u l t s  212  Mexican Mining Company S.A. de C.V. Investment d e c i s i o n 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  Mexican Mining Company S.A. de C.V. F i n a n c i n g d e c i s i o n 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  215  P l a c e r Development L i m i t e d - Investment d e c i s i o n case cash flow r e s u l t s t o shareholder i n Mexican p r o j e c t  217  P l a c e r Development L i m i t e d - F i n a n c i n g d e c i s i o n case cash flow r e s u l t s t o shareholder i n Mexican p r o j e c t  218  P l a c e r Development L i m i t e d - Investment d e c i s i o n base case cash flow r e s u l t s to s h a r e h o l d e r i n Mexican p r o j e c t and s e n s i t i v i t i e s  220  P l a c e r Development L i m i t e d - F i n a n c i n g d e c i s i o n base case cash flow r e s u l t s to s h a r e h o l d e r i n Mexican p r o j e c t and s e n s i t i v i t i e s  221  Mexican Mining Company S.A. de C.V. Investment 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 occurrence  223  Mexican Mining Company.S.A. de C.V. Financing d e c i s i o n cases: p r o b a b i l i t y o f occurrence  224  4  5  6  7  8  9  10  11  12  APPENDIX NUMBER 13  Mexican Mining Company S.A. de C.V. P r o j e c t cash flow: e q u i t y base case f o r investment d e c i s i o n  14  Mexican Mining Company S.A. de C.V. P r o j e c t cash flow: l o a n base case f o r f i n a n c i n g d e c i s i o n  15  P l a c e r Development L i m i t e d - Canadian cash flow: e q u i t y base case f o r investment d e c i s i o n  16  P l a c e r Development L i m i t e d - Canadian cash flow: l o a n base case f o r financing decision  17  S o c i a l b e n e f i t s and c o s t s - F o r e i g n currency i n f l o w and outflow  18  Hurdle  Rate  viil LIST OF TABLES  TABLE NUMBER I II III  IV V  VI  VII  VIII IX X XI XII XIII  PAGE NUMBER Geographical d i s t r i b u t i o n o f ownership in Placer Mines operated by P l a c e r - past and present P l a c e r Development L i m i t e d E x t r a c t s from c o n s o l i d a t e d balance sheet - 31 December 1978 Pro-forma balance sheets - 31 December 1980  9 1  1  0  2  P l a c e r Development L i m i t e d - l i n e s o f business i n f o r m a t i o n  13  Net c o s t t o a B r i t i s h Columbian" company of $100 o f e x p l o r a t i o n expenditure i n B r i t i s h Columbia  24  Net c o s t t o a Canadian company o f $100 of e x p l o r a t i o n expenditure i n Mexico through i t s wholly-owned Mexican corporation  26  Canadian f e d e r a l and B r i t i s h Columbian e f f e c t i v e t a x r a t e s on mining income ( c u r r e n t / d e f e r r e d t a x expense combined)  63  P l a c e r Development L i m i t e d - Cost o f c a p i t a l c a l c u l a t e d as a t 31 December 1980  85  P u b l i c l y owned p r o d u c t i o n and s e r v i c e i n d u s t r i e s i n Mexico and Canada  115  Mexican Mining Company S.A. de C.V. - Ore Reserves  124  Mexican Mining Company S.A. de C.V. - Mining and M i l l i n g Rates  125  Mexican Mining Company S.A. de C.V. - Concentrate Output  127  Mexican Mining Company S.A. de C.V. - Metal P r o d u c t i o n i n Concentrates  128  ix TABLE NUMBER XIV  XV XVI XVII XVIII XIX  XX  XXI  XXII  XXIII  XXIV  PAGE NUMBER Mexican Mining Company S.A. de C.V. - F o r e c a s t Product P r i c e s and Terms of Sale  133  Mexican Mining Company S.A. de C.V. - Mine Costs  138  Mexican M i n i n g Company S.A. de C.V. - C a p i t a l C o n s t r u c t i o n Expenditures  139.  Mexican Mining Company S.A. de C.V. - P o s t p r o d u c t i o n C a p i t a l Expenditures  140  Mexican Mining Company S.A. de C.V. - Operating Costs  141  Mexican Mining Company S.A. de C.V. - R e s u l t s o f s e l e c t e d cash flows the p r o j e c t  147  P l a c e r Development L i m i t e d - R e s u l t s of s e l e c t e d cash flows - shareholder i n Mexican p r o j e c t  149  Mexican Mining Company S.A. de C.V. - F o r e c a s t earnings statement p r o d u c t i o n years 1 t o 5  151  Mexican Mining Company S.A. de C.V. - F o r e c a s t a l l o c a t i o n o f mine generated cash - l o a n base case  153  Mexican Mining Company S.A. de C.V. - E f f e c t i v e t a x r a t e s over the mine - l o a n base case  life  157  S o c i a l b e n e f i t s and c o s t s - Tax revenue  164  S o c i a l b e n e f i t s and c o s t s - F o r e i g n currency i n f l o w and outflow  166  S o c i a l b e n e f i t s and c o s t s - I n f r a s t r u c t u r e  169  XXVII  S o c i a l b e n e f i t s and c o s t s - Summary  173  XXVIII  Silver - historic  prices  181  Mexican Mining Company S.A. de C.V. - Orebody v a l u a t i o n s based on m u l t i p l i e r of n e t earnings  185  XXV XXVI  XXIX  X  ACKNOWLEDGMENT  The w r i t e r wishes t o express h i s a p p r e c i a t i o n t o the management o f P l a c e r Development L i m i t e d , Vancouver, f o r t h e i r  willing-  ness t o p r o v i d e data concerning t h e i r i n t e r e s t i n g mining  prospect  i n the S t a t e o f Zacatecas, Mexico. Thanks a r e due t o B e r n i c e Larade o f P l a c e r who k i n d l y adapted  an e x i s t i n g computer programme t o s u i t Mexican t a x laws  as understood  by the author and then i n p u t g i v e n data t o p r o v i d e  the p r o j e c t ' s f o r e c a s t cash f l o w s . In a d d i t i o n , the c o n s i d e r a b l e t y p i n g e f f o r t o f Roberta Mah i s appreciated.  CHAPTER ONE INTRODUCTION Introduction It's a r i s k y business.  A l a b e l given t o the mining  i n d u s t r y by mining e x e c u t i v e s i n a f r u s t r a t e d e f f o r t t o d e s c r i b e complex e x p l o r a t i o n and mining problems, degrees o f r i s k , l u c k and the v a g a r i e s o f the metal markets. Experienced  mining e x e c u t i v e s assess the magnitude  of r i s k i n t u i t i v e l y i n many i n s t a n c e s as under competit i v e circumstances  and, f r e q u e n t l y , time p r e s s u r e s  they  make s u b s t a n t i a l commitments out o f l i m i t e d e x p l o r a t i o n budgets.  Many have become enthused over an i n t e r e s t i n g  mining prospect only t o be d i s a p p o i n t e d as i n f o r m a t i o n about the anomaly i s p i e c e d together t o form a d i s couraging p i c t u r e . . The o f t e n repeated  process o f p r o s -  p e c t e v a l u a t i o n beginning w i t h the s i t e examination  and  a c q u i s i t i o n o f mining r i g h t s , through t o the c o l l e c t i o n and review o f data, and the i n i t i a l o r e r e s e r v e c a l c u l a t i o n s , p r o v i d e s the i n d u s t r y ' s l e a d e r s with a broad understanding  o f the economics and c o m p e t i t i v e  nature  of the i n d u s t r y over an extended p e r i o d o f time. There are no s t a t i s t i c s t o s u b s t a n t i a t e the statement t h a t f o r every one thousand prospects examined, j u s t one p r o s p e c t matures t o an o p e r a t i n g m i n e ; h o w e v e r , few i n the i n d u s t r y w i l l d i s p u t e i t i s a small  likelihood.  2 T h i s paper assumes c o n s i d e r a b l e progress has been made along the path to the c o n v i c t i o n t h a t an economica l l y v i a b l e orebody e x i s t s i n the s t a t e o f Mexico.  Zacatecas,  A d e t a i l e d and comprehensive study of the  g e o l o g i c a l area of i n t e r e s t and an o p t i m i z e d  feasible  outcome from the o p e r a t i o n of a mine a t the s i t e been made.  Much i n f o r m a t i o n i s a v a i l a b l e to the  p o t e n t i a l i n v e s t o r s but s t i l l importance  has  q u e s t i o n s o f the utmost  concerning the value of the p r o p e r t y have  to be answered. Is more i n f o r m a t i o n needed t o reduce  the r i s k of  u s i n g poor data upon which to base an assessment of the v a l u e o f the p r o p e r t y ?  Is i t worthwhile  more to r e t a i n the mining r i g h t s pending of  improved i n d u s t r y c o n d i t i o n s ?  spending  the  arrival  Is s u f f i c i e n t  r e l i a b l e i n f o r m a t i o n a v a i l a b l e to c o n f i r m t h a t under the base case s e t o f circumstances feasibility investment  f o r e c a s t i n the  study, an e c o n o m i c a l l y a t t r a c t i v e exists?  What e f f e c t s w i l l an  mining  investment  i n the p o t e n t i a l mine have on the i n d i v i d u a l i n v e s t o r ' s present and f u t u r e business?  1.2  The purpose o f the Two  study  s i g n i f i c a n t q u e s t i o n s the paper w i l l proceed  to  answer concern P l a c e r Development L i m i t e d as a Canadian  3 i n v e s t o r i n a proposed Mexican S i l v e r mine and  are:  What i s the value of P l a c e r Development L i m i t e d ' s m i n o r i t y i n t e r e s t i n Mexican Mining Company S.A. C.V.  which holds the Zacatecas  property,  de  and  should P l a c e r i n v e s t a d d i t i o n a l 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 q u e s t i o n s can be g i v e n i n a words; so-many-dollars  and e i t h e r yes or no.  few  However,  the process of v a l u a t i o n and d e c i s i o n making can be a long and arduous one,  particularly i f a  a n a l y s i s i s undertaken.  reasoned  Both answers are a f f e c t e d  the purpose f o r a s k i n g and the circumstances  by  surrounding  and p r e c e d i n g the questions i n the f i r s t p l a c e .  A  v a l u a t i o n and commitment d e c i s i o n r e q u i r e d i n haste i n order to minimize a l o s s w i l l l e a d to one value p o s s i b l y a d i f f e r e n t d e c i s i o n on investment  and  when com-  pared w i t h answers a r r i v e d a t i n a more r e l a x e d atmosphere.  In t h i s i n s t a n c e , the questions are posed by  the owner of an i n t e r e s t i n m i n e r a l r i g h t s .  A minority  i n t e r e s t complicated by the f a c t t h a t i t i s a f o r e i g n asset held j o i n t l y  w i t h a f o r e i g n government agency  a f o r e i g n business i n the p r i v a t e s e c t o r .  T h i s paper  assumes there are no s p e c i a l f o r c e s i n f l u e n c i n g q u e s t i o n s and answers other than 1979  and  the  mining i n d u s t r y  g e n e r a l v a r i a b l e s , such as f o r e c a s t metal  supply  demand, and a completed f e a s i b i l i t y study on  the  and  4 Zacatecas  1.3  property.  L i m i t a t i o n s o f the study At the best o f times and a f t e r many man-years o f e f f o r t , information  concerning  an orebody i s incom-  p l e t e and not e n t i r e l y a c c u r a t e .  T h i s study has taken  as i t s b a s i c data c o s t s determined i n a 1975 f e a s i b i l i t y study which themselves were dependent on metal market f o r e c a s t s made a t t h a t time. The p a r t i c u l a r  combination  of metal p r i c e s , c o n s t r u c t i o n c o s t s , o p e r a t i n g  c o s t s and  t a x a t i o n p r e v a i l i n g i n 1975 and f o r e c a s t f o r the f u t u r e determined the then optimal The  mine capacity.and  mine p r o d u c t i o n  capacity.  i t s costs established at that  time have been used i n t h i s study t o estimate product i o n volumes, revenues and c o s t s t o f o r e c a s t cash flows o f both the Mexican corporate  v e h i c l e and the.Canadian  i n v e s t o r . The four year i n t e r v e n i n g p e r i o d t o 1979 has brought c o n s i d e r a b l e  change t o Mexico having an impor-  t a n t e f f e c t on the estimate o f c o s t s , 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  o f the Mexican Peso which began i n 1976.  A r e v i s e d comprehensive c o s t e s t i m a t i o n mine's c o n s t r u c t i o n and o p e r a t i o n The  f o r the  has not been made.  w r i t e r made e n q u i r i e s o f P l a c e r employees most,  f a m i l i a r with p r e v a i l i n g Mexican c o n d i t i o n s and r e ferred extensively to l i t e r a t u r e providing  information  on the c u r r e n t business environment i n t h a t country t o  5 a r r i v e at up-to-date estimated c o s t s .  The  economic  f i n d i n g s of t h i s study, p a r t i c u l a r l y the r a t e s of r e t u r n on investment, are s u b j e c t to the l i m i t a t i o n s described  above but the d e c i s i o n whether to go ahead  with the p r o j e c t i s not expected to be a f f e c t e d .  1.4  Organization  of the  study  L a t e r i n t h i s chapter, Development L i m i t e d mining company and  a b r i e f h i s t o r y of  i s given.  Placer  P l a c e r i s a Canadian  i t i s e v a l u a t i n g a mine prospect  in  Mexico from which i t i s hoped to achieve long-term benefits. followed  The  f i n a n c i a l p o s i t i o n of P l a c e r i s reviewed,  by an assessment of the company's  toward r i s k and of  propensity  a d i s c u s s i o n on the corporate  objectives  Placer. Chapter Two  concerns e x p l o r a t i o n f o r minerals  g i n n i n g w i t h the o b j e c t i v e s and need f o r constant l o s s attached  c o s t and  explains  the  e x p l o r a t i o n e f f o r t and  the r i s k  of  to spending e x p l o r a t i o n funds.  examination of governmental m i n e r a l provides  resource  A brief policy  an i n d i c a t i o n of the environment w i t h i n which  mining companies work.  An o u t l i n e of the  process through s e v e r a l stages i s given followed  be-  by an eleven  exploration  and  n a t i o n review of the  l e a d i n g to d e c i s i o n s concerning  exploration this i s reasons  the l o c a t i o n of  Placer's  effort.  Chapter Three d i s c u s s e s  a mining view of Mexico.  6 B r i e f r e f e r e n c e i s made t o 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 p o p u l a t i o n growth and the unequal d i s t r i b u t i o n o f income.  Any i n v e s t o r p l a y i n g an a c t i v e r o l e i n Mexico  has t o come to terms w i t h the customs and c h a r a c t e r o f the people.  Fundamentally, i t ' s a matter o f choosing  ones f r i e n d s and s t i c k i n g w i t h them; the working o f the h i e r a r c h i c a l system must be understood by any Canadian i n v e s t o r i n Mexico.  A s h o r t d e s c r i p t i o n o f the m i n e r a l  i n d u s t r y i s f o l l o w e d by a n e c e s s a r i l y l i m i t e d review o f the p o l i t i c a l c l i m a t e which d e a l s w i t h the need f o r good business advice from l o c a l n a t i o n a l s , . e c o n o m i c n a t i o n a l ism and m i n e r a l r i g h t s .  Chapter Three a l s o  includes  comments on the impact on the mining i n d u s t r y o f potent i a l , o i l revenues f o r Mexico, a s h o r t d i s c u s s i o n on the c o u n t r y ' s bout o f i n f l a t i o n i n the l a t e 1970's and the n a t i o n ' s f o r e i g n exchange  policies.  L a s t l y , the chapter  o f f e r s a governmental p e r s p e c t i v e o f the mining i n d u s t r y and suggests t h a t the i n d u s t r y i s welcome t o operate p r o f i t a b l y w i t h i n the country but under government dictated  conditions.  Chapter Four o f f e r s a b r i e f i n s i g h t t o Canadian and Mexican taxes a p p l i c a b l e t o the v a l u e o f mine p r o d u c t i o n i n B r i t i s h Columbia and Mexico.  The t a x b i t e from the  value o f p r o d u c t i o n i s an o v e r t s i g n a l t o the mining i n d u s t r y on the degree o f acceptance i n a country. Canadian mining company w i l l assess the welcome by  A  Mexico t o a l a r g e extent on the e f f e c t i v e r a t e o f t a x a p p l i e d to earnings i n Mexico t h a t can be r e p a t r i a t e d compared with a f t e r tax earnings from a Canadian mine. Chapter F i v e begins w i t h a d i s c u s s i o n on what needs to be valued when examining a p o t e n t i a l mine as value i s a f f e c t e d by the i n t e r e s t e d p a r t i e s and the reasons f o r seeking a v a l u a t i o n . mineralized  property  The v a l u a t i o n o f the Zacatecas  i s being made t o e s t a b l i s h whether  a mine should be b u i l t and operated, o r what i s being c a l l e d the investment d e c i s i o n .  The commitment o f r e -  sources t o a p r o j e c t f o l l o w s an investment d e c i s i o n and the importance o f the s e p a r a t i o n  o f the investment de-  c i s i o n from the d e c i s i o n concerning how best t o f i n a n c e the p r o j e c t i s s t r e s s e d . volved  Two matters n e c e s s a r i l y i n -  i n any c a r e f u l l y considered  are the c o s t o f c a p i t a l and r i s k .  valuation  procedure  The c a l c u l a t i o n o f  the c o s t o f c a p i t a l o f P l a c e r Development L i m i t e d i s used by example t o d e s c r i b e  how the c o s t i s e s t a b l i s h e d  f o r subsequent use i n the d i s c o u n t i n g flows.  o f f o r e c a s t cash  Risk i s assessed by the v a l u a t o r  t i o n o f a p o t e n t i a l mine.  i n any v a l u a -  Some r i s k s are mentioned  s p e c i f i c a l l y but the s u b j e c t i v e nature o f the o v e r a l l impact o f r i s k on the v a l u a t i o n does not allow  precise  c o s t s o f r i s k t o be determined owing t o the o f t e n cont e s t e d assumptions used.  However, two o f the four  methods o f v a l u a t i o n d i s c u s s e d seek t o allow  for r i s k .  o f f e r mechanisms which  The cash flow method and  8 earnings  c a p i t a l i z a t i o n method use a d i s c o u n t r a t e and  earnings m u l t i p l i e r r e s p e c t i v e l y . to four v a l u a t i o n methods:  Reference i s made  the two t h a t have a l r e a d y  been mentioned together with the a s s e t a p p r a i s a l method and  the s o c i a l c o s t / b e n e f i t method.  and  a preference  Each i s reviewed  f o r the cash flow method o f v a l u i n g a  p o t e n t i a l mine i s s t a t e d . Chapter S i x d e s c r i b e s the formation o f the p a r t n e r s h i p , the need f o r a common purpose and the a t t r i b u t e s of the Mexican p a r t n e r sought by P l a c e r . Some problems experienced  with the p a r t n e r s h i p i n 1976 a r e a l l u d e d t o  and  the new p a r t n e r s h i p momentum i n 1979 i s mentioned.  The  form o f ownership i n the m i n e r a l i z e d p r o p e r t y i s  d e a l t with,  f o l l o w e d by a d i s c u s s i o n on p a r t n e r s h i p  p o l i c i e s and the v a r i o u s rounds o f n e g o t i a t i o n s r e q u i r e d to i n i t i a t e the p a r t n e r s h i p and c a r r y the p r o j e c t through t o s u c c e s s f u l o p e r a t i o n s and r e p a t r i a t i o n o f funds. Chapter Seven d i s c u s s e s s e l e c t e d cash flow and  provides pro forma earnings  Mining flows.  results  statements o f Mexican  Company S.A. de C.V. u s i n g the loan base cash C a l c u l a t i o n s o f s o c i a l c o s t s and b e n e f i t s are  i n c l u d e d f o l l o w e d by comments on economic r e s u l t s o f the p r o j e c t .  Chapter Seven ends with v a l u a t i o n s o f  the p o t e n t i a l mine and P l a c e r ' s i n t e r e s t i n Mexican Mining  Company S.A. de C.V.  9 Chapter E i g h t summarizes the r e s u l t s of the study draws c o n c l u s i o n s  and  on the value of the i n t e r e s t i n the  orebody.  1.5  Background of P l a c e r Development L i m i t e d P l a c e r Development L i m i t e d i s i n c o r p o r a t e d B r i t i s h Columbia and Montreal,  r e g i s t e r e d on the American, Toronto,  Vancouver and  company had  Sydney stock exchanges.  5088 shareholders  t r i b u t e d per Table  in  The  at 31 December 1978,  I, owning 12,104,000 i s s u e d  dis-  shares.  TABLE I Geographical  D i s t r i b u t i o n of Ownership i n P l a c e r  Canada Australasia USA and other  78.6% 12.0% 9.4% 100.0%  Source: The  P l a c e r Annual Report 1978,  page  30.  company, i t s s u b s i d i a r i e s and managed a s s o c i a t e s (2)  employed 2389 persons at 31 December 1978  m  nine  c o u n t r i e s but predominantly i n Canada, the P h i l i p p i n e s and A u s t r a l i a . The m a j o r i t y of the company's income  has  to date been d e r i v e d from mining.  P l a c e r i s Canada's  l a r g e s t producer of molybdic oxide  (contains molybden-  um)  and major producers  w i t h i n the group.  of  copper concentrate  are  In a d d i t i o n , the P l a c e r group pro-  duces c o a l , mercury, g o l d , s i l v e r and magnetite.  The  10 company a l s o has i n t e r e s t s i n the Canadian o i l and p r o d u c t i o n i n d u s t r y and the A u s t r a l i a n p a s t o r a l manufacturing  gas  and  industries.  P l a c e r began i n 1926  w i t h an e x p l o r a t i o n programme  t h a t concentrated on B r i t i s h Columbia, the USA Alaska) and Colombia.  In 1928  and i n the few  t h e r e a f t e r , mines a t B u l o l o , New  (mostly years  Guinea and C l u t h a , 13)  A u s t r a l i a s t a r t e d the r e a l growth of the company so t h a t by 1979,  e i g h t e e n mines had been operated,  e i g h t o f which are s t i l l  l i v e today  (Table I I ) .  TABLE I I Mines Operated  by P l a c e r - Past and  Present  Country  Important Primary  Endako Gibraltar Craigmont E q u i t y ( i n 1980) Marcopper Cortez (mothballed) McDermitt P l a c e r Coal  Canada Canada Canada Canada Philippines USA USA USA  Molybdenum Copper Copper Silver Copper Gold Mercury Coal  Canex Bulolo Pato C o n s o l i d a t e d Nechi C o n s o l i d a t e d Asnazu Iron Age Evans Jones Clutha Rutherglen Mitel  Canada New Guinea Colombia Colombia Colombia USA USA Australia Australia Portugal  Tungsten,.Lead Gold Gold Gold Gold Iron Coal Coal Gold Lead,Zinc  Mine  Products Secondary  Operating 1. 2. 3. 4. 5. 6. 7. 8.  Molybdenum Iron Copper,Gold Silver,Gold  Closed 9. 10. 11. 12. 13. 14. 15. 16. 17. 18.  Zinc  Silv  11 1.6  Placer's  financial  The  position  c o n s o l i d a t e d B a l a n c e S h e e t o f P l a c e r a t 31  December 1978  (Table  I I I ) shows t o t a l  assets of  $377,300,000 a r e h e l d b u t a t h o r o u g h u n d e r s t a n d i n g the  company r e v e a l s t h a t  mines' in  (Table  II) assets  that t o t a l .  and  subsidiaries.  two a r e a c c o u n t e d  using  adjustment it  sales  are included  venture  assets"  i n the t o t a l ; the  a s one l i n e  accounting  expressed  consolida-  (Table  After  methods e m p l o y e d ,  almost  in historic  over s e v e r a l years.  $170,300,000  and  f o r under t h e heading o f  f o r the various  i n 1978 i n c r e a s e d  The  100% by P l a c e r  i s a joint  i s found t h a t P l a c e r a d m i n i s t e r s  invested  included  t h e e q u i t y method o f a c c o u n t i n g .  worth o f assets  of  partially  a r e n o t owned  One o f t h e t h r e e  " I n v e s t m e n t s and o t h e r tions  operating  under t h e heading o f c o n s o l i d a t e d  51% o f i t s a s s e t s  other  of the eight  are only  The t h r e e  two do n o t f a l l  only  three  of  $500  value  million  dollars  S i m i l a r adjustments t o  the consolidated IV) t o $270  sales  reported  million.  company has r e c e n t l y c o m m i t t e d  itself  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 British  C o l u m b i a due f o r c o m p l e t i o n I I I shows how  i n t h e summer o f  1980.  Table  affect  t h e B a l a n c e S h e e t o f P l a c e r between 1 J a n u a r y  1979 and 31 December 1980. i n Appendix  1, t h r e e  t h e new mine c o s t  will  B a s e d on a s s u m p t i o n s  statistics  listed  deserve a t t e n t i o n .  TABLE I I I PLACER DEVELOPMENT LIMITED ( M i l l i o n s Canadian D o l l a r s ) E x t r a c t s from C o n s o l i d a t e d Balance Sheet Pro-Forma Balance Sheets 31 December 1978 31 December 1980 Including Equity Including Equity S i l v e r Mines L i m i t e d S i l v e r Mines and Mexican Mining Limited Co. S.A. de C.V. Current a s s e t s : Cash,deposits and marketable s e c u r i t i e s $ 56 .6 $ 93.3 $ 81.8 44. 0 35 .0 44. 0 Receivables 42. 3 42. 3 Inventories 33 .3 124 .9 179. 6 168. 1 121. 8 Investments and other a s s e t s 73 .0 133. 3 Property, p l a n t and equipment: B u i l d i n g s and equipment 82 .1 132. 6 132. 6 P r o p e r t i e s and development 97 .3 130. 3 130. 3 179 .4 262. 9 262. 9 $564. 3 $37 7 .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 w i t h i n one year 11 .0 24. 7 24 . 7 82. 6 82. 6 63 .9 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 22. 7 17 .7 22. 7 Shareholders' e q u i t y : C a p i t a l and c o n t r i b u t e d s u r p l u s 18 .3 18. 3 18. 3 Earnings r e i n v e s t e d i n the business 213 .6 327. 0 327 . 0 231 .9 345. 3 345. 3 $377 .3 $564. 3 $564. 3 Statistics Working c a p i t a l $ 61 .0 $ 85.5 $ 97.0 Working c a p i t a l r a t i o 2.2: 1 2.0 :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 L i n e s o f Business Information ( M i l l i o n s Canadian D o l l a r s )  Years ended December 31 1978 1977  Industry Segments Sales: Mining O i l and gas Manufacturing Other i n d u s t r i e s Operating E a r n i n g s : * Mining O i l and gas Manufacturing Other i n d u s t r i e s T o t a l o p e r a t i n g earnings General c o r p o r a t e expenses I n t e r e s t and exchange l o s s E x p l o r a t i o n expense I n t e r e s t and o t h e r income Earnings before taxes and o t h e r items Geographic Area Sales: Canadian o p e r a t i o n s Foreign operations Operating E a r n i n g s : * Canadian o p e r a t i o n s Foreign operations  $112.8 17.7 27.6 12.2  $119. 8 14. 4 33. 0 9.9  $170.3  $177. 1  $ 37.5 8.9 1.4 0.9  $ 33.6 6. 9 2. 3 0. 3  48.7 (3.9) (7.9) (12.1) 8.8  43. 1 (4. 3) (5. 8) (9. 9) 7. 7  $ 33.6  $ 30.8  $122.1 48.2  $132. 2 44. 9  $170.3  $177. 1  $ 46.4 2.3  $ 39.8 3. 3  $ 48.7  $ 43.1  *Represents s a l e s l e s s c o s t o f s a l e s , d e p r e c i a t i o n , d e p l e t i o n and a l l o c a t e d g e n e r a l and a d m i n i s t r a t i v e expenses. Source:  P l a c e r Annual Report  1978, page 27.  14 The  first  i s t h a t cash i s f o r e c a s t to i n c r e a s e  $56,600,000 t o $93,300,000.  from  The second i s t h a t the  working c a p i t a l r a t i o i s steady i n the r e g i o n of 2 t o 1 and the t h i r d s t a t i s t i c  i s t h a t , even immediate-  l y a f t e r b u i l d i n g a new mine a t a c o n s t r u c t i o n c o s t of $80 m i l l i o n , the debt t o e q u i t y r a t i o f a l l s to only 1:2.9.  C l e a r l y , the company has the f i n a n c i a l  to undertake a mine c o n s t r u c t i o n programme  strength  i n Mexico  i n a s s o c i a t i o n 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 c o n c u r r e n t l y with b u i l d the E q u i t y Mine.  i t s commitment t o  The pro-forma c o n s o l i d a t e d  Balance Sheet a t 31 December 1980 i n c l u d i n g both the E q u i t y and Mexican proposed mine (Table I I I ) confirms t h a t view.  1.7  Placer's propensity  toward r i s k  P l a c e r ' s h i s t o r y has demonstrated the company's w i l l i n g n e s s to change i t s business c o n d i t i o n s appear to d i c t a t e .  as p r e v a i l i n g  Examination of mine  openings by P l a c e r show how the company plunged i n t o New Guinea's i n t e r i o r t o produce gold from a l a r g e dredging  operation.  The r i s k s i n v o l v e d i n New Guinea  were s u b s t a n t i a l as there was no i n f r a s t r u c t u r e , not even a road near the p r o p e r t y , tense.  and the i s o l a t i o n i n -  The company was a pioneer  i n the use of a i r -  c r a f t i n the mining i n d u s t r y when i n the e a r l y 1930's it  t r a n s p o r t e d mine equipment t o the c o n s t r u c t i o n  site  at B u l o l o . The company's i n t e r e s t i n g o l d p r o d u c t i o n d i r e c t e d i t s resources to Colombia and A u s t r a l i a soon a f t e r Bulolo.  Both e n t r i e s were b o l d steps i n the d e p r e s s i o n  of the 1930's and the reward was r i s k s accepted.  commensurate with  For example, i n 1935  the  P l a c e r ' s net (5)  earnings rose f i f t e e n - f o l d to $1.5 second world war  years presented  million.  s p e c i a l problems to  the company as the B u l o l o o p e r a t i o n was Japanese.  The  l o s t to the  A l s o , the passage of time and the  value f o r an ounce of g o l d was uneconomic.  fixed  r e n d e r i n g many g o l d mines  P l a c e r r e c o g n i z e d the time  f o r a change of  emphasis and r e d i r e c t e d i t s e f f o r t to o i l and gas d u c t i o n i n Texas, tungsten mining and c o a l mining  i n Alaska.  in British  These ventures,  pro-  Columbia particularly  the tungsten mine, represented l a r g e f i n a n c i a l r i s k s f o r the company mainly  through  size.  J u s t as important  the m e t a l u r g i c a l problem a t the Canex tungsten which was  known to e x i s t a t the time the  commitment was  made.  The  property  financial  s u r v i v a l of the company  threatened but d e d i c a t e d e f f o r t won  was  was  the day and P l a c e r  operated the mine which p r o v i d e d the base f o r the post war  r e b u i l d i n g o f i t s mining  strength.  e x p e r t i s e and  financial  Todays d e c i s i o n makers i n the company were  c l o s e l y i n v o l v e d w i t h the Canex o p e r a t i o n . In the l a t e 1960's and e a r l y 1970's s u b s t a n t i a l r i s k s were taken;  firstly  i n the d e c i s i o n to produce  16  molybdenum i n such l a r g e q u a n t i t i e s at Endako, secondly  to enter the P h i l i p p i n e s i n a high volume low  copper o p e r a t i o n u t i l i z i n g new  technology i n the  c a p a c i t y o f a v a i l a b l e equipment and, the G i b r a l t a r mine with  grade  t h i r d l y , to b u i l d  i t s very low copper content  in  ore. Since acquired  1926, them.  the company has b u i l t mines, not I t i s t r u e today t h a t the p o l i c y 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 o p e r a t i o n s . 1978  An exception  and by December 1978  bitten.  occurred  in early  the f i n a n c i a l b u l l e t  was  Losses were i n c u r r e d by P l a c e r Coal and  extraordinary  item was  to h a l f the i n i t i a l  written o f f representing  investment.  The  outcome of  p o l i c y i s the s t r e n g t h of i t s Balance Sheet but  an close the small  s i z e when compared to a company such as i t s major shareholder,  Noranda, which began i t s l i f e  same e r a as P l a c e r .  i n the  Given t h a t a proposed investment  concerns d i r e c t involvement i n the c o n s t r u c t i o n of a mine, P l a c e r d i s p l a y s a strong p r o p e n s i t y  1.8  P l a c e r ' s strengths The  toward r i s k .  and weaknesses  d i s c u s s i o n on P l a c e r ' 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 s a t t i t u d e toward the 1  company i n i t s p r o j e c t n e g o t i a t i o n s .  17 ;  to  Placer.  1  s.' .mo.sfe. important. /• strength,  is  likely  ..be, the company's proven a b i l i t y to b u i l d  and  operate s u c c e s s f u l mines on time, w i t h i n budget t e c h n i c a l l y up-to-date.  The  company's w i l l i n g n e s s to  operate o u t s i d e Canada e s p e c i a l l y i n previous i s w e l l known and  and  a good r e p u t a t i o n has  decades  been maintained  w i t h f o r e i g n governments i n a l l i t s d e a l i n g s .  Mining  e x p e r t i s e i s a v a i l a b l e w i t h i n the company although many of those a s s o c i a t e d w i t h the l a t e 1960's and  early  1970's c o n s t r u c t i o n a c t i v i t y are approaching  retirement  age.  activity,  The  s i x year dry s p e l l of c o n s t r u c t i o n  McDermitt Mine excepted, when mining world-wide went through a down c y c l e a f t e r the  1974  boom has  done no more harm to P l a c e r than to i t s  probably  competitors.  Perhaps the experience gained by the company and i t s p e r s o n n e l as they design  and  b u i l d the E q u i t y mine  w i l l be  f r e s h i n the minds of those assigned  i n 1980  f o l l o w i n g a go-ahead d e c i s i o n .  The  f i n a n c i a l s t a b i l i t y of the company  e a r l i e r i s important to i t s partners.. together  with r e l i a b i l i t y  study.  described  Stability,  i n c o s t of mine performance,  allows managements of the p a r t n e r s w i t h confidence  to Mexico  i n data provided  to make d e c i s i o n s  by the  feasibility  They w i l l . a l s o f e e l t h a t the c o s t of  proposed Mexican mine at $80  m i l l i o n i s of  the  sufficient  s i z e to ensure t h a t P l a c e r w i l l take no chances i n j e o p a r d i z i n g i t s e f f i c i e n t c o n s t r u c t i o n and  operation.  18 An i n t a n g i b l e s t r e n g t h l i e s i n the f a c t t h a t P l a c e r i s a r e l a t i v e l y s m a l l Canadian and not a l a r g e American multinational.  Mexico i s anxious t o d i v e r s i f y i t s  f o r e i g n investment sources  t o reduce the dominant p o s i -  t i o n o f the United States i n t h a t  field.  Weaknesses are not b e l i e v e d to be important a t t h i s stage but c o u l d become so i n the event three mines are b u i l t by P l a c e r a t approximately The  the same time.  company has a l r e a d y a c q u i r e d a known molybdenum  orebody i n n o r t h e r n B r i t i s h Columbia.  The market f o r  molybdenum i s very s t r o n g and the company w i l l be tempted t o go-ahead w i t h t h a t p r o j e c t a t an e a r l y date i n the event i t i s economically has  feasible.  The company  the o p t i o n t o use c o n s u l t a n t s i n i t s design and  c o n s t r u c t i o n and given i t s p r e f e r e n c e itself,  t o do the work  the Mexicans w i l l watch the s i t u a t i o n  care-  fully.  1.9  Objectives of Placer S u r v i v a l i s most l i k e l y the key o b j e c t i v e o f the company.  As a mining company, the continued  existence  of economic o p e r a t i o n s depends on o b t a i n i n g new o r e bodies  t o r e p l a c e those phased out  of r e s e r v e s .  through  exhaustion  Any company has the o p t i o n open t o  d i v e r s i f y i t s e f f o r t s by e n t e r i n g new f i e l d s and, indeed,  P l a c e r has gone t h a t route as r e c e n t l y as 1977  when i t a c q u i r e d a p u b l i c l y traded Calgary o i l company  19 f o r approximately $50 m i l l i o n .  However, f o r purposes  of t h i s paper, o n l y those o b j e c t i v e s t i e d to mining are important.  The need to e x p l o r e i s fundamental  to  the i n d u s t r y as a whole but i n d i v i d u a l mining companies can a v o i d a c t u a l e x p l o r a t i o n by a c q u i r i n g proven o r e 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 d e c i s i o n process and the v a l u a t i o n of the company's i n t e r e s t i n the Zacatecas p r o p e r t y assumes t h a t P l a c e r ' s o b j e c t i v e i s wealth maximization. I f the o b j e c t i v e were to be simply s u r v i v a l then p r o f i t would not be r e q u i r e d except to f i n a n c e the e f f e c t s of i n f l a t i o n and t o a l l o w f o r the p o s s i b i l i t y of new  mines  coming on stream a t c o s t s g r e a t e r than the one being phased  out.  20 CHAPTER ONE REFERENCES  1.  L. Adie o f P l a c e r Development L i m i t e d , Western C o n s t r u c t i o n and Industry, December  2.  P l a c e r Development L i m i t e d 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  1977  21  CHAPTER  TWO  EXPLORATION 2 .1  Objective of exploration E x p l o r a t i o n i s the name o f 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 e c o n o m i c a l l y  feasible  orebody which has not p r e v i o u s l y been r e c o g n i z e d . E x p l o r a t i o n by the m i n e r a l i n d u s t r y i n v o l v e s a g r e a t d e a l o f time, money and e f f o r t and every l e v e l o f a c t i v i t y i s important  t o the p r o c e s s .  The one man  p r o s p e c t o r can c o n t r i b u t e v a l u a b l e i n f o r m a t i o n i n g e n e r a l j u s t as the major p a r t i c i p a n t s can p r o v i d e imp o r t a n t voluminous data on a s p e c i f i c p r o p e r t y . o b j e c t i v e o f e x p l o r a t i o n i s the replenishment stock o f economically  f e a s i b l e orebodies  a l l o w a l e v e l o f m i n e r a l p r o d u c t i o n which p r e v a i l i n g and f o r e c a s t demand.  s u f f i c i e n t to satisfies level,  w i t h a c q u i r i n g the  I t i s obvious  i d e n t i f y i n g an economically  o f the  At the c o r p o r a t e  e x p l o r a t i o n i s more c l o s e l y concerned m i n e r a l ownership r i g h t s .  The  t h a t simply  f e a s i b l e orebody does not  n e c e s s a r i l y lead to recovery of e x p l o r a t i o n c o s t s . The  f e a r o f imminent l o s s o f non-renewable resources  has been upon us f o r y e a r s . economist Stanley Jevons,  For example, the E n g l i s h  warned o f the approaching  exhaustion o f c o a l i n 1 8 6 0 . ^  In the 1 9 7 0 ' s , the  Club o f Rome's p u b l i c a t i o n " L i m i t s to have a profound  impact  t o Growth" continues  on p u b l i c p o l i c y .  as P r o f e s s o r Adelman o f MIT observed  "....the  However, fear of  22  imminent raw m a t e r i a l exhaustion has f o r i t s b a s i s a (2) complete  d i s r e g a r d of theory, s t a t i s t i c s and h i s t o r y " .  The world i s i n the Best shape ever i n terms o f known r e serves, which have been growing  f a s t e r than consumption  and s u f f i c i e n t f o r hundreds o f years f o r such products as i r o n , n i c k e l , aluminum, manganese and potash.  It i s  important t o remember t h a t many m i n e r a l s are not consumed, but merely transformed, and can be i , (3) recycled.  2.2  endlessly  Costs of e x p l o r a t i o n There i s seemingly an u n l i m i t e d number o f f a c t o r s b e a r i n g on the c o s t o f e x p l o r a t i o n but perhaps best be c a t e g o r i z e d  they can  as those r e l a t i n g t o :  the l o c a t i o n o f the e x p l o r a t i o n a c t i v i t y , the type o f m a t e r i a l b e i n g examined or  and  sought.  The c o s t o f e x p l o r a t i o n i n a r c t i c r e g i o n s w i t h s p e c i a l expenses a t t r i b u t a b l e to remoteness and c o l d i s easy t o r e c o g n i z e as r e l a t i v e l y h i g h .  conditions  The s i t u a t i o n  of the e x p l o r e r ' s head o f f i c e or e x p l o r a t i o n base versus the e x p l o r a t i o n s i t e i s another important f a c t o r . exploration force operating  An  from Vancouver is-most  l i k e l y t o perform more work per e x p l o r a t i o n d o l l a r expended i n southern B r i t i s h Columbia i n Southern Peru f o r a l i k e amount.  than can be done These f a c t o r s are  q u i t e obvious but the f i n a n c i a l c o n s t r a i n t s u s u a l l y r e q u i r e research, i f unnecessary  c o s t s are t o be avoided.  23 Such c o s t s are v a r i e d but the s i g n i f i c a n t f a c t o r 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  s l a n t on tax law, taxable  income and d e d u c t i b l e  expenses  i n a r r i v i n g a t i t s own impact on the r e s u l t s o f e x p l o r a tion.  The sheer s i z e o f the world-wide t a x p o l i c y sub-  j e c t , even when i t i s narrowed to the treatment o f e x p l o r a t i o n expenditure, d i c t a t e s t h a t j u s t two j u r i s d i c t i o n s be d i s c u s s e d  here and then only  briefly;  namely, Canada with emphasis on B r i t i s h Columbia and Mexico. E x p l o r a t i o n expenditure on B r i t i s h Columbian p r o p e r t i e s i s t r e a t e d favourably  mineral  i n tax law p r o v i d i n g  the e n t i t y i n c u r r i n g these c o s t s has other come from which t o deduct the expenditure.  taxable i n Table V  shows t h a t e x p l o r a t i o n 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 a f t e r taxes w i t h the p r o v i s o a l r e a d y mentioned.  Similar calculations for a B r i t i s h  Columbian company e x p l o r i n g elsewhere i n Canada d e t e r mine t h a t e x p l o r a t i o n c o s t s t h i r t y - t w o cents on the d o l l a r and a f u l l d o l l a r a f t e r taxes when e x p l o r a t i o n outside  the country i s conducted through another  ( u s u a l l y f o r e i g n ) corporate  vehicle.  Foreign  explora-  t i o n does rank f o r a deduction a g a i n s t taxable  income  i n Canada but o n l y a f t e r the f o r e i g n corporate  vehicle  has  been abandoned and the Canadian company has no other  presence i n t h a t f o r e i g n country. means v i r t u a l l y no t a x d e d u c t i b l e  In p r a c t i c e , t h i s costs of exploration  24 TABLE V Net Cost t o a B r i t i s h Columbian Mining Company o f $100 o f E x p l o r a t i o n Expenditure i n B r i t i s h Columbia B r i t i s h Columbia E x p l o r a t i o n Expenditure $0 Assume t a x a b l e income before exploration Exploration Resource p r o f i t s  $100  $1000 0 1000  $1000 100 900  F e d e r a l income tax 36% o f r e s o u r c e p r o f i t s l e s s resource allowance o f $250 (25% of $1000) and earned d e p l e t i o n of $33 (1/3 o f $100 e x p l o r a t i o n expenditure)  $270  $222  P r o v i n c i a l income tax 15% o f resource p r o f i t s l e s s earned d e p l e t i o n o f $33 (1/3 of $100 e x p l o r a t i o n expenditure)  150  130  M i n e r a l r e s o u r c e tax 17.5% o f 85% o f r e s o u r c e p r o f i t s l e s s earned d e p l e t i o n o f $33 (1/3 of $100 e x p l o r a t i o n expenditure) T o t a l taxes  149  Net earnings Net c o s t t o a B r i t i s h Columbian mining company o f $100 o f e x p l o r a t i o n expenditure i n B r i t i s h Columbia i s ($4 31 minus $419) Note:  Any b e n e f i t s o f the e x p l o r a t i o n are ignored.  569 $ 431  129 481 $ 419  $  12  2 5' through a f o r e i g n v e h i c l e and, when i t does occur, i t i s t r e a t e d as a c a p i t a l l o s s w i t h the r e s u l t a n t r e s t r i c t i o n s on amounts and t i m i n g o f d e d u c t i b l e In the event the f o r e i g n corporate taxable  costs.  v e h i c l e has  income o f i t s own, the a f t e r tax c o s t t o the  Canadian company i s reduced.  To s i m p l i f y the demon-  s t r a t i o n , a 100% owned Mexican s u b s i d i a r y o f a Canadian company i s chosen and Table VI shows t h a t f o r e i g n e x p l o r a t i o n under those circumstances i s t h i r t y e i g h t 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 o f Mexican resources  restricts  ownership to 49% o r 34% depending on c e r t a i n c o n d i t i o n s but as the Canadian i s o f t e n o b l i g e d t o f i n a n c e the e x p l o r a t i o n e f f o r t the a f t e r tax c o s t can be h i g h e r . choice  a v a i l a b l e t o the Canadian i s t o conduct  A  explora-  t i o n through a branch o f f i c e and thereby o b t a i n a deduction a g a i n s t Canadian taxable  income o f 10% o f the  d e c l i n i n g balance o f such e x p l o r a t i o n c o s t s .  However,  other business f a c t o r s such as the need f o r l i m i t e d liability  i n f o r e i g n c o u n t r i e s u s u a l l y i n f l u e n c e the  d e c i s i o n when r e l a t i v e l y l a r g e amounts are f o r e c a s t t o be  spent i n a country and the company i s r e s o l v e d t o  stay i n on a long-term e x p l o r a t i o n programme. Taxation  e f f e c t s on e x p l o r a t i o n p o l i c i e s o f a  Canadian company are c o n s i d e r a b l e of the d e c i s i o n process  and form a major p a r t  on the choice o f l o c a t i o n s to  i n v e s t a company's r e s o u r c e s .  That i s not t o say t h a t  1 26 TABLE VI Net Cost to a Canadian Company o f $100 of E x p l o r a t i o n Expenditure i n Mexico through i t s wholly owned Mexican Corporation Outlay f o r e x p l o r a t i o n Taxes no longer payable as taxable income reduced Income tax Employee tax P r o d u c t i o n tax abated: between 0% and 2% of p r o d u c t i o n value depending on c a p i t a l expenditure and e x p l o r a t i o n l e v e l s . Assume  $100 42 8  _2  52  Reduction i n cash a v a i l a b l e f o r d i s t r i b u t i o n  48  W i t h h o l d i n g tax (21%) no longer payable as d i s t r i b u t i o n to Canada reduced  10  Net  c o s t of $100  Note:  e x p l o r a t i o n i n Mexico  (see note)  I t i s assumed f o r t h i s purpose t h a t the Canadian company never abandons a l l e x p l o r a t i o n e f f o r t and i t s presence i n Mexico. I t i s a l s o assumed t h a t the Mexican c o r p o r a t i o n 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 b e n e f i t s o f the e x p l o r a t i o n are ignored.  $ 38  27 if  the a f t e r tax c o s t of e x p l o r a t i o n i s minimal a  company w i l l d i r e c t i t s a t t e n t i o n to the with low  c o s t s f o r t h a t reason.  The  jurisdiction  likelihood  of  s u c c e s s f u l e x p l o r a t i o n e f f o r t coupled w i t h the p o t e n t i a l rewards i s uppermost i n the minds of an manager.  Target m i n e r a l s '  exploration  c h a r a c t e r i s t i c s and  their  abundance or r a r i t y of n a t u r a l occurrence sought through e x p l o r a t i o n are bound to have a b e a r i n g costs.  on  exploration  A f o r e c a s t demand excess over supply  c u l a r mineral  and  of a p a r t i -  taking into consideration prices  a n t i c i p a t e d c o s t s of f i n d i n g and  and  g e t t i n g the product i n  s a l e a b l e form to market, i s an important f a c t o r which encourages e x p l o r a t i o n e f f o r t .  An example of problems  f a c i n g an e x p l o r a t i o n manager r e l a t e s to uranium. substantial increase  i n demand f o r uranium has  f o r e c a s t throughout the  1970's and  b r i n g a uranium mine on stream has environmental concerns. to c o n s t r u c t and exponentially now  The  lengthened owing t o  operate uranium mines has  expected to be delayed.  As  been  the lead-time to  c o s t of o b t a i n i n g  i n , r e c e n t years and  permits  grown  the demand surge i s  the c o s t of b r i n g i n g  the product to a s a l e a b l e form r i s e s and  the  forecast  demand f a l l s so the e x p l o r a t i o n manager i s o b l i g e d consider  A  to  the r e d i r e c t i o n of h i s e x p l o r a t i o n e f f o r t away  from uranium.  Accordingly,  the c o s t of  combined with the l i k e l i h o o d o f , and  exploration  the amount  t i m i n g of expected rewards f o r s u c c e s s f u l  and  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 o f the e x p l o r a t i o n objective. Tax c o n s i d e r a t i o n s can reduce the impact  of e x p l o r a -  t i o n expenditure but the e x p l o r a t i o n manager has to be prepared  to i n c u r about $27 m i l l i o n  (1977  Canadian  d o l l a r s ) per economic mine d i s c o v e r y t y p i c a l i n the f i r s t h a l f of the 1970*s i n C a n a d a .  2.3  (4)  Resource p o l i c y A n a t i o n ' s n a t u r a l resource p o l i c i e s must be viewed i n the context of the g l o b a l market f o r r e s o u r c e s . There are two  stages t o c o n s i d e r ; b e f o r e and  p r o d u c t i o n i s achieved.  after  I n i t i a l l y , questions on m i n e r a l  resource p o l i c i e s focus on where to permit e x p l o r a t i o n and who  may  o b t a i n r i g h t s to e x p l o r e .  i s achieved the q u e s t i o n s concern who  After production i s allowed  to  share i n the net b e n e f i t s of mine p r o j e c t s and the c a t i o n o f the cash flows from p r o j e c t s .  allo-  The e x p l o r a t i o n  d o l l a r i s spent under world market c o n d i t i o n s . degree of welcome and the f i n a n c i a l treatment  The  afforded  e x p l o r e r s i n f l u e n c e s the flow of e x p l o r a t i o n funds to a n a t i o n and t h e r e f o r e 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 e x p l o r a t i o n manager b e f o r e d e c i d i n g on the a l l o c a t i o n of e x p l o r a t i o n e f f o r t .  There i s a world-  wide shortage o f h i g h r i s k venture c a p i t a l and t h e r e i s i n t e n s e c o m p e t i t i o n between and w i t h i n n a t i o n s to  29 a t t r a c t e x p l o r a t i o n funds and  expertise.  Columbia o f f e r s a good example of t h i s  British competition.  As mentioned e a r l i e r , e x p l o r a t i o n by a tax paying B r i t i s h Columbian company i n the p r o v i n c e  has  an  tax c o s t o f 12% o f the e x p l o r a t i o n expense but the e x p l o r a t i o n i s conducted o u t s i d e  the  after  32% i f  province.  Resource p o l i c i e s which govern where to permit e x p l o r a t i o n i n c l u d e r e s t r i c t i o n s on a c t i v i t y i n areas s e t a s i d e as parks, on a g r i c u l t u r a l lands  and  areas o f p a r t i c u l a r environmental concern.  other  Often,  r e s t r i c t i o n s a p p l i c a b l e today were enacted i n the without c o n s i d e r a t i o n or even knowledge of the on mining.  P r o v i n c i a l and  n a t i o n a l parks are  which have e i t h e r i n c r e a s e d  The  past  effects examples  the c o s t o f e x p l o r a t i o n  subsequent mining o p e r a t i o n s - or banned the altogether.  the  activity  p r o l i f e r a t i o n of the bureaucracy i n  many c o u n t r i e s apparently  by design  has  served  i n c r e a s e the adverse impact of resource the mining i n d u s t r y .  I t has  i n t e r n a t i o n a l l y to regard  to  policies  become more  on  fashionable  f o r e i g n i n v e s t o r s with  s u s p i c i o n e s p e c i a l l y those i n the mining i n d u s t r y are thought to e x t r a c t h i g h p r o f i t s , c o n t r i b u t e i n taxes and  who  little  then leave problems behind as they move to  the next v i c t i m .  L i m i t s to f o r e i g n ownership i n  companies allowed to conduct the business o f mining o f t e n s e t by law and at a l l .  and  i n some c o u n t r i e s  Even when permitted  i s not  are  permitted  there can be b l o c k s  to  the  30 r a p i d g r a n t i n g o f permits and removal o f other  barriers  before work can b e g i n . The p o t e n t i a l rewards from s u c c e s s f u l e x p l o r a t i o n are g e n e r a l l y h i g h l y v i s i b l e as new mining  for geological  reasons  Is f r e q u e n t l y c l o s e t o e x i s t i n g mines.  thought  appears t o be g i v e n by the bureaucracy  Little t o the  degrees o f r i s k Involved i n r e a c h i n g the p r o d u c t i o n as i s evidenced  stage  by the u s u a l l y higher e f f e c t i v e r a t e s o f  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 p e r c e p t i o n s o f the importance o f non-renewable resources i n the 1970's stemming from the 1973 OPEC c r i s i s and d i r e p r e d i c t i o n s of resource shortages by the Club o f Rome have served t o p e n a l i z e the mining  i n d u s t r y . The s t a b i l i t y o f f e r e d by  business c o n t r a c t law i s no longer a v a i l a b l e i n d e a l i n g s with government. Tax laws change a l l too o f t e n . E n v i r o n mental laws a r e i n t r o d u c e d r e g u l a r l y , sometimes w i t h onerous r e t r o a c t i v e e f f e c t . The combined impact  of r e -  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 o f the cash i n f l o w from a p r o j e c t t h e r e f o r e a l s o have to be c a r e f u l l y researched by the e x p l o r a t i o n manager b e f o r e a d e c i s i o n i s made on where t o p l a c e the e x p l o r a t i o n e f f o r t . I t i s economics t h a t u l t i m a t e l y determines  the v i a b i l i t y o f an  orebody and governmental resource p o l i c i e s can render worthless what would otherwise be an economically f e a s i b l e orebody.  Regardless  o f who owns the r i g h t s t o e x p l o r e and  develop mining p r o p e r t i e s , i d e n t i f i c a t i o n o f economically  31 f e a s i b l e orebodies must be achieved before a p r o p e r t y may  be regarded as a n a t i o n a l a s s e t .  The  combined  weight of resource p o l i c i e s should always be s e t with the fundamental o b j e c t i v e of e x p l o r a t i o n i n mind:  to  l o c a t e those a s s e t s .  2.4  Process of e x p l o r a t i o n As soon as an i n t e r e s t i n undertaking e x p l o r a t i o n i s k i n d l e d a d e c i s i o n on where and when to look and f o r what has to be made.  F i n a n c i a l and personnel  limita-  t i o n s d i c t a t e t h a t the area to be e x p l o r e d has to be narrowed to s p e c i f i c c o u n t r i e s and the t i m i n g of e n t r y considered.  The  initial  step i s to l i s t c o u n t r i e s  thought to be of g r e a t e s t i n t e r e s t and then document the r e s u l t s of a study i n t o the resource  policies,  business and p o l i t i c a l environments and the e x p l o r a t i o n p o s s i b i l i t i e s of each country.  Once a t a r g e t country  has been s e l e c t e d more i n f o r m a t i o n i s gathered to supplement the i n i t i a l  data on resource p o l i c i e s  p r e v a i l i n g business c o n d i t i o n s .  and  If a local national i s  sought as an e x p l o r a t i o n partner, p a r t i c u l a r l y i f f o r e i g n ownership r e s t r i c t i o n s apply, i t i s a d v i s a b l e to  f i n d the p a r t n e r and f o r m a l l y agree to the terms of  p a r t n e r s h i p b e f o r e e x p l o r a t i o n f i e l d work begins. N e g o t i a t i o n 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 e x p l o r a t i o n and mining  rights.  These  r i g h t s are supplemented a t a l a t e r stage w i t h  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 a l l o w the t i o n of a mine.  opera-  A l l these permits are needed but owner-  s h i p of m i n e r a l r i g h t s a t the beginning of e x p l o r a t i o n work i s e s s e n t i a l .  A f t e r e a r l y data i s c o l l e c t e d about  a p r o p e r t y some i n i t i a l  i n d i c a t i o n s of i t s mine poten-  t i a l can be e s t a b l i s h e d .  The p o t e n t i a l tonnage of the  d e p o s i t and average grades e v i d e n t so f a r combined w i t h s e l e c t i v e mining  and c u t o f f c o n t r o l  possibilities,  estimates of c o n s t r u c t i o n and o p e r a t i n g c o s t s and s t a t i s t i c s , enable the e x p l o r a t i o n manager to judge the l i k e l i h o o d o f b r i n g i n g the e x p l o r a t i o n programme to a successful conclusion.  S e n s i t i v i t y a n a l y s i s of the  a v a i l a b l e i n f o r m a t i o n can be used to prepare  a reference  s c a l e of tonnage and grades needed a t v a r i o u s metal p r i c e s a g a i n s t which r e s u l t s can be compared as e x p l o r a (5) t i o n work p r o g r e s s e s .  These e a r l y economic s t u d i e s  are very u s e f u l i n the r a n k i n g of t a r g e t s to be e x p l o r e d when budget r e s t r a i n t s r e q u i r e e l i m i n a t i o n of p r o s p e c t s . There comes a time when s i g n i f i c a n t resources have to be committed to the e x p l o r a t i o n t a r g e t i f work i s to continue.  A p r e l i m i n a r y economic study i s prepared i n  order to ensure the next major expense, t h a t of c o m p i l i n g a comprehensive f e a s i b i l i t y study, i s worthwhile.  The  33 d e c i s i o n may  be to h o l d or drop the prospect  and, i f  h e l d , to proceed with or delay the implementation o f a feasibility aspects  study.  The  feasibility  study d e a l s with a l l  of the mine's c o n s t r u c t i o n and  includes l i s t i n g s casts.  The  operations  of important assumptions and  o b j e c t i v e of p r e p a r i n g  fore-  a feasibility  i s to p r e d i c t the economic outcome a r i s i n g from produced i n s a l e a b l e form from a property supportive  and  with  study minerals  sufficient  i n f o r m a t i o n to permit management to make the  important d e c i s i o n whether to c o n s t r u c t and  operate  the  mine.  2.5  Path to a d e c i s i o n on the l o c a t i o n of e x p l o r a t i o n e f f o r t P l a c e r Development L i m i t e d and a s s o c i a t e d companies do now, operated  i t s subsidiary  or have i n the  mines i n seven c o u n t r i e s  past,  (Table I I ) ; a c r e d i t -  able r e c o r d f o r a company the s i z e of P l a c e r . l a s t two  and  In the  years, P l a c e r ' s e x p l o r a t i o n d o l l a r s have been  committed to B r i t i s h proportions  according  Columbia and Canada i n i n c r e a s i n g to Mr.  Duthie,  President  of  P l a c e r , a t the Company's annual g e n e r a l meeting i n 1979.  At t h a t meeting, he went on to say  of e x p l o r a t i o n and doubt continue  development expenditures  "the  May  shifting  will  no  as p o l i t i c a l p o l i c i e s i n world areas are  r e v e a l e d and put i n t o p r a c t i c e .  The most  areas r e c e i v e the g r e a t e s t a t t e n t i o n " .  favourable  The p o l i c y  statement puts P l a c e r with the m a j o r i t y of members i n  the mining i n d u s t r y . centrated  For years,  to an u n c e r t a i n  world.  to favourable  investment c l i m a t e i n the  During the 1960's, f o r example, 80%  e x p l o r a t i o n expenditures were i n developed w i t h 70% and  third  of p r i v a t e countries  States.^  time h o r i z o n of the e x p l o r a t i o n s e c t o r i n mining  i s , of n e c e s s i t y , q u i t e d i f f e r e n t to the sector.  The  operator  has  l e a s t two  years.  The  i n d e t a i l f o r at  exploration sector i s l i k e l y  work i n terms of a decade f o r a general l e a s t two  operations  to p l a n c a r e f u l l y w i t h broad  parameters f o r perhaps f i v e years and  at  geology  i n o n l y four - A u s t r a l i a , Canada, South A f r i c a  the United The  con-  i t s exploration e f f o r t in industrialized  c o u n t r i e s out o f a l l p r o p o r t i o n due  the i n d u s t r y has  t a r g e t area  years i n d e t a i l e d e x p l o r a t o r y work.  i s not to say t h a t s e t e x p l o r a t i o n budgets are o b s t a c l e to i n t e r e s t i n g new to time, but  prospects  to and  That  an  n o t i c e d from time  i t would appear t h a t the m a j o r i t y of  t i o n funds are spent i n c o u n t r i e s i n c l u d e d  explora  i n the  explora  t i o n budget. The  lead-time from i n i t i a l  interest i n a target  area,  u s u a l l y a n a t i o n , to the d e c i s i o n to b u i l d a mine i s considerable.  P l a c e r , f o r example, added Mexico as  e x p l o r a t i o n t a r g e t area  i n 1969  earned anything  Even with an immediate  there.  and  by May  1979  d e c i s i o n on a p o t e n t i a l mine, i t i s l i k e l y to be ten years before  had  an not  favourable another  the necessary investment i s r e p a i d  and  35 the i n i t i a l p r o f i t s r e a l i z e d .  The d e c i s i o n t o c o n s t r u c t  a mine i s based on the e x p e c t a t i o n o f an acceptable f i t and t h a t may take up to twenty years ment o f p r o d u c t i o n . span t h i r t y y e a r s .  pro-  from commence-  P l a c e r ' s example i n Mexico w i l l In these dynamic times,  the c o n f i -  dence expressed i n Mexico by P l a c e r i s g r e a t . Lead-time then, p l a y s an important r o l e i n the s e l e c t i o n of target nations  f o r exploration effort.  Management's p e r c e p t i o n o f a n a t i o n s  long-term  business  environment governs the d e c i s i o n to i n v e s t time, e f f o r t and  2.6  resources  t o an area.  Exploration target nations The  four most popular  f o r Placer n a t i o n s as f a r as e x p l o r a t i o n  e f f o r t by the p r i v a t e s e c t o r i s concerned have a t t r a c t e d P l a c e r ' s a t t e n t i o n i n the 1970's. A f r i c a i s no longer the t i o n and i t i s probably business  o b j e c t o f grass r o o t s  understood.  f o r t h a t country  i s , at  l i k e l y t o d e t e r i o r a t e f o r reasons w e l l  The major p o r t i o n o f P l a c e r ' s e x p l o r a t i o n  push has been d i r e c t e d to Canada, the United Australia.  explora-  safe to say t h a t the t h i r t y year  environment outlook  best, c o n s i d e r e d  However, South  S t a t e s and  Among the i n d u s t r i a l i z e d western n a t i o n s ,  geology favours  those three c o u n t r i e s and the s i m i l a r i -  t i e s o f language, business  and p o l i t i c s a l l combine t o  a t t r a c t a s i g n i f i c a n t share o f P l a c e r ' s e x p l o r a t i o n budget.  36 P l a c e r manages an o p e r a t i n g mine i n the P h i l i p p i n e s owning approximately 40% of the mine was quently  of the e q u i t y .  h e l d by P l a c e r but P h i l i p p i n e law  f o r c e d the s a l e o f 25%  L o c a l law,  Initially  the a v a i l a b i l i t y  65% subse-  to P h i l i p p i n e nationals.  of expert  p e r s o n n e l and  necessary equipment a t the m i n e s i t e has  l e d to  an  e x p l o r a t i o n programme i n the P h i l i p p i n e s conducted the P h i l i p p i n e a s s o c i a t e d  company.  the  by  Placer's i n t e r e s t  i n the P h i l i p p i n e s as an e x p l o r a t i o n t a r g e t i s t h e r e f o r e satisfied. Other c o u n t r i e s which P l a c e r has more than a passing  i n t e r e s t i n are mostly i n L a t i n America.  Greece, France, T h a i l a n d , i n c l u d e d i n a long l i s t come to naught.  New  Zealand and  of ventures, but  Three o f ten mines now  Fiji  True;  are  these have c l o s e d which  were p r e v i o u s l y operated by P l a c e r were i n Colombia (Table I I ) .  A l l were g o l d mines and  i n t e r e s t i n Colombia s t i l l  centres  P l a c e r ' s main  on g o l d . Continuous  e f f o r t s have been d i r e c t e d toward renewing P l a c e r ' s mining a c t i v i t i e s  there and  recent  l a c k of success i s  a t t r i b u t e d to d i f f i c u l t i e s i n coping w i t h the f o r e i g n investment and laws.  P l a c e r has  country's  capital/earnings repatriation  an a f f i n i t y w i t h Colombia born of  1930's and  1940's.  recall  i t s Colombian mines kept the company a l i v e  how  through the war  Members of s e n i o r management  the  years when i t s other  s e i z e d by the Japanese.  still  investments were  A permanent  representative  i n Colombia b r i n g s mining p r o s p e c t s t o the a t t e n t i o n of Head O f f i c e but a sense o f f r u s t r a t i o n w i t h  Colombian  m i n e r a l p o l i c i e s Is b u i l d i n g . High u n c e r t a i n t y i n two important a r e a s . tion's  remains  F i r s t l y , the new a d m i n i s t r a -  (August 1978) h a n d l i n g o f the i n f l a t i o n plagued  economy and tax laws revamped by the predecessor Lopez Government.  Secondly, the annual r e m i t t a n c e of p r o f i t s  which are l i m i t e d t o 20% o f the Investment,  but which  (7) sometimes can be h i g h e r .  Less and l e s s e f f o r t and  r e s o u r c e s are b e i n g channeled t o Colombia by P l a c e r  even  though major investment p o t e n t i a l l i e s i n the country's mineral sector. B r a z i l i s on the s i d e l i n e s o f P l a c e r ' s  exploration  t h r u s t but a w a t c h f u l eye i s maintained over mining prospects.  Other major companies'  d e c i s i o n s t o put  resource s e c t o r p r o j e c t s on i c e f o r v a r i o u s reasons draw a t t e n t i o n t o d i f f i c u l t i e s i n s e t t i n g up a l a r g e f o r e i g n managed investment i n B r a z i l .  U.S. S t e e l p u l l e d  out o f a l a r g e i r o n - o r e venture p a r t l y because o f d i s (8) agreement over who should c o n t r o l the p r o j e c t .  In-  f l a t i o n poses a severe business problem and the c o s t o f c r e d i t i s high.  There f o l l o w c o r r e s p o n d i n g l y h i g h  e x p e c t a t i o n s o f p r o f i t from h i g h r i s k investments such as surround mining. The b u s i n e s s environment  i n B r a z i l i s not s t a b l e  enough a t present t o p r o v i d e P l a c e r with the c o n f i d e n c e to devote worthwhile amounts of i t s e x p l o r a t i o n and  38 other r e s o u r c e s . and investment  F i f t e e n years down the e x p l o r a t i o n  road i n B r a z i l u n t i l a p r o j e c t cash flow  turns p o s i t i v e , assuming a l l the r i g h t d e c i s i o n s were made, i s f u r t h e r than P l a c e r i s p r e s e n t l y w i l l i n g t o look. The  four major copper e x p o r t e r s are C h i l e along w i t h  Zambia, Peru and Z a i r e .  P l a c e r has n o t looked upon  A f r i c a as a f a v o u r a b l e area of investment and  shows no s i g n o f changing  i n the p a s t  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 A u s t r a l a s i a and Zambia's and Z a i r e ' s post-war h i s t o r y does l i t t l e  t o encourage otherwise.  Peru i s an area  where grass r o o t s e x p l o r a t i o n i s c o n s i d e r e d by P l a c e r as known undeveloped  orebodies e x i s t f o r which  the government seeks f o r e i g n investment. expressed  unnecessary  P l a c e r has  i n t e r e s t but by May 1979 no commitments have  been made. The C h i l e a n mining investment ent from Peru.  picture i s quite d i f f e r -  The Peruvian government maintains  strict  c o n t r o l s over i t s mining and the terms o f b u s i n e s s , whereas the C h i l e a n government does not.  C h i l e ' s economic  p o l i c y s i n c e 1973 encourages p r i v a t e e n t e r p r i s e t o t h r i v e and the chance o f f i n d i n g and d e v e l o p i n g a h i g h 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 f o r the mining wealth, p r i m a r i l y copper  industry.  The m i n e r a l  and n i t r a t e s but a l s o  by-product  molybdenum, g o l d and s i l v e r , i s a t t r a c t i v e t o P l a c e r  and  the major m u l t i n a t i o n a l energy and mining companies.  I n t e r n a l s e c u r i t y and  consequently the s a f e t y of i t s  non-Chilean n a t i o n a l s i s good and  s t a f f i n g a f u t u r e mine  i n C h i l e i s not regarded as a problem. P l a c e r has  found a s u i t a b l e p a r t n e r  good r a p p o r t has ment l e v e l .  i n C h i l e and  a  been e s t a b l i s h e d a t the s e n i o r manage-  Resident r e p r e s e n t a t i v e s  of  Placer's  e x p l o r a t i o n department have been a c t i v e l y examining mining p r o p e r t i e s s i n c e 1977  and  P l a c e r ' s commitment to  a long-term stay i n the country i s c l e a r .  T h e i r budget  does not approach the magnitude of t h a t a l l o t t e d to i n d u s t r i a l c o u n t r i e s but, promising prospect  the  i f and when a p a r t i c u l a r l y  i s located, i t i s evident  the company  i s prepared to i n c r e a s e i t s e x p l o r a t i o n commitment there. Argentina, kinds  of raw  l i k e C h i l e , i s r i c h l y endowed w i t h  materials  the  that Placer i s interested i n .  P l a c e r has p o t e n t i a l p a r t n e r s  i n Argentina  and,  as i n  Peru, known orebodies wait on an improved business environment f o r development.  The  p r i n c i p a l conditions  which have s t a l l e d the e x p l o r a t i o n and  investment pro-  cess i n the country are the p o l i t i c a l t u r m o i l and p e r s i s t e n t t e r r o r i s t problem t h a t has and  property.  One  threatened  orebody l i e s adjacent  to the  border f a r from the A t l a n t i c Ocean p o r t s and  the life  Chilean  smelters.  I t s l o c a t i o n o f f e r s an obvious economic s o l u t i o n .  Mine  and m i l l i n A r g e n t i n a :  the  t r a n s p o r t , the concentrate  40  150  km v i a a nearby e x i s t i n g highway to a  smelter,  and  export.  Chilean  T h i s seemingly l o g i c a l answer i s  f r u s t r a t e d by inter-governmental a t t i t u d e s stemming from long-term t e r r i t o r i a l d i s p u t e s . P l a c e r ' s Argentine e x p l o r a t i o n programme cannot get s t a r t e d d e s p i t e l a t e n t enthusiasm i n Vancouver. In the l a t e 1960's, P l a c e r went through an expansionary p e r i o d which i n c l u d e d the s u c c e s s f u l P h i l i p p i n e copper mine.  I t was  a time when proof was  fresh i n  management's mind t h a t f o r e i g n e x p l o r a t i o n o u t s i d e i n d u s t r i a l i z e d nations and  i n t e r e s t was  already  c o u l d indeed t u r n up a winner  kindled.  famous mining area  the  Mexico, an  historically  l a y j u s t to the south of an  area  t r a v e l l e d by P l a c e r ' s e x p l o r a t i o n people.  o f f e r e d a natural, tion/investment  extension  climate  in  i n a favourable  It  explora-  1969.  P l a c e r ' s f o r e i g n e x p l o r a t i o n programme has  not  u n t i l recent years i n c l u d e d a d e t a i l e d study of  pre-  v a i l i n g business c o n d i t i o n s .  was  l e s s need to do  In the past there  so as entry to c o u n t r i e s f o r  t i o n purposes was  e a s i e r than today.  explora-  Nationalism  had  not manifested i t s e l f i n r e s t r i c t i v e f o r e i g n investment laws and  the tax burden was  e a s i e r to c a r r y .  ownership of a f o r e i g n p r o j e c t was  Complete  the norm and  rewards great f o r a company w i l l i n g to devote able a t t e n t i o n to i t s f o r e i g n o p e r a t i o n s .  the consider-  Todays need  f o r l o c a l n a t i o n a l s as p a r t i c i p a n t s i n f o r e i g n mining  ventures, r a p i d changes i n taxes as w e l l as other business c o n d i t i o n s means t h a t more p r e l i m i n a r y work i s needed before selected.  an e x p l o r a t i o n t a r g e t n a t i o n i s  A f t e r the s e l e c t i o n , a r o u t i n e m o n i t o r i n g  system has to be maintained t o ensure the company's continued  presence i n t h a t country i s warranted.  42 CHAPTER  TWO  REFERENCES  1.  A. Powis, " P u b l i c P o l i c y and the M i n e r a l Industry" 2nd McParland Lecture Mining A s s o c i a t i o n o f Canada, 1976, page 10  2.  IBID, page 10  3.  IBID, page 10  4. May  "Exploration: 1979, page 387  changing b e n e f i t s "  Mining Magazine,  5.  H.K. T a y l o r , "Mine V a l u a t i o n and F e a s i b i l i t y S t u d i e s " M i n e r a l Industry Costs, Northwest Mining A s s o c i a t i o n , Spokane, 1977, Chapter 1, page 5  6.  A. Powis, " P u b l i c P o l i c y and the M i n e r a l Industry" 2nd McParland L e c t u r e , Mining A s s o c i a t i o n of Canada, 1976, page 3  7.  "Colombia's new a d m i n i s t r a t i o n w i l l i n h e r i t h e a l t h y economy" Commerce America, 10 A p r i l 1978, page 15  8.  "The B r a z i l i a n gamble" page 81  9.  " C h i l e : the move to a market economy" J u l y 19 7 8 supplement, pp 1-37  Business Week, 5 December 1977, Euromoney,  43 CHAPTER THREE A MINING VIEW OF MEXICO 3.1  An i n t r o d u c t i o n t o Mexico The Canadian mining d e c i s i o n maker contemplating a mining venture i n Mexico needs answers t o fundamental q u e s t i o n s as a f i r s t ture.  step i n h i s a p p r a i s a l o f the ven-  Does Mexico's geology and mining h i s t o r y  encourage the view t h a t an i n t e l l i g e n t l y planned and implemented e x p l o r a t i o n programme have an a c c e p t a b l e chance of success?  Can non-Mexican business  interests  o b t a i n and h o l d r i g h t s to e x p l o r e f o r , develop and s u c c e s s f u l l y operate mines i n Mexico?  Do business  environmental c o n d i t i o n s a l l o w a Canadian t o 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 i n v e s t e d , make a p r o f i t and send b o t h amounts back t o Canada? The f i r s t of these q u e s t i o n s p o s i t i v e i n s e c t i o n 3.2 below  as  i s answered i n the Mexico i s r i c h i n  mining h i s t o r y and remains one of the world's g r e a t e s t mining n a t i o n s .  The ownership and o p e r a t i o n o f mining  p r o p e r t i e s i n Mexico by n o n - n a t i o n a l s i s i n e x t r i c a b l y woven i n Mexican p o l i t i c s .  D i s c u s s i o n o f t h i s l i n k be-  tween p o l i t i c s and mine ownership i n s e c t i o n 3.3  below  i n d i c a t e s t h a t non-Mexicans can own and operate mines but is  t h a t p o l i t i c a l a s s i s t a n c e to achieve t h a t p o s i t i o n important.  government's  Mexican economics and the Mexican  a t t i t u d e toward mining are d e s c r i b e d i n  s e c t i o n s 3.4  and  3.5  below.  The w r i t e r b e l i e v e s the  Mexican business environment w i l l a l l o w  a good mine  p r o j e c t to earn p r o f i t s which can be sent t o owners i n Canada.  The p r i n c i p a l i n g r e d i e n t s f o r a s u c c e s s f u l  mining investment  i n Mexico are present i f an  attrac-  t i v e orebody i s i d e n t i f i e d . Some background i n f o r m a t i o n 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 w i t h Canada. Of Mexico's p o p u l a t i o n of 65 m i l l i o n , m i l l i o n are under 14 years o l d ^ a n d  about  30  the b i r t h r a t e  (2) i s high.  Mexico i s the world's  fourteenth, l a r g e s t  country In area w i t h i t s p o p u l a t i o n c o n c e n t r a t e d on  15%  o f i t s t e r r i t o r y , y e t having 40% l i v i n g i n w i d e l y d i s (3) persed communities of about 2500 people.  I t i s one  of the most unequal c o u n t r i e s i n the world i n terms o f the d i s t r i b u t i o n of n a t i o n a l Income where the top 20% of households  r e c e i v e d 64% of f a m i l y income and i t (4) i s s t i l l g e t t i n g worse. Zacatecas i s one of the s m a l l e r of t h i r t y - o n e s t a t e s i n Mexico having a 1976 estimated p o p u l a t i o n of (5)  1 097  0.00.  ground.  i n 1969  I t has three o p e r a t i n g mines; a l l underThe F r e s n i l l o mine produces l e a d , z i n c ,  silver  and copper and has an ore p r o d u c t i o n c a p a c i t y In the range 500  000  to 1 000  000 tonnes a year.  The other two  are  s m a l l e r mines i n the ore p r o d u c t i o n annual c a p a c i t y range of 150  000  to 300  000  tonnes.  f 6 )  45 Canadian mining i n d u s t r y managements have to apprec i a t e the d i f f e r e n c e s i n outlook of a Mexican as compared with the b e t t e r understood a t t i t u d e s of Canadians. i n Mexico "machismo" i s one i s t i c s o f any  Today  of the e s s e n t i a l c h a r a c t e r -  a u t h o r i t y r e l a t i o n s h i p which a f f e c t s  t r a d i t i o n a l values of f a m i l y , p a t e r n a l i s m , order and p o l i t i c s . competitiveness  and  The  other  hierarchy,  violence, g u i l t ,  excessive  consequent d i s t r u s t o f others which  form the essence of machismo aggravate c o n f l i c t on a l l l e v e l s from c h i l d h o o d on. demonstrates d i s t r u s t and tions.  The  "mana" of an  individual  s u s p i c i o n of another's i n t e n -  I t i s the a b i l i t y to formulate  stratagems not  e a s i l y d i s c e r n e d by o t h e r s , to fathom another's motives and p l a n s , which are always presumed h o s t i l e and must be thwarted b e f o r e they reach f r u i t i o n ;  which  i t i s to  (7) be s l y and  to be good a t d u p l i c i t y .  mana together prevent Canadians and  Machismo and  an open r e l a t i o n s h i p f a m i l i a r to  i n t e r p e r s o n a l c o n f l i c t can e a s i l y e s c a l a t e  to group c o n f l i c t , and v i c e v e r s a .  The  prevalence  machismo and the emphasis on mana i n t u r n has  created a  p e r s o n a l s e c u r i t y system grounded i n the v a l u e s f a m i l y , p a t e r n a l i s m and  hierarchy.  The  of  of  strongest  ties  are to members o f the immediate f a m i l y , then down to u n c l e s , aunts,  c o u s i n s and  godparents.  Mexicans have a f e r o c i o u s p r i d e i n t h e i r country  but  they a l s o have deep c y n i c i s m about i t s a b i l i t y to pro(8) gress.  C o r r u p t i o n 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 r a p i d as t h a t of p o l i t i c i a n s and bosses. However, apathy r a t h e r 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 i n Mexico.  3.2  Minerals M i n e r a l r e s o u r c e s are abundant and v a r i e d i n n e a r l y a l l p a r t s of the c o u n t r y . exception.  The Yucatan P e n i n s u l a i s the  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 l a r g e s t p a r t of the Mexican mining i n d u s t r y . Guanajuato f i r s t new years.  A  mine developed i n the e a r l y 19 70's was s i l v e r p r o p e r t y opened i n more than  Even so, Mexico i s s t i l l  primary producer of s i l v e r .  the world's  the  fifty largest  Lead and z i n c p r o d u c t i o n  puts Mexico amongst the world l e a d e r s and the world's l a r g e s t f l u o r s p a r mine operates w i t h Canadian and ownership  i n San L u i s P o t o s i S t a t e .  expertise  Mexico i s the  world's second l a r g e s t producer of sulphur, the country's most important n o n - m e t a l l i c m i n e r a l . T h e  l i s t of  m i n e r a l s a v a i l a b l e i s l o n g but some are of p a r t i c u l a r i n t e r e s t to P l a c e r owing to i t s mining h i s t o r y .  They  are gold found mainly i n the S i e r r a Madre O c c i d e n t a l ; low grade copper widely d i s t r i b u t e d i n c l u d i n g Zacatecas; tungsten and molybdenum i n Sonora; mercury i n the S i e r r a Madre d e l Sur and l e a d and z i n c a l r e a d y mentioned. Many undeveloped  d e p o s i t s are known but t h e i r  isolation  and consequently high i n f r a s t r u c t u r e c o s t s r e q u i r e d to  47 b r i n g them on stream render them uneconomic at Southern Zacatecas has  the advantage of a d i r e c t  rail  l i n k to the p o r t of Tampico on the Gulf of Mexico  and,  in  with  the other d i r e c t i o n v i a A q u a s c a l i e n t e s ,  Torreon, the s t r a t e g i c a l l y l o c a t e d r a i l s h i p p i n g p o i n t f o r the mining and  3.3  present.  a link  centre  smelting  and  industry.  Mexican p o l i t i c s The  power centre i n Mexico r e s t s i n Mexico C i t y and  i n p a r t i c u l a r with the P r e s i d e n t . system w i t h a p r e s i d e n t who  may  party  be e l e c t e d f o r o n l y  term of o f f i c e l a s t i n g s i x y e a r s . dents have been p o l i t i c a l l y  There i s a one  The  l e f t and  l a s t few  presi-  right alternately.  The  incumbent i s regarded as r i g h t l e a n i n g compared  his  predecessor.  for  fifty  political  in Latin  o f t e n c i t e d as the c h i e f reason behind  headway i n developing  f o r e i g n investment.  with  s i t u a t i o n has been s t a b l e  years, a r e c o r d almost unequalled  America and country's  The  one  the  i t s economy and a t t r a c t i n g  Mexico's a d m i n i s t r a t o r s  are u s u a l l y  e f f i c i e n t although they are not above f e i g n i n g delays make t h e i r i n t e n t i o n s more f o r c e f u l .  A l l l e v e l s of  p u b l i c a d m i n i s t r a t i o n can be t o l e r a n t of c o n f l i c t s i n t e r e s t and  to  of  acceptance of payment f o r f a v o u r i t i s m ,  d e s p i t e c o n t i n u i n g h i g h - l e v e l e f f o r t s to e l i m i n a t e (11) corruption. 0  P o l i t i c a l power i n Mexico i s not to be  A f o r e i g n i n v e s t o r cannot go alone  underestimated.  i n t o Mexico and  expect  48 to o b t a i n a l l the i n c e n t i v e s a v a i l a b l e to the  investor  and  h i s aims.  a v o i d innumerable delays i n accomplishing  I t i s v i t a l to use Mexican l e g a l and f o r example, and tem  financial  advice,  i t i s important to understand the  of " c a m a r i l l a s " .  C a m a r i l l a s are quasi-permanent,  h i e r a r c h i c a l , cooperative  s t r u c t u r e s composed of a group  of c l o s e c o l l a b o r a t o r s around a " c h i e f " with t i o n i n the governing h i e r a r c h y .  some p o s i -  The more power he  the more rewards come t o h i s c o l l a b o r a t o r s .  i n the  has,  Each hopes  to get i t s c h i e f locked i n t o a c a m a r i l l a with a niche  sys-  higher  hierarchy.  Economic n a t i o n a l i s m 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  c o n t r o l s such as f o r e i g n e q u i t y ownership and t r a n s f e r r e s t r i c t i o n s , i n recent years.  technology  Mexico wants  f o r e i g n investment on a m i n o r i t y b a s i s t h a t w i l l  comple-  (13) ment, r a t h e r than d i s p l a c e , l o c a l investment. appropriate  to mention here t h a t Indianism  t a n t thread of the n a t i o n a l i s t t r a d i t i o n .  It i s  i s one  impor-  Indianism  regarded as the a n t i t h e s i s of the Spanish h e r i t a g e . Indian  i s conceptualized  n a t i o n a l t r a d i t i o n and  as the b a s i s of the  the Spaniard  is The  truly  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 f o r c e s working a g a i n s t Mexican s e l f - d e t e r m i n a t i o n and (14) as a n a t i o n a l group. mining company seeking Even i f he  The  the progress  of Mexicans  dangers posed to a Canadian  to i n v e s t i n Mexico are' c l e a r .  i s welcome today, the c l i m a t e can change  and  the investment p l a c e d i n jeopardy.  Nationalization  p o l i c i e s are r e g u l a t e d by the c o n s t i t u t i o n and a law which r e q u i r e c o u r t approval and adequate s a t i o n f o r takeovers f o r reasons of p u b l i c Rights o f appeal and  "adequate  compensation"  1936  compen-  convenience. are taken  s e r i o u s l y by Mexico as the country's dependence on  foreign  loans r e q u i r e s t h a t i t m a i n t a i n a good i n t e r n a t i o n a l r e p u t4-a t4.-i o n . (15) Another area i n the p o l i t i c a l to  sphere of s i g n i f i c a n c e  the mining i n d u s t r y i s t h a t of access to mining pro-  perty.  Two  types of l a n d tenure are r e s t r i c t i v e t o the  i n d u s t r y ; n a t i o n a l lands and e j i d o s .  Both are p r e v a l e n t  throughout the country and both are o b s t a c l e s to obtaining mineral r i g h t s .  N a t i o n a l lands are c o n t r o l l e d  by the c e n t r a l government i n Mexico C i t y and any  mining  a c t i v i t y i n c l u d i n g the use of n a t i o n a l lands cannot c a r r i e d out by an e n t i t y more than 34% owned by ers.  be  foreign-  E j i d o s are a form of tenure under which i n d i v i d u a l s  have s e c u r i t y of tenure to work the l a n d , even though land i t s e l f s t i l l belongs to the s t a t e .  the  Apart from those  i n the S t a t e of Sonora, most ej idos are not worked on a (16) c o l l e c t i v e b a s i s and are i n a desperate p o s i t i o n . P o t e n t i a l investment i n e c o n o m i c a l l y depressed areas i s given p o l i t i c a l  a s s i s t a n c e to remove the problems f a c i n g  the mining i n d u s t r y with regard to m i n e r a l r i g h t s but the a s s i s t a n c e r e q u i r e s the use of p o l i t i c a l power a l r e a d y r e f e r r e d to i n t h i s s e c t i o n .  Obtaining b u i l d i n g  5Q  permits  i s given s i m i l a r p o l i t i c a l  mining a c t i v i t y A list  i s contemplated.  of national p r i o r i t i e s  USA/Mexico b u s i n e s s m e n ' s priorities F.R. water  meeting  p r e s e n t e d i n 1976 had  relevance to mining  the e j i d o  property  education  (#4)  (#7)  i n the r u r a l  and  impracticality  the r e c o g n i t i o n of  zones  (#8)  (#2),  infrastructure  (#5) , r e c o g n i t i o n o f t h e  system  ten  i n Mexico.  suggested the areas of r u r a l  mining  to a  s i x o f the f i r s t  r e s o u r c e s (#3), t r a n s p o r t a t i o n  for of  of d i r e c t  Miranda  e n c o u r a g e m e n t when  were r i g h t  private  behind  the  (17) highest p r i o r i t y evident tial  of population  the mining i n d u s t r y  to a s s i s t  the n a t i o n  control.  i n Mexico  It is  has  great  poten-  s o l v e some o f i t s most  pressing  problems. 3.4  Mexican  economics  Mexico's  economy i s c h a n g i n g r a p i d l y  l a r g e o i l and  gas  discoveries  resulting  i n recent years.  i m p o r t a n c e o f m i n i n g t o t h e nation's w e l l - b e i n g the  d e c l i n e but s t i l l  prime  target  until  t h e mid  the  tax load  1970's. c a n be  Now  i s on  l o n g e r the  seekers that  This  i s a new  reduce the r i s k The  The  i t was  there i s another source  shared.  likely  laws b e i n g e n a c t e d .  prone  M i n i n g i s no  o f government revenue  one w h i c h w i l l  ness  great.  from  and  situation  o f new  and  harsh tax  apparently unrelated o i l busi-  i s s e e n as m a k i n g m i n i n g t o u n f a v o u r a b l e changes  foreign  investment  less  i n law and more f u n d s  are  51 being d i r e c t e d t o Mexico as i t s c r e d i t r a t i n g improves. The o i l bonanza w i l l have o t h e r s i d e e f f e c t s , not l e a s t of which i s the f o r e c a s t a v a i l a b i l i t y o f cheap  fertili-  zers to improve the l o t o f the r u r a l p o p u l a t i o n .  A  massive problem f a c i n g the a d m i n i s t r a t i o n i s the movement o f the r u r a l p o p u l a t i o n to the a l r e a d y overcrowded r e l a t i v e l y prosperous c i t i e s .  A host o f secondary pro-  blems need s o l u t i o n s before the p o p u l a t i o n w i l l encouraged to stay put.  be  Food p r i c e s are c o n t r o l l e d so  as not to antagonize urban d w e l l e r s , but the p o l i c y keeps the farming community poor.  Job o p p o r t u n i t i e s 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 c a u t i o u s  mining i n v e s t o r w i l l assess the e f f e c t s o f the o i l r e venue on the demands of the people f o r too r a p i d a r i s e i n t h e i r share o f the n a t i o n a l wealth; a demand which c o u l d s p i l l over to the mining i n d u s t r y . At the end o f 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 o c c u r r e d i n Mexico and c u l minated i n the d e v a l u a t i o n o f the Mexican Peso which had been f i x e d i n terms o f the United S t a t e s d o l l a r f o r many years.  I n f l a t i o n i n the years s i n c e 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 r a t e o f a mere 2.5% f o l l o w e d the lowest i n decades (19) 2% r a t e of i n c r e a s e o f r e a l growth xn 1976.  Indica-  t i o n s i n 1979 are t h a t i n f l a t i o n has slowed but t h a t the b e n e f i t s o f d e v a l u a t i o n have been worked through the economy and domestic c o s t s such as wages are back to t h e i r  p r e - d e v a l u a t i o n l e v e l s i n terms of United S t a t e s  dollars.  The bank l e n d i n g r a t e to t h e i r best customers i s i n the r e g i o n o f 26.0%  p.a.  Vancouver, March 1980) of for  domestic long-term  i n Mexico  (A.E. Ames & Co. ,  and there i s a c h r o n i c credit.^ ' 2 0  Legal  shortage  requirements  Mexican e q u i t y ownership i n mining compounds  diffi-  c u l t i e s f o r Canadians In f i n d i n g a s u i t a b l e p a r t n e r has both the w i l l i n g n e s s and c a p a b i l i t y to share  the  business r i s k s and o b l i g a t i o n s of mining ventures country.  The  economic c r i s i s  H i s t o r y has  i n the  flow of f o r e i g n exchange i n and out of  Mexico i s not s u b j e c t to exchange c o n t r o l . the 1976  who  Even d u r i n g  c o n t r o l s d i d not m a t e r i a l i z e .  shown t h a t the r i s k of being unable to  convert revenues i n t o f o r e i g n exchange f o r payment of debt o b l i g a t i o n s , d i v i d e n d s or purchase of r e q u i r e d to operate regarded bility  a Mexican mining p r o j e c t can  as a c c e p t a b l e .  t h a t the f e d e r a l government i n Mexico C i t y  the c e n t r a l bank.  be  There i s o n l y a s m a l l proba-  r e q u i r e a l l f o r e i g n exchange earnings to  imports  Nevertheless,  to be  will  surrendered  f o r e i g n exchange and  r e c o n v e r s i o n r i g h t s should be n e g o t i a t e d and,  to the  extent p o s s i b l e , s e t out i n any agreement to i n v e s t i n Mexico between p a r t n e r s and  government.  Mexico i s a heavy i n t e r n a t i o n a l borrower and crisis  induced  the  1976  the i n t e r n a t i o n a l Monetary Fund to impose  53 c o n d i t i o n s f o r new loans which r e q u i r e d p u b l i c d e f i c i t s t o reduce as a percentage o f GDP.  sector  New  foreign  debt was l i m i t e d i n 1977 and 1978 and the IMF a l s o  sti-  p u l a t e d t h e r e be no exchange c o n t r o l s and a r e d u c t i o n (21) i n trade p r o t e c t i o n . subsequent toward  The economic c r i s i s and the  r e c e s s i o n produced  a more sympathetic stand  f o r e i g n and p r i v a t e b u s i n e s s , but f o r reasons  t h a t are f a r more p r a c t i c a l than i d e o l o g i c a l .  The r e -  c o n c i l i a t i o n o f government and business should not be taken as a movement away from b a s i c f o r e i g n  investment  c o n t r o l measures enacted i n the e a r l y 1970's.  The new  government has s e t long-term goals with an understanding of short-term n e c e s s i t i e s and has i n s i s t e d , o n  thorough  (22)  p l a n n i n g 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 b l e s s i n g t o Mexico. 3.5  Government a t t i t u d e s toward  mining  There has been no r e l a x a t i o n o f l i m i t s on the percentage o f e q u i t y ownership and none i s expected. does encourage  i n Mexican mining ventures  However, the new government  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 o f i t s a d m i n i s t r a t i o n i s evidence o f i t s w i l l i n g n e s s to improve c l i m a t e i n the i n d u s t r y .  the b u s i n e s s  The e f f e c t i v e r a t e s o f taxes  coupled with M e x i c a n i z a t i o n o f ownership  p o l i c i e s has  l e a d t o the need f o r l a r g e r mines o f h i g h e r grade i n  Mexico than i n other titive money.  c o u n t r i e s i n order  to remain compe-  f o r the Mexican, as w e l l as f o r f o r e i g n , investor's Expressed another way,  i t means t h a t otherwise  economic orebodies i n Mexico are rendered worthless • 4. (23) under present4- circumstances.  The  mining i n d u s t r y continues  important source of new  to be viewed as  jobs i n the f i g h t to c r e a t e  enormous number o f o p p o r t u n i t i e s needed so badly reduce unemployment.  an  The  an  to  c a p i t a l intensive industry i s  known to have a high r a t i o o f i n d i r e c t jobs to d i r e c t jobs a t a mine and  the forward and  e f f e c t s are not l o s t on government  backward  linkage  administrators.  Mexican manufacturing c a p a b i l i t y i s c o n s i d e r a b l e a l though trade p r o t e c t i o n p o l i c i e s are i n c l i n e d to  leave  products high p r i c e d f o r t h e i r q u a l i t y ; an area of c o n t r o l concern to f o r e i g n mining i n v e s t o r s and The  mining i n d u s t r y i s welcome i n Mexico but  c r a t i c red-tape i s formidable.  The  delays  and  cost  operators. bureaucosts  i n v o l v e d i n s t a r t i n g up a mining venture w i l l t e s t the f o r t i t u d e of even the most e n t h u s i a s t i c and  willing  investor.  Why  i n v e s t i n Mexico? P l a c e r has  i t s resources  already made a s i g n i f i c a n t commitment of s i n c e i t s d e c i s i o n i n 1969  Mexico as a t a r g e t area programme has  for exploration.  to  include  The  a t times proceeded r a p i d l y and  exploration on  other  occasions  come t o a complete h a l t .  The company's t e n  year stay i n the country has not produced a source o f revenue but the recent renewal o f i n t e r e s t i n the most promising o f i t s Mexican i n t e r e s t s i s a s i g n o f c o n f i dence i n the long-term f u t u r e t h e r e .  The gestures o f  welcome t o f o r e i g n mining i n t e r e s t s are manifested i n improved tax laws, not generous by any means, and the c o n t i n u a t i o n o f f r e e currency through very  exchange p o l i c i e s  tough economic c o n d i t i o n s .  of f o r e i g n investment together d i e n t s ; the e x i s t e n c e  The  present  ingre-  o f g e o l o g i c a l l y i n t e r e s t i n g areas  a l l p o i n t t o a favourable conditions  The acceptance  w i t h the primary  f o r e x p l o r a t i o n and the prospect run,  tested  o f p r o f i t i n the long  view o f Mexico by P l a c e r .  f o r s u c c e s s f u l investment i n Mexico are  and the l i k e l i h o o d o f l o c a t i n g an  v i a b l e orebody i s h i g h .  The prospect  economically  o f p r o f i t i s much  b e t t e r than r e p o r t s from L a t i n America o f c o r r u p t i o n , r e v o l u t i o n and e x p r o p r i a t i o n might l e a d us t o t h i n k .  (24) '  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 o f the s t a t e s o f the world f o r 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 e d i t i o n , pages 66-67  8.  D. Gordon,  "Mexico", The Economist, 22 A p r i l  9.  IBID, page  34  1978, page 10  10.  T.E. W e i l , Area handbook f o r Mexico, 2nd e d i t i o n , Washington GPO 1975, pp 21-22  11.  I n v e s t i n g , L i c e n c i n g and T r a d i n g C o n d i t i o n s Abroad:Mexico, Business I n t e r n a t i o n a l Corp., 1978, page 2  12.  L.V. Padgett, The Mexican P o l i t i c a l System, 2nd e d 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 e d i t i o n , page 13  15.  I n v e s t i n g , L i c e n c i n g and T r a d i n g Conditons Abroad: Mexico , Business I n t e r n a t i o n a l Corp., 1978, page 6  16.  D. Gordon, "Mexico", The Economist, 22 A p r i l  17.  F.R. Miranda " S o c i a l 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 d e l i v e r e d a t the 31st Plenary Meeting o f 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 31  1978, page 19  5:7  19.  Supra, page 20  20.  "Domestic Financing-Mexico" F i n a n c i n g F o r e i g n Operations, Business I n t e r n a t i o n a l Corp, 1978, page 918  21.  D. Gordon, "Mexico", The Economist,22 A p r i l 1978,  22.  I n v e s t i n g , L i c e n c i n g and T r a d i n g C o n d i t i o n s Abroad:Mexico, Business I n t e r n a t i o n a l Corp., 1978, page 2  23.  T.S. Nye, "Mexico, the C l o s e l y Guarded M i n e r a l Storehouse" Mining E n g i n e e r i n g Volume 74, December 1972, page 42  24.  J.B. U t l e y , "Doing business w i t h L a t i n n a t i o n a l i s t s " , Harvard Business Review January-February 1973, pp 77-86  page 19  58 CHAPTER FOUR TAXES 4.1  The tax comparison A Canadian company, such as P l a c e r , viewing the tax burden on a Mexican mining venture undoubtedly measures Mexican mining taxes on a s c a l e based on Canadian taxes. There i s l i t t l e inevitable.  t o j u s t i f y such a comparison but i t seems  What r e a l l y matters i s the cash flow a f t e r  taxes f o r e c a s t t o be d i s t r i b u t a b l e to the i n v e s t o r and t h a t f o r e c a s t i s , among t h i n g s , dependent  on the degree  of s t a b i l i t y o f tax laws p e r c e i v e d by the i n v e s t o r . In the 1970's the mining i n d u s t r y has witnessed a c o n s i d e r a b l e number o f changes  i n Canadian tax laws,  some so s i g n i f i c a n t as to be c o n f i s c a t o r y .  Even i f  such deeper i s s u e s as the i n f l a t i o n a r y e f f e c t s on dep r e c i a t i o n f o r t a x purposes are ignored, the mining i n d u s t r y has been i n B r i t i s h Columbia and c o n t i n u e s to be i n Saskatchewan  saddled w i t h e f f e c t i v e tax r a t e s  g r e a t e r than 100% o f i n c o m e . A  f a v o u r i t e o f the  i n d u s t r y was l o s t when i n 19 72 the three year income t a x f r e e p e r i o d was a b o l i s h e d ; a t r u l y major change.  The  frequency o f tax amendments has l e f t the mining i n d u s t r y i n the p o s i t i o n o f coping w i t h a "banana r e p u b l i c " on i t s home ground.  The p r e v i o u s l y f a v o u r a b l e Canadian tax  environment has been downgraded i n the minds o f Canadian mining management.  The p r a c t i c a l e f f e c t i s t o s h a r p l y  reduce the p e r c e i v e d d i f f e r e n c e i n l e v e l o f u n c e r t a i n t y  59 attached to f o r e i g n taxes as Canadian managements l e a r n to l i v e w i t h u n s e t t l e d c o n d i t i o n s a t 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 e i t h e r 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 i n v e s t o r i n a Mexican mine should be (2) c o n s i d e r e d i n the assessment of the mine p r o j e c t .  An  example o f a p o s s i b l e change i s the r a t e of w i t h h o l d i n g tax on income p a s s i n g from Mexico t o Canada.  Canada and  Mexico do not have a tax t r e a t y t o minimize double t a x a t i o n of income but perhaps t h i s may  alter.  As the  management o f P l a c e r i s expected to make the r e l a t i o n s h i p of Canadian and Mexican taxes an important i s s u e i n the investment d e c i s i o n p r o c e s s , a b r i e f o u t l i n e of the more s i g n i f i c a n t of such taxes i s g i v e n i n t h i s 4.2  chapter.  Canadian taxes on mining business F e d e r a l , p r o v i n c i a l and m u n i c i p a l governments l e v y taxes on the mining i n d u s t r y i n Canada and as they each s e t t h e i r r u l e s and have tax bases which d i f f e r i n some manner, only the taxes o f Canada and B r i t i s h Columbia as they a f f e c t new mines are c o n s i d e r e d here. The f e d e r a l 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 p r o v i n c e s .  As a  g e n e r a l r u l e , f e d e r a l and p r o v i n c i a l income tax laws compute the income amount to which the tax r a t e s are a p p l i e d on the same b a s i s .  There are d i f f e r e n c e s , o f  60 course, and those which deserve mention are d i s c u s s e d l a t e r i n t h i s chapter. Columbia mining  Taxes borne by the  i n d u s t r y are the two  British  income taxes a l -  ready mentioned, resource tax and c a p i t a l tax  levied  by the p r o v i n c e and a number of taxes on m a t e r i a l s and s e r v i c e s such as f u e l tax, s a l e s taxes and even a stumpage tax on timber  4.3  cut.  Canada's f e d e r a l income tax The  f e d e r a l income tax r a t e i s p r e s e n t l y 36% of t a x a b l e  income from mining but, b e f o r e a r r i v i n g a t the amount of t a x a b l e income, there i s an important of  c e r t a i n resource p r o f i t s which e f f e c t i v e l y  the tax r a t e to 27% The  (36% l e s s 25%)  25%  reduces  of q u a l i f y i n g income.  r u l e s a l s o a l l o w f l e x i b l e r a t e w r i t e o f f of c o n s t r u c -  t i o n c o s t s of a new of  deduction of  mine d e d u c t i b l e from t a x a b l e income  the same company up to 100%  of the c o s t i n any  year  (3) i n c l u d i n g the c o n s t r u c t i o n p e r i o d . o f f e r e d through  This  c a p i t a l c o s t deductions  flexibility can be a s i g n i -  f i c a n t advantage to companies w i t h o t h e r sources of income as up to approximately c o s t can be recouped through to  completion  50% of the c o n s t r u c t i o n tax payment r e d u c t i o n s p r i o r  of mine c o n s t r u c t i o n .  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 f a c t o r b r i n g i n g the date forward when a m i n e r a l prospect transforms body.  i n t o an economically  E x p l o r a t i o n a l s o deserves  f e a s i b l e ore-  a t t e n t i o n i n any  61 d i s c u s s i o n of f e d e r a l income taxes.  Chapter Two  refers  to the net a f t e r tax c o s t of e x p l o r a t i o n expenses where it  i s shown i n Table V t h a t taxes saved as a r e s u l t ; of  e x p l o r a t i o n expenses can be as much as 88% of the expenditure. F l e x i b l e and f a s t w r i t e - o f f c a p i t a l c o s t deductions, p l u s e x t r a deductions from t a x a b l e income based q u a l i f y i n g c o n s t r u c t i o n expenditure  (called  on  "earned  d e p l e t i o n " ) and the f a v o u r a b l e treatment of e x p l o r a t i o n c o s t s f o r tax purposes, combine to o f f e r s u b s t a n t i a l i n c e n t i v e s to the mining i n d u s t r y . perhaps  These i n c e n t i v e s ,  they are r e d u c t i o n s of tax d i s i n c e n t i v e s , p r e s e n t  an a t t r a c t i v e f e d e r a l tax s t r u c t u r e i n Canada but there i s a notable exception.  The Canadian  constitutional  squabble m a n i f e s t s i t s e l f i n the f e d e r a l government d i s a l l o w i n g resource taxes p a i d to p r o v i n c e s as a deduction i n determining net t a x a b l e income f o r f e d e r a l tax purposes.  The inter-governmental d i s p u t e puts the mining  i n d u s t r y i n the middle and i t w i l l continue to s u f f e r u n j u s t l y h i g h combined e f f e c t i v e tax r a t e s on mining income u n t i l the governments come to terms on an e q u i t a b l e a l l o c a t i o n o f 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  i n d u s t r y i n B r i t i s h Columbia; Resource  tax.  Income tax and M i n e r a l  The p r o v i n c i a l income tax r a t e a t 15% of  t a x a b l e income i s the h i g h e s t p r e v a i l i n g r a t e of a l l the p r o v i n c e i ^ a n d the M i n e r a l Resource tax a t 17%% income i s a l s o a s i g n i f i c a n t burden.  of t a x a b l e  Like i t s federal  c o u n t e r p a r t , p r o v i n c i a l income tax laws allows  flexible  r a t e f a s t w r i t e o f f of mine c o n s t r u c t i o n c o s t s and,  by  so doing, the p r o v i n c i a l government c o n t r i b u t e s the tax r a t e share of the p r o j e c t cash flow to the  investment  payback a t the same or a t an even f a s t e r pace than i n v e s t o r h i m s e l f can d i r e c t h i s share of net cash to the repayment.  Earned  the flow  d e p l e t i o n i s a v a i l a b l e f o r pro-  v i n c i a l income tax purposes,  which make e x t r a  deductions  a v a i l a b l e f o r mining e x p l o r a t i o n and development c o s t s i n c u r r e d ; however u n l i k e i t s f e d e r a l income tax equival e n t , t h e r e i s no resource allowance income.  The resource allowances  o f 25% o f q u a l i f y i n g  and resource tax  deduct-  i b i l i t y are the two major causes f o r d i f f e r i n g amounts of t a x a b l e income f o r f e d e r a l and p r o v i n c i a l income tax purposes. The m i n e r a l resource tax i s regarded  by government  as a r o y a l t y based on income and i t i s perhaps f o r t h a t reason t h a t requests to allow l o s s e s f o r resource  tax  purposes to be c a r r i e d forward u n t i l u t i l i z e d have so f a r been i g n o r e d . a new  The d e n i a l of l o s s e s i s more important  to  mine where s t a r t - u p problems and the t i m i n g 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 r a t e of  resource tax on mining  income.  Another f e a t u r e of the  m i n e r a l resource tax a c t i s t h a t a l o s s cannot be  offset  63 a g a i n s t t a x a b l e income o f another mine owned by the same company.  Each mine i s s e l f c o n t a i n e d f o r resource tax  purposes. The o v e r a l l e f f e c t o f the m i n e r a l resource tax i s t h a t i t i s onerous  and i s the cause f o r the l a r g e pro-  v i n c i a l tax b i t e from mining income compared with other income.  Table VII shows the taxes on income l e v i e d by  the f e d e r a l 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 r a t e i s l e s s owing to earned d e p l e t i o n but the l e v e l o f income can r a i s e the r a t e . TABLE V I I Canadian F e d e r a l and B r i t i s h Columbian E f f e c t i v e Tax Rates on Mining Income (Current and D e f e r r e d Tax Expense Combined) v  F e d e r a l income tax P r o v i n c i a l income tax P r o v i n c i a l m i n e r a l resource tax  Newly Constructed Mine 20.25% 11.25% 11.16%  Mature Mine 27% 15% 15%  42.66%  4.5  57%  Other taxes i n Canada Sales taxes are l e v i e d by the f e d e r a l and p r o v i n c i a l governments, not on mine product s a l e s as l o g i c  might  l e a d one to b e l i e v e , but on the value o f purchases. F e d e r a l taxes are o f t e n hidden i n the purchase p r i c e but p r o v i n c i a l taxes are d i s c l o s e d on a l l purchases. g e n e r a l , s a l e s taxes and duty p a i d on s u p p l i e s  In  consumed  i n t r a n s f o r m i n g ore i n t o a s a l e a b l e product f o r export (a l a r g e p o r t i o n o f p r o d u c t i o n i n Canada i s exported) are  64 not a p p l i e d o r , i f a p p l i e d , are r e f u n d a b l e . A l a r g e port i o n of the c o s t of mine c o n s t r u c t i o n does not  suffer  s a l e s tax but more items, p a r t i c u l a r l y machinery and equipment s u f f e r p r o v i n c i a l s a l e s tax than f e d e r a l  sales  tax. In a d d i t i o n , a mining company pays p r o p e r t y taxes based on the assessed value of i t s a s s e t s and,  since i t  is i n a capital intensive industry, a disproportionately h i g h share of p r o p e r t y taxes are borne compared with labour i n t e n s i v e i n d u s t r i e s . In the r e g i o n of 1% of the assessed value i s p a i d a n n u a l l y as a p r o p e r t y t a x . A tax not u s u a l l y n o t i c e d by Canadians  i s the w i t h -  h o l d i n g tax on c e r t a i n income of n o n - r e s i d e n t s . The  rate  depends on the country of r e s i d e n c e of the r e c i p i e n t  and  i s 25% f o r "non-treaty" c o u n t r i e s and a lower 15% f o r "treaty" countries.  Mexico f a l l s i n the 25% category;  an important f a c t o r when i t comes to c o n s i d e r i n g the Mexican w i t h h o l d i n g tax r a t e of 21% of income p a s s i n g to Canadians  4.6  from Mexico.  Mexican taxes on mining business The  f e d e r a l government i n Mexico C i t y takes the  lion's  share of taxes imposed on the mining i n d u s t r y through a v a r i e t y o f taxes but mostly p r o d u c t i o n taxes and based on income.  The p r o d u c t i o n tax i s shared by  taxes agree-  ment with the a p p r o p r i a t e s t a t e government and a r e l a t i v e l y minor p r o p e r t y tax i s c o l l e c t e d d i r e c t l y by the  65 state. and  Other s i g n i f i c a n t  value  effect  added t a x e s  (VAT).  1 J a n u a r y 1980  receipts  tax  taxes  are The  to replace  as w e l l as  the w i t h h o l d i n g latter  the  taxes  comes i n t o  present  4%  gross  a s u b s t a n t i a l number o f  special  taxes.^ Incentives years  through taxes  to Mexico's mining  t i v e s were t a i l o r e d were n e c e s s a r y known as  industry. U n t i l  prior  to the  "convenios".  dict  and  favour  the the  s i g n i n g of  the  fiscal  C o n v e n i o s were n e v e r a the  costs of  agreements satisfactory  initial  the  loss  breakdown o f n e g o t i a t i o n s was  c a u s e d by  any  At present,  i t s stead  with  so c o s t s may  still  rules  the  different  Negotiations  convenio system i s not  that w i l l  tax  be  still  i n c u r r e d simply  a p p l i e d and  the  t o be a v a i l a b l e .  Mexico's production  taxes  non-metallic  taxes  minerals  taxation  are and  used  and  abatements.  to find and  the  however,  out  length  e x i g i b l e on m e t a l l i c p a y a b l e by  consi-  required,  size  time abatements are  Production  in  zones i n M e x i c o  e x e m p t i o n s and  government a r e be  pre-  l a s t m i n u t e when t h e p o t e n t i a l  i s a system o f economic  which a t t r a c t  to  themselves h e a v i l y weighted  ground r u l e s u n t i l  in  negotia-  s u b s e q u e n t r e n e w a l s were d i f f i c u l t negotiations  incen-  negotiations  o f g o v e r n m e n t . Management n e v e r knew t h e  derable.  4.7  1976,  t o i n d i v i d u a l m i n e s and  mechanism t o management as t i o n s and  have b e e n a v a i l a b l e f o r  the of  and  producer  at  tax  66 percentage  r a t e s of the values of metal  content commer-  c i a l l y u s e f u l and non-metal dry weight.  Values are based  on smelter terms before deductions  for refining.  and  z i n c 7%.  s i l v e r a t t r a c t 9% and  l e a d and  An  Gold unfor-  tunate p r o v i s i o n of the law allows the M i n i s t r y of Finance to determine values monthly which leaves the door open to f i x i n g income l e v e l s f o r tax purposes i n c o n s i s t e n t with a c t u a l revenue. value of two be earned  percentage  An amount up to the  p o i n t s of the p r o d u c t i o n tax can  by the tax payer who,  i n the same calendar  year  as the abatement, i n c u r s p r o s p e c t i n g e x p l o r a t i o n and development c o s t s .  The amount earned  o f reduced p r o d u c t i o n t a x e s . metal metals  i s c o l l e c t e d by  The commercially  content of a mine's p r o d u c t i o n may  i n concentrate i s a nuisance  or worse s t i l l E i t h e r way,  i t may  be regarded  useful  well include  f o r which there are no s a l e proceeds.  the metal  way  I t may  be  to the customer  as a p e n a l t y  metal.  the mine i s i n an i n v i d i o u s p o s i t i o n of  paying tax on something which has no value to i t . e f f e c t i v e r a t e of the combined p r o d u c t i o n taxes  The  will  vary f o r each mine owing to the method of t h e i r d e t e r mination.  The  lower the mine's o p e r a t i n g p r o f i t margins  the g r e a t e r the impact  of the p r o d u c t i o n tax and  i t is  easy to f o r e s e e s i t u a t i o n s 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% r e s p e c t i v e l y of taxa b l e income computed on p r i n c i p l e s s i m i l a r to methods-  Canadian  Deduction from income i s allowed f o r p r o d u c t i o n  taxes which i s an improvement over the Canadian  treatment  of m i n e r a l r e s o u r c e t a x e s . In g e n e r a l , the r u l e s f o r the deduction of c a p i t a l c o s t allowances are not as as those i n Canadian  flexible  law as r a t e s are lower and, once s e t ,  the allowance must be taken.  T h i s r u l e leaves the tax  payer open t o l o s s of c o s t d e d u c t i b i l i t y as l o s s e s can not be c a r r i e d forward more than three years and an  adverse  metal p r i c e p e r i o d o f t e n l a s t s longer than three y e a r s . The years 1975 In 1979  to 1979  f o r copper  i s an example.  t h e r e 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 i n c l u d e s c e r t a i n mining expenditure.  U n f o r t u n a t e l y the c r e d i t r e q u i r e s  annual renewal by government r e g u l a t i o n so no f u t u r e 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 c o n d i t i o n s than Canadian  owing t o the longer  p e r i o d of tax d e f e r r a l r e l a t e d t o the speed t h a t c o s t allowances may  be claimed i n the two  capital  countries.  Dividends p a i d by Mexican companies i n c l u d i n g  mining  companies are s u b j e c t to a 21% w i t h h o l d i n g tax but the u l t i m a t e bearer of the tax depends on the circumstances o f the r e c i p i e n t .  I t i s p o s s i b l e f o r a Canadian  r e c i p i e n t of Mexican d i v i d e n d s to get Canadian  resident  tax r e l i e f  68 from the tax deducted is  a t source i n Mexico hut the  law  complicated. The combined e f f e c t i v e r a t e of taxes on income of  Mexican mining companies i s not c o n s t a n t o r comparable owing t o the d e d u c t i b i l i t y of p r o d u c t i o n t a x e s : p r i c e s and the metals produced  a l t e r the e f f e c t i v e r a t e s .  Per-  haps i t w i l l s u f f i c e t o r e f e r t o Table XXIII where i t shows t h a t 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 p r o s p e c t i n . Z a c a t e c a s ,  the o v e r a l l mine l i f e e f f e c t i v e r a t e o f taxes on is  42% when the p r o d u c t i o n taxes a l r e a d y absorb  earnings another  18% of earnings b e f o r e t a x e s .  4.9  Other  taxes i n Mexico  The  impact o f the v a l u e added tax of 10% which comes  i n t o e f f e c t January  1980  can o n l y be estimated a t 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 t o the  export o r i e n t e d s i l v e r producer.  The a d m i n i s t r a t o r s of  the tax w i l l d o u b t l e s s take two or t h r e e 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 e l s e  i n Mexico, w i l l have t o watch t h e i r s i t u a t i o n  carefully.  An i n i t i a l area of concern i s the b e l i e f t h a t t e c h n i c a l s e r v i c e s rendered to Mexicans by n o n - r e s i d e n t s 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) t e c h n i c a l s e r v i c e s w i t h h o l d i n g tax, Mexico of badly needed t e c h n i c a l h e l p . c o s t of the s e r v i c e  to  be  rendered  serves to s t a r v e I f the 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 o f 42% o f $58:  a loss  to the t e c h n i c a l p r o v i d e r  o f $22.  are encouraged.  the s e r v i c e can be withdrawn  and,  Firstly,  Two courses o f a c t i o n  secondly, the b i l l i n g can be adjusted  (up $72.41) which w i l l $100.  t o $172.41  net the n o n - r e s i d e n t h i s o r i g i n a l  Meanwhile, the Mexican government c o l l e c t e d an  a d d i t i o n a l $72.41 plus t e n percent VAT t o t a l l i n g $79.65. The  Mexican purchaser o f the n o n - r e s i d e n t s  s u f f e r s a 72% i n c r e a s e  i n the before income and employee  tax c o s t o f imported s e r v i c e s , whopping 245% i n c r e a s e  services  ($189.65 vs $110) and a  i n the a f t e r tax c o s t  ($134.65  vs $55) as the t e c h n i c a l s e r v i c e s tax i s a non-deductible expense. Another c y c l e o f c a l c u l a t i o n s i s needed i f the nonresident providing  the s e r v i c e s i s a l s o an e q u i t y  holder  (assume 34% f o r the purpose) i n the Mexican user.  A re-  duction  of p r o f i t s remittable  t o the owner occurs i n the  amount o f $21.39 (34% o f $79.65 l e s s 21% w i t h h o l d i n g I t i s easy to see why the Mexican 42% w i t h h o l d i n g a stumbling block  tax)  tax i s  to the i n t r o d u c t i o n o f Canadian mining (7)  expertise provider  t o Mexico. ' v  Recovery o f $100 by a f o r e i g n  o f t e c h n i c a l s e r v i c e s t o a Mexican  when t h a t p r o v i d e r  corporation  i s a l s o a 34% e q u i t y holder  Mexican c o r p o r a t i o n ,  i n the  r e q u i r e s a b i l l i n g o f $250.  The  $250 i n v o i c e nets $145 i n cash which represents h i s b i l l i n g o f $100 p l u s  $45 d i v i d e n d s  received  i n advance  70 of other p a r t n e r s i n the Mexican venture. i n v o i c e c o s t of $150  The e x t r a  ($250 vs $100) a t t r a c t s t e n percent  VAT and there i s no income and employee tax r e d u c t i o n . The f o r e i g n e q u i t y h o l d e r p i c k s up 34% o f the h i g h e r c o s t of $165  ($275 vs $110) and a f t e r 21% d i v i d e n d w i t h h o l d i n g  tax saved i s worse o f f by approximately d i v i d e n d s are reduced.  $45 as f u t u r e  71 CHAPTER FOUR REFERENCES 1.  B r i t i s h Columbia's G i b r a l t a r Mines L i m i t e d annual r e p o r t 1975 r e c o r d s taxes o f 123% o f income b e f o r e t a x . Noranda's C e n t r a l Canada Potash i n Saskatchewan bore 137% o f i t s 1978 income before tax a c c o r d i n g 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 o f Mattagami Lake Mines L i m i t e d (NPL)  2.  D.G. K r i g e , "The impact of t a x a t i o n systems on mine economics", Decision-making i n the m i n e r a l i n d u s t r y C.I.M. S p e c i a l Volume No. 12, 1971 pp 283-288  3.  "Income tax a c t , Chapter 63 S.C. 1970-71-72 as amended", R e g u l a t i o n 1210 (1) and r e g u l a t i o n 1100 (1) (w)  4.  "Canadian income tax a c t with r e g u l a t i o n s " , CCH Canadian L i m i t e d , 51st e d i t i o n , 1979 page X  5.  Gonzalez V i l c h i s y C i a , B o l e t i n Informativo No 1A i s s u e d 2 January, 1979, page 4  6.  Mexican f o r e i g n investment and t r a n s f e r o f technology laws, S p a n i s h - E n g l i s h 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 o f technology and f o r e i g n investments i n Mexico: Speech d e l i v e r e d a t 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 t o value A d e c i s i o n has t o be made e a r l y i n the e x e r c i s e to e v a l u a t e a mining  i n t e r e s t and the d e c i s i o n problem con-  cerns what needs t o be valued.  I t i s easy t o ask "what  i s the value of a h o l d i n g i n mining i s the value o f mining  company A?" or "what  p r o p e r t y B?" but d i f f i c u l t i e s  arise  i n the v a l u a t i o n process when the v a l u a t o r must s e l e c t what has value t o whom and what i n f l u e n c e s the v a l u e . A p o t e n t i a l mine p r o p e r t y may have value i n the form of  an a n t i c i p a t e d flow o f cash from mining  reserves.  I t most l i k e l y  the p r o p e r t y ' s  has a value based on i t s r e -  placement c o s t and government w i l l a l s o value the mining i n t e r e s t i n terms o f tax revenues,  employment, f o r e i g n  exchange and some i n t a n g i b l e c o s t s and b e n e f i t s .  An  example of an i n t a n g i b l e b e n e f i t i s the encouragement t o others i n the i n d u s t r y p r o v i d e d by the a c t of i t s e l f , p a r t i c u l a r l y i f the investment category of needed f o r e i g n investment.  investment  f a l l s i n t o the The v a l u a t o r must  determine who the i n t e r e s t e d p a r t i e s are as they each s e t a value on the p r o p e r t y based on t h e i r own o b j e c t i v e s f o r h o l d i n g an ownership i n t e r e s t o r , i n the case of government, f o r d e c i d i n g on the amount o f e x t r a p o l i t i c a l o r f i n a n c i a l help to be made a v a i l a b l e .  In a d d i t i o n , the  v a l u a t o r ought t o review the circumstances the c a l l f o r a v a l u a t i o n .  surrounding  I f the h o l d e r o f the p r o p e r t y  or of an i n t e 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 h o l d e r wants to make an  investment  d e c i s i o n r e l a t e d to the p r o p e r t y or when an o f f e r to purchase has been r e c e i v e d . Any  v a l u a t i o n of a p o t e n t i a l mine i s going to be  expressed  i n terms of another  asset.  U s u a l l y t h a t other  a s s e t i s a n a t i o n a l currency but i t c o u l d w e l l be a share i n a company, government bonds or a c a r r i e d est of  i n the p o t e n t i a l mine i t s e l f .  inter-  Individual objectives  the p a r t i e s i n t e r e s t e d i n a v a l u a t i o n w i l l have an  impact  on the v a l u a t i o n too.  A q u e s t i o n of what to  maximize and the degree of c o n t r o l e x e r c i s e d by  the  p a r t i e s can a l t e r the r a t e o f a n t i c i p a t e d cash flow, f o r example. for  A mine l i f e of t h i r t y years may  s o c i a l reasons  but present values of cash flows  be maximized a t f i f t e e n y e a r s . maximized  s u i t government may  Perhaps p r o f i t i s to be  (as d i s t i n c t from cash) and then a new  s e t of  c o n s t r a i n t s w i l l apply i n a r r i v i n g a t a value of the p o t e n t i a l mine.  T h i s paper w i l l d e s c r i b e the v a l u a t i o n  process l e a d i n g to a number expressed S t a t e s d o l l a r s mainly  i n terms of United  to a v o i d a lengthy d i s c u s s i o n on  the f o r e c a s t exchange r a t e s of the Canadian d o l l a r i n terms of United S t a t e s d o l l a r s . I t i s r e c o g n i z e d t h a t the mine i n t h i s case i s i n Mexico which means the host government and Mexican pesos.  l o c a l n a t i o n a l e q u i t y owners d e a l i n Those p a r t i e s w i l l most l i k e l y do  their  sums i n pesos but as the pesos/US d o l l a r exchange r a t e i s u n s e t t l e d and because the p o t e n t i a l 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 n a t i o n a l  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 n a t i o n a l currency as the medium f o r value has  some s p e c i a l problems.  The US d o l l a r i s f r e e l y  c o n v e r t i b l e to o t h e r c u r r e n c i e s , a t l e a s t a t present, i t does s u f f e r from the e f f e c t s of i n f l a t i o n .  The  valua-  t o r has to decide whether i t i s a p p r o p r i a t e to use concept  of constant d o l l a r s ^  but  the  (deflated future dollars)  i n the v a l u a t i o n 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 knows t h a t any  i s rejected.  The v a l u a t o r  s a l e of an i n t e r e s t i n the p o t e n t i a l mine  w i l l be based on a p r i c e expressed  i n terms of  today's  values but i t i s a l s o known t h a t the e x p e c t a t i o n of i n f l a t i o n a f f e c t s the thought  process o f the p a r t i e s .  Another area of p o s s i b l e d i s p u t e , p a r t i c u l a r l y i f p r o f i t maximization  i s a h i g h p r i o r i t y t a r g e t , i s the  accounting  (2) method used i n a r r i v i n g a t the v a l u e .  Governments and  f o r e i g n i n v e s t o r s , f o r example, use q u i t e 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 c o s t a l l o c a t i o n which causes a d i f f e r e n c e . be c o r p o r a t e c o s t s  It  may  (as opposed to p r o j e c t c o s t s ) or  e x p l o r a t i o n c o s t s which leads to p r o f i t s a t v a r i a n c e i n a c t u a l amount or i n the t i m i n g of t h e i r r e c o g n i t i o n .  75 Timing o f s a l e s r e c o g n i t i o n i s another  source o f c o n f l i c t  e s p e c i a l l y f o r the f o r e i g n i n v e s t o r i n charge o f marketing. Perhaps the most important area o f p o t e n t i a l c o n f l i c t i n any v a l u a t i o n i s the l i s t o f assumptions made i n a r r i v i n g at  a value.  There i s no doubt t h a t long-term f u t u r e  product p r i c e s cannot be gauged a c c u r a t e l y and even a s p e c i f i c p r i c e may have d i f f e r e n t l e v e l s o f p r o b a b i l i t y of  occurrence as p e r c e i v e d by any two experts on the  subject. What has value 'to .whom: i si /largelyv sub jectiveiiand'.the value amount a r r i v e d a t i s o n l y p a r t o f the i n f o r m a t i o n needed by the user o f the v a l u a t i o n .  The l o g i c used t o  e s t a b l i s h the value i s j u s t as s i g n i f i c a n t .  The circum-  stances surrounding the p o t e n t i a l mine p r o p e r t y , the motives  l e a d i n g t o the c a l l  f o r the v a l u a t i o n , the b a s i s (4)  on which t h e v a l u e i s d e r i v e d and the l i m i t s of accuracy are a l l p a r t o f the e v a l u a t i o n needed i f the user i s going t o be able t o use the value 5.2  intelligently.  V a l u a t i o n methods Some business a s s e t s have i n d i v i d u a l i n d u s t r y accepted value-measuring  sticks;  f o r example, the o i l and gas  p r o d u c t i o n i n d u s t r y uses ,$x p e r b a r r e l or b a r r e l equival e n t o f proved r e s e r v e s f o r p a r t i c u l a r l o c a t i o n s as one of  i t s more important methods.  Although o r e r e s e r v e s  p l a y a v i t a l r o l e i n the mine e v a l u a t i o n p r o c e s s , there i s no m e t e r s t i c k $ per tonne of metal c o n t a i n e d i n proven  ore r e s e r v e s i n common use i n the mining i n d u s t r y .  Each  mine has i t s own p e c u l i a r i t i e s o f metallurgy,ground  con-  d i t i o n , l o c a t i o n and so on, such t h a t i t s product homogenous with any other mine product  i s not  and the c o n d i t i o n  leads t o an i n d i v i d u a l net r e t u r n from smelters (the u s u a l mine product p u r c h a s e r s ) .  In t h e example g i v e n , a  s i g n i f i c a n t d i f f e r e n c e between the o i l and mining  indus-  t r i e s i s t h a t o i l r e s e r v e s r e q u i r e major expenditures p r i o r to being proven and the c o s t o f 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 r e v e r s e true.  The value o f mining r e s e r v e s i s t h e r e f o r e h i g h l y  s e n s i t i v e to both product the product  t o the buyer.  p r i c e and the c o s t o f g e t t i n g Here, the term 'reserves" has  been used l o o s e l y implying t h a t the economic of  holds  feasibility  s e l l i n g the r e s e r v e s i s not mandatory whereas i n  r e a l i t y proven r e s e r v e s mean the r e s e r v e s can be s o l d a t (5) a profxt.  v  ;  The v a l u a t o r i s t h e r e f o r e o b l i g e d t o look a t v a r i o u s methods o f v a l u a t i o n and s e l e c t those a p p r o p r i a t e t o a p o t e n t i a l mine p r o p e r t y .  C l e a r l y , any d o l l a r  figure  a p p l i e d to the tonnes o f proven m i n e r a l r e s e r v e s  ignores  the f a c t t h a t mining c o s t s a r e unique t o a m i n e ^ ^ and, even though v a l u a t i o n s are s u b j e c t i v e , i t s use i s entirely  inappropriate.  user o f the v a l u a t i o n .  A second aspect r e l a t e s t o the Government, as has been s a i d ,  views a p o t e n t i a l mine i n a q u i t e d i f f e r e n t l i g h t and may need a value based on f o r e i g n exchange e a r n i n g s .  77 Such a v a l u a t i o n has  little  relevance  to an e q u i t y  holder  except t h a t of an i n t e r e s t i n e n s u r i n g  the government's  balance of payments permits favourable  treatment f o r the  p o t e n t i a l mine. In t h i s study, the p o t e n t i a l mine p r o p e r t y  i s held  by a Mexican c o r p o r a t i o n which i n t u r n i s owned by equity partners.  The  v a l u a t i o n i s being undertaken f o r  a Canadian m i n o r i t y h o l d e r o f the e q u i t y and stances  three  these  circum-  c o u l d m a t e r i a l l y a f f e c t the value of the p o t e n t i a l  mine to the Canadian.  Any  value p l a c e d on the i n t e r e s t  ought to take i n t o c o n s i d e r a t i o n the manner i n which a s s e t i s l e g a l l y h e l d and  i t s r e l a t i v e ease of t r a n s f e r  or s a l e to new  owners.  process  take these s i t u a t i o n s i n t o account.  should  the  Adjustments l a t e i n the  Methods of v a l u a t i o n t h a t may  evaluation  be used by a Canadian  i n v e s t o r f o r the p o t e n t i a l mine i n Mexico and i n g r e a t e r d e t a i l l a t e r i n t h i s chapter  discussed  are:  the cash flow method, the a s s e t a p p r a i s a l method, the earnings  c a p i t a l i z a t i o n method,  a l l of which are u s u a l l y f o l l o w e d by the p r i v a t e s e c t o r . and the s o c i a l c o s t / b e n e f i t method o f t e n p r a c t i c e d by government. An understanding of  this  l a t t e r method by the Canadian i n v e s t o r may  im-  l e a d to  proved p r e s e n t a t i o n to the host government of the  case  i n favour of the p r o j e c t . Another approach to the v a l u a t i o n i s to t e s t  the  78 assumptions and v a l u a t i o n methodology employed i n the above methods on a v a i l a b l e data r e g a r d i n g  a purchase made  by a competitor f o r a s i m i l a r mining prospect, a r e c e n t t r a n s a c t i o n i n Mexico. and  l o g i c produces a value  being valued. the property  I f the v a l u a t o r ' s methods  c l o s e to o r . r e c o n c i l a b l e with  the a c t u a l p r i c e p a i d , g r e a t e r be p l a c e d on the value  preferably  l e v e l s o f confidence can  e s t a b l i s h e d f o r the p o t e n t i a l mine  A t a r g e t i s t o p l a c e no g r e a t e r a value on than others  are w i l l i n g t o s u b s t a n t i a t e  with  t h e i r w a l l e t s , g i v i n g due c o n s i d e r a t i o n t o the o b j e c t i v e s of the p a r t i e s concerned. The  v a l u a t o r ought t o c o n s i d e r  the economic  environ-  ment surrounding the p o t e n t i a l mine i n p a r t i c u l a r and the economy i n general  as r e l a t e d c a l c u l a t i o n s and assumptions  are made f o r each method.  The uses to which the v a l u a t i o n  w i l l be put have a s t r o n g b e a r i n g may r e q u i r e a range o f v a l u e s ,  on the f i n a l value and  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 u s e f u l as n e g o t i a t o r s  seek  avenues o f agreement l e a s t c o s t l y or most b e n e f i c i a l . l e v e l o f confidence relaxed  i n c e r t a i n assumed s t a t i s t i c s  The  may be  i f the purpose o f the v a l u a t i o n i s , f o r example,  to decide whether more e x p l o r a t i o n expenditure i s j u s t i fied  5.3  o r the p r o p e r t y  i s to be dropped.  Investment and f i n a n c i n g d e c i s i o n s Two questions  are posed i n any study o f a p r o j e c t  l e a d i n g t o a p o t e n t i a l commitment o f r e s o u r c e s .  Firstly,  should the investment be made?  This question  r e l a t e s to  the v a l u a t i o n process designed to d i s t i n g u i s h the accept(7) able  from the unacceptable investment p r o j e c t s .  Secondly, how t o f i n a n c e to f i n a n c e  the proposed .investment?  the investment must be kept q u i t e  from whether t o i n v e s t o r not.  How  separate  They are r e l a t e d  questions,  of course, but i t i s important not t o c l u t t e r the i s s u e of investment w i t h matters p u r e l y  concerned with the  source o f funds t o be used i n making the investment.  Just  as the o b j e c t i v e s o f i n v e s t o r s can d i f f e r which may l e a d to d i f f e r e n t p r o j e c t values and p r e f e r r e d  valuation  methods, so the f i n a n c i a l s i t u a t i o n s and p r e f e r e n c e s of investors d i f f e r widely.  I t may be t h a t a p r o j e c t i s  a c c e p t a b l e but t h a t the f i n a n c i a l c o n s t r a i n t s implementation.  prevent  These two q u e s t i o n s are c h a r a c t e r i z e d  i n t h i s paper as the investment d e c i s i o n and the f i n a n c i n g d e c i s i o n p a r t i c u l a r l y i n the cash flow data prepared f o r the Mexican Mining Company S.A. de C.V. and the Canadian investor The the  (Tables  XIX and XX).  d e c i s i o n t o i n v e s t i s not made i n i s o l a t i o n  from (8)  i n t e r n a l and e x t e r n a l environments o f the i n v e s t o r .  Many f a c t o r s a r e i n v o l v e d r i s k s inherent chapter),  i n the p r o j e c t  c a p i t a l constraints  of the p r o j e c t . ^ ^ 1 0  considered needed.  such as other p r o j e c t  I f there  (discussed (9)  later in this  and the long run e f f e c t s are other p r o j e c t s  then a means o f ranking  Some u s e f u l ranking  proposals,  being  the p r o p o s a l s i s  t o o l s are the present value  80 of f o r e c a s t cash flow, the percentage and the investment  r e t u r n on  investment  payback term which are d e s c r i b e d i n  g r e a t e r d e t a i l elsewhere i n t h i s chapter.  Another  r a n k i n g t o o l 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  utilizes  the q u o t i e n t o f the sum  of the present values of the bene-  f i t s d i v i d e d by the sum  of the present values of the c o s t s  of the p r o j e c t .  The advantage of the p r o f i t a b i l i t y  i s t h a t a h i s t o r i c a l p e r s p e c t i v e i s p o s s i b l e as the  index effects  of i n f l a t i o n are removed from the index but i t s d e t r a c t i o n i s t h a t the s i z e of p r o j e c t s i s i g n o r e d .  The  wealth  (12) growth r a t e  i s y e t another  r a n k i n g t o o l which may  be  used i n c o n j u n c t i o n with others to p r o v i d e the i n v e s t o r with r a n k i n g guides i n cases where the luxury of more than one p r o s p e c t  exists.  Most mining  companies are r a r e l y faced w i t h two  p r o s p e c t s a t any one  time a t s i m i l a r stages of development  along the path to becoming a mine. o c c a s i o n s two  However, on many  or more mine prospects are p r e s e n t and a  p o s i t i v e d e c i s i o n to i n v e s t i n one may mentation regret  mining  of the next mine investment.  delay the The  imple-  c o s t of  (the present value of d e l a y i n g f u t u r e income) i n  making a d e c i s i o n to i n v e s t now  with the p o s s i b i l i t y of  d e l a y i n g a f u t u r e p r o f i t a b l e investment  i n a property  a l r e a d y owned, or perhaps to be owned, may I f an investment  be  significant.  p r o p o s a l i s accepted t h i s time, what  does i t do to the next proposal?  The d e c i s i o n maker  f i n d i t u s e f u l to allow f o r the long run e f f e c t s of a  may  81 d e c i s i o n to i n v e s t : and  r e g r e t i s but one  of the many f a c t o r s  to a t t a c h a v a l u e to i t the p r o b a b i l i s t i c e x p e c t a t i o n s  of f u t u r e investment o p p o r t u n i t i e s  and  forecast c a p i t a l  (13) a v a i l a b i l i t y are The  considered.  d e c i s i o n to borrow funds c a r r i e s w i t h i t c e r t a i n  o b l i g a t i o n s u n t i l payback i s achieved and t i o n s have a p r i c e mostly i n the  those o b l i g a -  form of i n t e r e s t and  other f i n a n c i n g c o s t s but a l s o i n business (14)  constraints  such as working c a p i t a l minimums.  presence of  greater  The  business r i s k owing to the d e c i s i o n to borrow  funds i n s t e a d of u s i n g e q u i t y c a p i t a l , demands higher r e wards and equity  the minimum a c c e p t a b l e investment r e t u r n s  funds ought not to be a c c e p t a b l e from  funds which are borrowed.  invested  To achieve a g r e a t e r  the percentage c o s t of borrowing has  to be  for  return,  l e s s than  the  percentage r e t u r n on investment of e q u i t y  funds i n the  investment d e c i s i o n case.  effect is  The  leveraging  necessary when funds are borrowed but  the d e c i s i o n maker  should take note t h a t the a d d i t i o n a l rewards from  the  p o t e n t i a l mine are compensation f o r undertaking the tional obligations.  addi-  I t can be demonstrated t h a t t h i s i s  so by altering..the f i n a n c i n g scheme to e i t h e r reduce or increase  the lender's r i s k i n which case the c o s t  of  borrowing and/or the business c o n s t r a i n t s w i l l change likewise. Business c o n s t r a i n t s and on borrowers concern d i v i d e n d  o b l i g a t i o n s commonly imposed declaration  restrictions,  82  merely to permit the long-term s u r v i v a l of the company. T h e o r e t i c a l l y , when an investment i s f o r e c a s t to achieve  a r a t e of r e t u r n equal to the c o s t of c a p i t a l , the marketp r i c e of the i n v e s t i n g company's shares w i l l grow a t required rate. Limited  the  The market value of P l a c e r Development  i s a r r i v e d at based on i t s e n t i r e b u s i n e s s and  separate values  are a t t r i b u t e d to i n d i v i d u a l mines or  businesses.  r e l i a b l e breakdown o f the corporate  No  no other  cost  of c a p i t a l to the Mexican p r o j e c t i s a v a i l a b l e although i t i s recognized  t h a t business environmental f a c t o r s i n Mexico  would e s t a b l i s h a higher  c o s t of c a p i t a l there than an (15)  e q u i v a l e n t mine m The  Canada.  Mexican mine p r o j e c t i s a n t i c i p a t e d to be  financed  p a r t l y out of funds from P l a c e r Development L i m i t e d and i t s partners  and  Company S.A.  p a r t l y out of funds borrowed by Mexican Mining de C.V.  As the  l a t t e r borrowings w i l l  not  appear on the Balance Sheet of P l a c e r i n accordance with e s t a b l i s h e d 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 c o s t of c a p i t a l to P l a c e r . Lenders to P l a c e r w i l l  i n c l u d e a l l P l a c e r ' s commitments and  fore w i l l consider  off-balance  there-  sheet b u s i n e s s which may  in  t u r n a f f e c t P l a c e r ' s borrowing c o s t . These l a s t two  p o i n t s ought not to encourage p u t t i n g  s t r o n g emphasis on P l a c e r ' s corporate  c o s t of c a p i t a l , i n  e l u d i n g the e x p l o r a t i o n f a c t o r , i n determining a hurdle  rate  (Appendix 18)for an investment d e c i s i o n on a proposed mine i n Mexico.  The  e x p l o r a t i o n f a c t o r i s analogous to the f i x e d  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 , a s s e t d i s p o s a l s and mortgages,  working  c a p i t a l minimums and r a t i o s , e q u i t y minimums and and a myriad of covenants.  ratios  A l l these r e s t r i c t i o n s  to be c o n s i d e r e d f o r the p e r i o d p r i o r  to loan  In some cases, the time comes when new  have  payback.  equity  capital  has to be sought to reduce the impact of b u s i n e s s constraints  to be taken on so t h a t the q u e s t i o n 'how  f i n a n c e the proposed investment' can be  5.4  to  solved.  Cost o f c a p i t a l The c o s t o f c a p i t a l i s a t o p i c unto i t s e l f and to a l a r g e degree r e q u i r e s a s u b j e c t i v e assessment.  Much has  been w r i t t e n elsewhere on the matter and academic  dis-  c u s s i o n on any chosen l e v e l of c o s t can be lengthy w i t h (14 A). out r e a c h i n g a consensus. blishing  The primary purpose o f e s t a -  a c o s t o f c a p i t a l i s to s e t a minimum percentage  r a t e o f r e t u r n on investment a t which l e v e l the share p r i c e of the i n v e s t o r w i l l grow a t a r a t e p e r c e i v e d be r e q u i r e d by the market.  to  Every i n v e s t o r ' s c o s t o f  c a p i t a l i s a f f e c t e d by i n d i v i d u a l circumstances so, f o r the purpose o f t h i s paper, c o s t o f c a p i t a l  i s d e a l t with  by d i s c u s s i n g P l a c e r Development L i m i t e d ' s c o s t w i t h p a r t i c u l a r a t t e n t i o n t o i t s proposed Mexican  project.  At P l a c e r , a d e t e r m i n a t i o n o f the c o s t o f c a p i t a l has been made from time t o time and a wide range of  84 values rose  established.  In the ten years to 1978  from 5% i n 1967,  to a peak i n 1974  back to 8% as c a l c u l a t e d below.  The  before  1974  values  falling  peak c o s t of  c a p i t a l can be a t t r i b u t e d to high d i v i d e n d concomitant with copper concentrate  the  expectations  and metal market  euphoria. The  c o s t o f c a p i t a l i s regarded by P l a c e r ' s manage-  ment as a r e l a t i v e l y small p a r t of mining investment criteria.  The  foremost cause f o r t h i s r e l a t e s to  c o s t of e x p l o r a t i o n . operating  The  the  i n d u s t r y i s renowned f o r i t s  u n c e r t a i n t i e s but one  factor i s certain;  that  mining an orebody w i l l e v e n t u a l l y render i t uneconomic and  the mine's c l o s u r e can be r e l i e d upon.  The  c o s t of  e x p l o r a t i o n i s not regarded as a v a l i d c o s t of a potent i a l mine, however. i t s cost unrelated  Exploration i s discretionary to an o p e r a t i n g mine.  f u t u r e e x p l o r a t i o n , other  The  and  cost of  than minor amounts f o r payments  i n l i e u of Mexican p r o d u c t i o n  taxes r e f e r r e d to elsewhere  i n t h i s paper does not appear, i n the cash flows of Mexican Mining Company S.A. though the w i l l be  de C.V.  f o r t h a t reason, even  l i k e l i h o o d t h a t f u t u r e e x p l o r a t i o n i n Mexico  funded by t h a t company i s s i g n i f i c a n t .  Future e x p l o r a t i o n c o s t s are a burden of a l l P l a c e r ' s mining p r o j e c t s and to c o u n t r i e s other  the e x p l o r a t i o n e f f o r t may than those generating  the  be d i r e c t e d  funds.  outcome i s t h a t P l a c e r i s o b l i g e d to i n c r e a s e the to be i n c l u d e d  i n the c a l c u l a t i o n of c o s t of  The  costs  capital  85 c o s t p o r t i o n of t o t a l f i x e d and  v a r i a b l e c o s t s of a b u s i -  ness i n t h a t the marginal p r o f i t i s f i r s t a p p l i e d to r e coup f i x e d c o s t s . I f the r a t e of earnings from a mining investment prospect c a p i t a l excluding  the e x p l o r a t i o n f a c t o r , the p r o j e c t  be b e n e f i c i a l to the age  i s expected to exceed the c o s t of  i n v e s t o r even i f the excess  i s s m a l l . P l a c e r ' s management has  t a r g e t s f o r the e x p l o r a t i o n c a p i t a l but  percent-  specific  "on-cost" to the c o s t of  i n s t e a d , combines the f a c t o r with other  t o r s such as p o l i t i c s and operating  not s e t  fac-  r i s k of s u b s t a n t i a l mine  problems, to a r r i v e at an o v e r a l l hurdle  A c a l c u l a t i o n o f P l a c e r ' s f o r e c a s t c o s t of at 31 December 1980 c o s t " i s given as a d i s c o u n t  i n Table V I I I and  t h a t c o s t has  f a c t o r f o r the stream of cash to  rate.  capital  of 8% without the e x p l o r a t i o n  "on-  been used the  Canadian i n v e s t o r i n the Mexican mine i n the case cash flows summarized i n Table  may  XX.  TABLE V I I I PLACER DEVELOPMENT LIMITED Cost of C a p i t a l C a l c u l a t e d as a t 31 December  1980  C a p i t a l breakdown 31 December 1980 (see Table III) Cdn $ m i l l i o n s Debt - current portion $ 24.7 - long-term p o r t i o n 94.8 $119.5 Equity - from shareholders 18.3 - from earnings r e i n v e s t e d i n the business 327.0 $464.8  26% 4% 70% 100%  86 The c y c l e o f b u i l d i n g new mines, loan drawdown and subsequent loan repayment i s captured i n mid-term a t 31 December 1980 as the E q u i t y S i l v e r Mine loan i s a t i t s maximum. I t i s assumed t h a t the average debt/equity r e l a t i o n s h i p i n the long run i s : Debt E q u i t y - from shareholders - from earnings r e i n v e s t e d i n the business  20% 4% 76% 100%  The f o r e c a s t i n t e r e s t c o s t f o r funds loaned t o P l a c e r over the next f i v e years to 1984 i s 11.5%. No attempt i s made here t o j u s t i f y t h a t i n t e r e s t l e v e l . I n t e r e s t expense i s a c o s t d e d u c t i b l e f o r t a x purposes but c e r t a i n methods o f f i n a n c e r e s u l t i n c o s t s o f f i n a n c e which are not tax deductible. T h i s c a l c u l a t i o n assumes t h a t P l a c e r w i l l arrange i t s f i n a n c e i n the more commonly accepted manner o f i n c u r r i n g c o s t s d e d u c t i b l e f o r tax purposes even though the E q u i t y S i l v e r Mine i s not financed t h a t way. P l a c e r ' s marginal tax r a t e a p p l i c a b l e to i n t e r e s t expense i s s t r o n g l y i n f l u e n c e d by Canadian tax law as p r o f i t s d e r i v e mostly from Canada. Loan funds are u t i l i z e d i n P l a c e r companies o p e r a t i n g i n Canada where i n t e r e s t expense may have the b e n e f i t o f a marginal tax r a t e as high as 51%. I t i s assumed t h a t the average marginal tax r a t e a p p l i c a b l e to i n t e r e s t expense o f P l a c e r over the next f i v e years t o 1984 i s 51%. No account i s taken o f the e f f e c t on marginal tax r a t e s o f " f a s t w r i t e - o f f " c a p i t a l expenditures and investment t a x c r e d i t s . These and other tax i n c e n t i v e s delay the payment o f taxes which t h e o r e t i c a l l y n e c e s s i t a t e s an adjustment to the average marginal tax r a t e i n any year. Cost o f the debt segment o f P l a c e r ' s c a p i t a l i s determined using the formula: k (1-t) where k and t  the i n t e r e s t r a t e (see 3 above) the marginal tax r a t e (see 4 above) k k  d d  0.115 0.0564  (1-0.51)  87 Cost of the e q u i t y from the shareholders segment of c a p i t a l i s determined u s i n g the formula: k  = S  where D P  = =  and  =  g  D P  +  Placer's  g  the expected d i v i d e n d per share ($1, May 1979) the c u r r e n t market p r i c e of a P l a c e r share ($26, 10 May 1979) the expected r a t e of d i v i d e n d growth (see 7 below)  • k  = _1 26  S  k  =  +  0.06  0.0985  P l a c e r ' s Annual Report f o r 1978 shows t h a t d i v i d e n d payout p o l i c y i n the p e r i o d 1970 to 1978 r e s u l t e d 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 r e s p e c t i v e l y . The nine year p e r i o d s t a r t e d with annual dividends of $0.59 per share and i n May 1979, the d i v i d e n d s are at the r a t e of $1.00 per year; an annual growth r a t e approximating 6%. The growth r a t e i s a f f e c t e d by Canadian tax i n c e n t i v e s to Canadian i n d i v i d u a l s i n the form of d i v i d e n d tax c r e d i t s but, f o r the purposes of t h i s paper, the adjustment i s regarded as minor and ignored. It i s assumed t h a t the group of i n d i v i d u a l s and c o r p o r a t i o n s comp r i s i n g P l a c e r ' s shareholders expect f u t u r e P l a c e r d i v i d e n d s to continue to grow annually at 6%. Cost of the e q u i t y from earnings r e i n v e s t e d i n the business segment of P l a c e r ' s c a p i t a l i s determined using the formula: k  =  e  where k  =  T  =  and  B  e  s  (1-T)  (1-B)  the c o s t of e q u i t y c a p i t a l from shareholders (9.85% from 6 above) the weighted average marginal tax r a t e of a l l P l a c e r ' s shareholders (estimateJ.10% - see note) the weighted average t r a n s a c t i o n c o s t t h a t would be i n c u r r e d i f the earnings were to be p a i d out and r e i n v e s t e d elsewhere (estimated at 1%)  =  k  k  =  0.0985 (1-0.10) (1-0.01)  k = 0.0878 Note: C o r p o r a t e shareholders marginal r a t e i s zero. The c o s t of 8.78% r e f l e c t s the c u r r e n t market p r i c e of P l a c e r ' s shares, as w e l l as the d i v i d e n d h i s t o r y i n the 1970's, and i s the r a t e of r e t u r n which, i t i s assumed, w i l l s a t i s f y present s h a r e h o l d e r s . I t i s i n f e r r e d that a lower r a t e of r e t u r n would r e s u l t i n shareholders s e l l i n g e  88 t h e i r h o l d i n g s t o seek investments with the same degree o f investment r i s k which can p r o v i d e a s u i t a b l e r a t e o f r e t u r n . The  weighted c o s t o f c a p i t a l i s 8% as f o l l o w s :  Debt E q u i t y from shareholders E q u i t y from earnings r e i n v e s t e d i n the business  Cost  Weight (see 1 above)  Weighted Cost  0.0564 0.0985  26% 4%  0.0146 0.0039  0.0878  70%  0.0615 0.0800  Risk The  r i s k s involved  i n a p o t e n t i a l mining investment  appear t o be endless and, l i k e the c o s t o f c a p i t a l , can be  the t o p i c o f another paper.  already  Some o f the r i s k s have  been r e f e r r e d t o such as the i n a c c u r a c y o f a v a i l -  able data, e x p l o r a t i o n ,  a t t i t u d e s toward f o r e i g n  invest-  ment and r e l a t e d laws i n c l u d i n g 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 o f changes i n governmental resource  p o l i c i e s c o n s i d e r e d adverse by the i n d u s t r y .  Suscepti-  b i l i t y t o changes i n the p o l i t i c a l and tax environments i n Mexico are a l l u d e d  to i n Chapters three and four  res-  p e c t i v e l y and these two r i s k s are high on the l i s t t o be reviewed by a d e c i s i o n maker i n a s s e s s i n g f o r e i g n mining investment t h e r e .  the r i s k s o f a  The r i s k o f f o r e i g n  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 o f a f t e r - t a x earnings has been mentioned as a l s o have the a d d i t i o n a l business r i s k s added when the p o t e n t i a l investment i s financed  with borrowed funds.  89 Two r i s k s d e s e r v i n g o f s p e c i a l note which f a l l w i t h i n the r i s k o f i n a c c u r a t e a v a i l a b l e data are the q u a n t i t y and c h a r a c t e r o f ore r e s e r v e s and metal market p r i c e s f o r e casts.  Time l i m i t a t i o n s and the high c o s t o f d r i l l i n g  render i t i m p r a c t i c a l to l e a r n e v e r y t h i n g about the o r e body and the experience o f g e o l o g i s t s has t o be employed in  p r o v i d i n g the raw data f o r mining  to  use i n a s s e s s i n g the nature and s i z e o f the orebody.  A reasonable  number o f d r i l l  engineers and others  holes u s u a l l y p r o v i d e s a  good l e v e l o f c o n f i d e n c e i n the orebody data and t h i s i s one  area o f concern which can be minimized  by p u t t i n g down  more holes u n t i l the d e c i s i o n maker i s s a t i s f i e d t h a t the nature o f orebody i s w e l l understood.  The f o r e c a s t metal  p r i c e s are u s u a l l y c r i t i c a l t o the f e a s i b i l i t y o f the proposed p r o j e c t with the e x c e p t i o n o f the high grade/low p r o d u c t i o n c o s t p r o p e r t i e s which are u n l i k e l y t o be a f f e c t e d by anything but a complete c o l l a p s e o f the markets f o r t h e i r products. market p r i c e s i s important  The c y c l i c a l nature o f metal i n the e a r l y years o f mining  from a p r o p e r t y as the g e n e r a l l y accepted p o l i c y o f opt i m i z i n g the present value o f cash flow, e s p e c i a l l y i n the e a r l y years o f o p e r a t i o n t o achieve a r a p i d i n v e s t ment payback, n e c e s s i t a t e s h i g h - g r a d i n g from the orebody. M a r g i n a l orebodies need to commence p r o d u c t i o n i n the u p - c y c l e of p r i c e s and they w i l l g e n e r a l l y be h e l d i n i n v e n t o r y u n t i l i t i s judged  the u p - c y c l e w i l l l a s t  long  enough t o a l l o w payback w i t h i n the p e r i o d a c c e p t a b l e to  90 the  i n d i v i d u a l d e c i s i o n maker.  market p r i c e c y c l e p o o r l y  The  r i s k of r e a d i n g  i s h i g h and  the most s i g n i f i c a n t v a r i a b l e s  r e p r e s e n t s one  Hedging may  n a t i v e open to the metal producer but  be an  alter-  even t h a t course of  s p e c i a l drawbacks as the a b i l i t y to produce  the q u a n t i t y  on time becomes the major r i s k .  strike-prone  age  and  of  i n a r r i v i n g at a d e c i s i o n  to i n v e s t i n a mining p r o j e c t .  a c t i o n has  the  and  In t h i s  w i t h long d e l i v e r y times f o r  material  equipment many d e c i s i o n makers f i n d hedging an  a c c e p t a b l y high  risk.  In the case of P l a c e r ' s  i n t e r e s t i n Mexico, there i s  an a d d i t i o n a l r i s k a s s o c i a t e d in partnership  un-  with o t h e r s .  w i t h a d e c i s i o n to The  invest  common purpose of owning  a s u c c e s s f u l l y operated mine i s dependent on the o b j e c t i v e s of each p a r t y mine.  being i n harmony throughout the  Even the  j o i n t preparation  p r e s e n t s e x t r a r i s k and  requires  of the  feasibility  the  study  careful coordination  c o n t r o l to ensure a l l p a r t i e s work w i t h the The  l i f e of  and  same data.  assessment of r i s k attached to an investment i n a  mining p r o j e c t i s an i n t e g r a l p a r t of the e v a l u a t i o n the p r o p e r t y .  (17)  of the r i s k has  The  . . s i z e of the p r o j e c t and  the  of  severity  a r e l a t i o n s h i p of i n t e r e s t as a minor pro-  j e c t with good p o s s i b l e gains can accompanied by high r i s k but  be r e a d i l y accepted  i t i s improbable t h a t a major  p r o j e c t c a r r y i n g a high r i s k of l o s s or bankruptcy w i l l (18) approved by the d e c i s i o n maker.  Although the  degree  of r i s k i s thoroughly reviewed by the p r i v a t e s e c t o r  in  be  i t s e v a l u a t i o n p r o c e s s , t h i s i s r a r e l y the case w i t h government when no e q u i t y i n t e r e s t i s h e l d . Government's review of a p r o j e c t p r o p o s a l , perhaps submitted of  i n support  a request f o r government tax concessions or a s s i s t a n c e  w i t h i n f r a s t r u c t u r e c o s t s , g e n e r a l l y c o n c e n t r a t e s on  the  (19) s i z e of the percentage  r e t u r n on investment.  case o f Mexican Mining Company S.A.  de C.V.  In the i n which  government holds 33% of the shares, government can expected  to assess the r i s k of l o s s owing to the  political  advantage t h a t c o u l d be presented to i t s c r i t i c s . assessment would form p a r t of the s o c i a l c a l c u l a t i o n r e l a t i n g t o the proposed The d i f f i c u l t y  mine  t a i n t y ; and,  The  cost/benefit investment.  i n a s s e s s i n g r i s k l i e s i n . t h e assumptions  made and t h e i r impact on the v a l u a t i o n . i n v o l v e s i t s own  be  Each  assumption  degree - o f t e n a h i g h degree - of  uncer-  taken t o g e t h e r , these combined u n c e r t a i n t i e s  can m u l t i p l y i n t o 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 p r e c i s e c a l c u l a t i o n s f o r cash flows and  v a l u e s are data which are not t h a t p r e c i s e . c a l c u l a t i o n s are based on an average  other  At best, the  of d i f f e r e n t o p i n i o n s  w i t h v a r y i n g 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 p r o b a b i lity.  However, the d i s c i p l i n e of t h i n k i n g through  u n c e r t a i n t i e s o f the investment help to ensure sion. of  project w i l l  the  in itself  improvement i n making an investment  deci-  I t i s important to a p p r e c i a t e t h a t the c a l c u l a t i o n s  cash flow and other values are f a r from c e r t a i n  although they may  be more l i k e l y  and  to be the c a l c u l a t e d  92 f i g u r e than any o t h e r the d e c i s i o n maker w i l l have doubts (21) and may be o n l y , say, 60% sure o f the a c t u a l  5.6  figure.  The cash flow method The cash flow method uses as i t s base the f o r e c a s t net cash outcome o f the p r o j e c t c a l c u l a t e d from a l l the known, estimated and assumed data r e l a t i n g t o the i n v e s t ment.  The year by year cash flow f o r e c a s t may be compiled  f o r the i n d i c a t e d l i f e o f the p r o j e c t o r some a r b i t r a r y s h o r t e r p e r i o d l i k e twenty y e a r s .  As cash flow  statements  are presented i n a s i m i l a r manner u n i v e r s a l l y and c l o s e t o the format o f c o r p o r a t e f i n a n c i a l statements f o r e a r n i n g s , cash flows are very i n f o r m a t i v e and o f f e r a u s e f u l h i s t o r i c a l r e c o r d f o r comparison  purposes.  There i s g e n e r a l agreement t h a t t o r e c e i v e cash  today  i s b e t t e r and more s a t i s f y i n g than t o a n t i c i p a t e the r e c e i p t o f cash i n the f u t u r e .  The cash flow method r e c o g -  n i z e s t h i s when the stream o f f o r e c a s t cash flow from an investment i s reduced t o a p r e s e n t day v a l u e .  Clearly,  the longer one has t o wait before r e c e i v i n g the cash, the f u r t h e r one i s from r e c e i v i n g the cash today and the l e s s it  i s worth as a percentage o f i t s nominal v a l u e .  p r e s e n t v a l u e can be expressed two ways:  The  as a d o l l a r  amount having a p p l i e d a s p e c i f i c d i s c o u n t r a t e t o the stream o f f o r e c a s t cash, or as a d i s c o u n t r a t e having s e t the present value o f the stream o f f o r e c a s t cash t o (22) zero.  The r e d u c t i o n o f the value o f the f o r e c a s t  stream of cash to a present  value has  an i n h e r e n t  assump-  t i o n t h a t the r a t e o f earnings from funds r e i n v e s t e d a f t e r r e l e a s e from the p r o j e c t i s e q u i v a l e n t discount  to the  specific  r a t e or to the i n t e r n a l r a t e of r e t u r n which  leaves a present  value o f zero.  t e r n a l rate of return i s high,  In cases where the in-:, i t becomes u n l i k e l y t h a t  investment a l t e r n a t i v e s are a v a i l a b l e which can the reinvestment earnings r a t e needed. r a t e of r e t u r n c a l c u l a t i o n has ducing more than one  provide  A l s o , the i n t e r n a l  the disadvantage of pro-  answer i n cases where the  forecast  stream of cash i n c l u d e s more than one  change from  to  After taking a l l  positive  amounts and  considerations  vice versa.  i n t o account, most experts  use of a s p e c i f i c d i s c o u n t of s e t t i n g the present e v a l1 u4 a- t- i n g an The  agree t h a t  r a t e i s s u p e r i o r to the method  value  to zero f o r the purpose of  present  value,  as has  been s a i d , i s e s t a b l i s h e d  r a t e s p e c i f i e d or c a l c u l a t e d .  flow method of v a l u i n g a mine prospect mark or hurdle  The  cash  r e q u i r e s a bench  r a t e to be s e t by the d e c i s i o n maker  t h a t l e v e l i s compared w i t h the r e s u l t s obtained  by  and dis-  the stream o f f o r e c a s t cash flow from the poten-  t i a l mine. and  the  4. (23) investment.  using a discount  counting  negative  The  hurdle  r a t e i s expressed as a percentage  a d e c i s i o n to i n v e s t r e q u i r e s the present  value of  cash flow to be a p o s i t i v e amount when the d i s c o u n t a p p l i e d equals the hurdle  the  rate  r a t e , or the c a l c u l a t e d i n t e r n a l  r a t e of r e t u r n to be g r e a t e r  than the hurdle  r a t e when the  94 present The  value o f the cash flow i s s e t a t zero. hurdle  r a t e i s a matter o f i n d i v i d u a l  f o r most investment d e c i s i o n makers.  preference  Industry  norms are  common and a r a t e o f t e n quoted i n mining c i r c l e s f o r p r o p e r t i e s a t the stage of f e a s i b i l i t y  s t u d i e s i s 15% (24)  a f t e r taxes but r a t e s from 12% t o 20% are a l s o used. Although each i n v e s t o r tends t o leave the hurdle unchanged, i t i s b e t t e r t o recognize climate  and  t h a t the investment  i s dynamic and amend the hurdle  changing c o n d i t i o n s .  The hurdle  rate  rate to s u i t  r a t e i s not i n v i o l a t e  circumstances may suggest t h a t a lower r a t e o f d i s -  count i s acceptable flow.  from an investment's f o r e c a s t cash  Another common hurdle  of c a p i t a l r a t e d i s c u s s e d theory  being  r a t e i s the i n v e s t o r ' s  cost  e a r l i e r i n t h i s Chapter; the  t h a t a p o s i t i v e present  value  using the c o s t  of c a p i t a l percentage r a t e maintains the needed r a t e o f growth i n the i n v e s t o r ' s share market p r i c e .  A weakness  i n the use o f the c o s t o f c a p i t a l r a t e has a l r e a d y discussed.  A mining company must explore  been  f o r or o t h e r -  wise a c q u i r e new mines and the c o s t o f ensuring  the l o n g -  term s u r v i v a l o f the company i s an unknown q u a n t i t y . Experience has taught the i n d u s t r y ' s d e c i s i o n makers to add  s i g n i f i c a n t l y to the c o s t o f c a p i t a l but the norms  have been i n use f o r so long and w i t h c u r r e n t  interest  r a t e s and i n f l a t i o n i t may be t h a t the 12% o r 15% r a t e s (25) r e q u i r e upward adjustment. acceptable  v  '  A l s o , the hurdle  rate  f o r Canadian mining investments may be lower  than i s needed f o r h i g h e r r i s k f o r e i g n ventures. h u r d l e r a t e should be adapted to the p r e v a i l i n g  The investment  c o n d i t i o n s but always commensurate with the l e v e l of r i s k involved. encountered  Measurement of the r i s k i s where d i f f i c u l t y i s and the i n v e s t o r ' s p r o p e n s i t y to r i s k  dominates. V a l u a t i o n of a p o t e n t i a l mine by the cash flow method enjoys great p o p u l a r i t y a t present as i t depends p r i m a r i l y on the mine's expected  f u t u r e e a r n i n g power.  flow c a l c u l a t i o n s i n d i c a t e the investment p e r i o d t h a t can be a n t i c i p a t e d and  The  cash  o u t l a y payback  the d e c i s i o n maker w i l l  undoubtedly take the p e r i o d i n t o account when a s s e s s i n g the r i s k s i n h e r e n t i n the p r o j e c t .  A r i s k may  be  accept-  able f o r a r e l a t i v e l y s h o r t d u r a t i o n but over a longer p e r i o d may  be too onerous.  The payback p e r i o d should  a c o n s t r a i n t r a t h e r than an investment f o r not to do so. would f a i l  decision criterion,  to r e c o g n i z e the cash  r e s u l t i n g from the investment  be  flows  a f t e r payback and the t i m i n g (26)  and magnitude of cash flows p r i o r to payback.  The  value e s t a b l i s h e d f o r the p o t e n t i a l mine by the cash  flow  method, l i k e any value f o r an a s s e t , i s a r r i v e d a t a f t e r accounting f o r the supply and demand of the  particular  type of m i n e r a l p r o p e r t y ; i t s form of ownership and t r a n s f e r a b i l i t y ; the circumstances form o f s a l e c o n s i d e r a t i o n .  o f the buyer and  the  However, the b a s i s of the  v a l u a t i o n i s the present v a l u e of the stream of f o r e c a s t cash flow d i s c o u n t e d a t the h u r d l e r a t e assuming no  96 borrowed funds a r e used t o f i n a n c e the p r o j e c t .  5.7  The a s s e t a p p r a i s a l method The  a s s e t a p p r a i s a l method has as i t s base the r e -  placement c o s t o f the a s s e t assuming there the a s s e t .  E x p l o r a t i o n being  i s , may e v e n t u a l l y tential  again,  the game o f chance t h a t i t  l e a d t o the l o c a t i o n o f a s i m i l a r po-  mine but i t c o u l d w e l l be a t a c o s t f a r i n excess  of the p o t e n t i a l b e n e f i t s . acquire  i s a need f o r  I t i s also possible to  a p o t e n t i a l mine property  by purchase but,  v a l u a t i o n on a replacement c o s t r e q u i r e s an  acceptable  s o l u t i o n t o the same problem o f e x p l o r a t i o n .  By going back f a r enough, every p o t e n t i a l mine has  here  i t s beginnings i n e x p l o r a t i o n e f f o r t .  property  Accordingly,  e x p l o r a t i o n c o s t s are c r i t i c a l t o any estimate o f the replacement c o s t o f a p o t e n t i a l and o p e r a t i n g mine. large majority  The  o f the c o s t o f a r r i v i n g a t the stage o f  producing a mineral  product i s , i n most i n s t a n c e s , i n - ,  c u r r e d a f t e r the d e c i s i o n t o c o n s t r u c t 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  c o s t s o f c o n s t r u c t i o n and mining are independent o f other mines, v a l u a t i o n o f a p o t e n t i a l mine a t the f e a s i b i l i t y stage on a replacement c o s t b a s i s overlooks aspect  o f mining.  are seldom found.  That i s t h a t two i d e n t i c a l orebodies Adjustments can,  by v a l u a t o r s t o a l l o w few  a vital  o f course, be made  f o r d i f f e r e n c e s i n f u t u r e c o s t s but  buyers and s e l l e r s w i l l agree on the- magnitude o f  97 adjustments when the b a s i c number f o r replacement i t s e l f a suspect v a l u e .  cost i s  As soon as f u t u r e c o s t s are  c o n s i d e r e d the b a s i s o f v a l u a t i o n s h i f t s t o the cash method which c o n s i d e r s both revenue  flow  and.cost.  The a s s e t a p p r a i s a l method i s r a r e l y used t o value a p o t e n t i a l mine p r o p e r t y and, even f o r an o p e r a t i n g mine (27) the method seldom f i n d s favour.  The method i s i n -  a p p r o p r i a t e owing t o the l a c k of confidence assigned t o the c o s t s o f e x p l o r a t i o n and i t s d i s r e g a r d f o r the f u t u r e net b e n e f i t s t h a t may accrue once the p r o p e r t y i s taken beyond the f e a s i b i l i t y 5.8  study  stage.  The earnings c a p i t a l i z a t i o n . m e t h o d The value o f a p o t e n t i a l mine p r o p e r t y a r r i v e d a t u s i n g the earnings c a p i t a l i z a t i o n method i s dependent on the s i z e of a m u l t i p l i e r a p p l i e d t o a n t i c i p a t e d average annual earnings from the mine. N e i t h e r 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 q u a n t i t i e s owing t o f a c t o r s such as the c a p i t a l c o s t s t o b r i n g the p r o p e r t y  into  p r o d u c t i o n and the r i s k s a s s o c i a t e d with the p r o j e c t , particularly  w i t h regard t o the l e v e l s o f p r o d u c t i o n and the  u n i t c o s t of p r o d u c t i o n f o r e c a s t i n the f e a s i b i l i t y study. A going concern o f f e r s a h i s t o r y of earnings  exper-  ience and r e l a t i v e l y high l e v e l s o f confidence can be p l a c e d on c a r e f u l l y prepared  f u t u r e earnings f o r e c a s t s . A  p o t e n t i a l mine l a c k s the h i s t o r y : produce has t o be proven.  even the a b i l i t y t o  Both a p o t e n t i a l mine and an  98 o p e r a t i n g mine r e l y on f o r e c a s t product p r i c e s t o support f u t u r e earnings estimates but a p o t e n t i a l mine has t o look f u r t h e r down the road because o f the i n t e r v e n i n g p e r i o d o f mine c o n s t r u c t i o n . The p o t e n t i a l mine's earnings are t h e r e f o r e bound t o be l e s s secure i n the mind o f a v a l u a t o r o f the p r o p e r t y a t the f e a s i b i l i t y study stage than l a t e r when designed p r o d u c t i o n l e v e l s have been achieved.  Earnings are a f u n c t i o n o f revenue  and c o s t and the c y c l i c a l nature o f metal markets means t h a t when the product p r i c e i s low, c o s t o f p r o d u c t i o n from the p o t e n t i a l mine assumes g r e a t e r s i g n i f i c a n c e .  A  danger t h a t e x i s t s i n any i n d u s t r y where, i n g e n e r a l , world wide supply and demand determines  product p r i c e  l e v e l s and i n d i v i d u a l producers have minor i n f l u e n c e over p r i c e s , i s t h a t the p o t e n t i a l mine may be unable to earn any p r o f i t i n some years; may have t o suspend t i o n s and i t s very e x i s t e n c e may be threatened. temporary  opera-  The  o r long-term c e s s a t i o n o f o p e r a t i o n s i s a r i s k  which can be assessed using the f o r e c a s t c o s t s o f product i o n , a c c o r d i n g to the p o t e n t i a l mine's f e a s i b i l i t y plus industry information.  I f the p o t e n t i a l mines u n i t  c o s t o f p r o d u c t i o n i s low i n comparison of the volume produced it  study,  with the m a j o r i t y  by the i n d u s t r y as a whole, then  f o l l o w s t h a t under f r e e market c o n d i t i o n s the p o t e n t i a l  mine w i l l continue o p e r a t i n g i n most down-price-cycle periods.  S i m i l a r l y the p r o p o r t i o n o f f o r e c a s t u n i t pro-  d u c t i o n c o s t s to the long-run metal p r i c e enables a  v a l u a t o r to assess the l e v e l of r i s k of business c l o s u r e f a c i n g a p o t e n t i a l mine. Earnings mean d i f f e r e n t t h i n g s to d i f f e r e n t In t h i s paper,  earnings are determined  people.  using generally  accepted accounting p r i n c i p l e s i n Canada and are t h e r e f o r e a f t e r both c u r r e n t and d e f e r r e d 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 a r r i v e a t a value and the m u l t i p l i e r i s i t s e l f based the v a l u a t o r ' s knowledge of what o t h e r p a r t i e s pay mine w i t h s i m i l a r r i s k . Although  on  for a  the m u l t i p l i e r i s d e t e r -  mined l a r g e l y by s u b j e c t i v e means, the earnings can  be  c a l c u l a t e d with more p r e c i s i o n ; not f o r e g e t t i n g the underl y i n g assumptions fundamental to the earnings numbers. However, i t must be r e c o g n i z e d t h a t a c c o u n t i n g p r i n c i p l e s do not r e q u i r e a l l earnings to be computed i n i d e n t i c a l manner.  For example, percentage  r a t e s of d e p r e c i a t i o n  expense can be d i f f e r e n t between companies. What matters then i s c o n s i s t e n c y and the v a l u a t o r may  be o b l i g e d to  amend earnings f i g u r e s to achieve i t . The v a l u a t i o n of a p o t e n t i a l mine based on earnings c a p i t a l i z a t i o n has an Important  d i f f e r e n c e compared with  a s i m i l a r v a l u a t i o n of an o p e r a t i n g mine.  The  potential  mine's earnings can not be r e c e i v e d u n t i l the c o s t of c o n s t r u c t i o n has been i n c u r r e d whereas the investment an o p e r a t i n g mine i s a l r e a d y i n p l a c e .  The  in  multiplier  chosen must a l l o w f o r c a p i t a l funds to b u i l d the new and f o r t h e i r recovery towards the end of the  mine  investment  100 payback p e r i o d .  Another  adjustment  t o earnings may be  necessary to a l l o w f o r the mining p r a c t i c e o f e x t r a c t i n g the h i g h e s t a v a i l a b l e grade ore i n the e a r l i e r years o f operation.  F r e q u e n t l y , average earnings r e f e r s to  earnings over a s h o r t p e r i o d o f say f i v e t o t e n years and, i n the normal mining sequence o f events always s u b j e c t t o the t i m i n g o f market p r i c e c y c l e s , the next f i v e t o t e n year p e r i o d ' s average earnings w i l l be l e s s . Two courses of  a c t i o n w i l l account f o r the gradual d e c l i n e i n annual  earnings; f i r s t l y ,  take the average  annual earnings over  the l i f e o f the mine and, secondly, a d j u s t the m u l t i p l i e r downward.  These adjustments  t o the v a l u a t i o n f o r c a p i t a l  c o s t and the g r a d u a l d e c l i n e o f earnings as the p o t e n t i a l mine matures are s u b s t a n t i a l changes to the earnings c a p i t a l i z a t i o n method so o f t e n a p p l i e d to the v a l u a t i o n of  investments o u t s i d e the mining i n d u s t r y . The time v a l u e o f money i s not d e a l t w i t h  i n the earnings c a p i t a l i z a t i o n method. it  adequately  To some extent  i s p o s s i b l e t o c o n s i d e r i t by amending the s i z e o f  the m u l t i p l i e r but the change i s l i k e l y t o be done i n t u i t i v e l y unless cash flow f o r e c a s t s are a v a i l a b l e .  The  m u l t i p l i e r chosen has t o take i n t o c o n s i d e r a t i o n the l i f e of  the p o t e n t i a l mine as those l a t e r y e a r s ' earnings not  i n c l u d e d i n the v a l u a t i o n have t o p r o v i d e the r e t u r n on the investment made to a c q u i r e the p o t e n t i a l mine a t the feasibility  study stage.  Ore r e s e r v e s , which i n t u r n are  dependent on g e o l o g i c a l c o n d i t i o n s combined with metal  101 p r i c e s , p r o d u c t i o n r a t e s and c o s t s and taxes, s e t the mine's expected  life.  Due c o n s i d e r a t i o n o f these  factors  and how they a f f e c t one another i s a d v i s a b l e before a r r i v i n g a t the m u l t i p l i e r to be used i n the v a l u a t i o n . The earnings c a p i t a l i z a t i o n method a p p l i e d to a potent i a l mine p r o p e r t y r e q u i r e s v i r t u a l l y the same i n f o r m a t i o n t h a t i s needed to prepare cash flows. assumptions to compile  A l l the b a s i c  the cash flows from the i n i t i a l  c o n s t r u c t i o n c o s t s t o the c o s t o f marketing  the f i n a l  duct are needed; o n l y the l a s t steps o f changing flows t o earnings statements  of  cash  and f i x i n g the m u l t i p l i e r  are p e c u l i a r t o the c a p i t a l i z a t i o n o f e a r n i n g s . two  pro-  These  steps are i n l i e u o f the c a l c u l a t i o n o f present values d i s c o u n t e d cash flows from the p o t e n t i a l mine.  The  very s u b j e c t i v i t y o f the m u l t i p l i e r i n d i c a t e s t h a t the earnings c a p i t a l i z a t i o n method o f v a l u i n g a p o t e n t i a l mine p r o p e r t y i s i n f e r i o r t o the cash flow method.  Risk i s  allowed f o r i n much the same way f o r both earnings t a l i z a t i o n and cash flow methods. via  capi-  Adjustment i s e f f e c t e d  the m u l t i p l i e r and present value r e s p e c t i v e l y and both  have the same degree o f d e c i s i o n maker s u b j e c t i v i t y .  5.9  The s o c i a l c o s t / b e n e f i t method The tial  s o c i a l c o s t / b e n e f i t method o f e v a l u a t i n g a poten-  mine i s used i n c r e a s i n g l y by governments i n t h e i r  assessment o f a p r o j e c t ' s value t o the host n a t i o n i n l i g h t o f n a t i o n a l p o l i t i c a l and economic p r i o r i t i e s .  The  102 method i n v o l v e s c o n s i d e r a b l e s u b j e c t i v e judgment and  will  not conclude w i t h a p r i c e f o r an i n t e r e s t i n a p o t e n t i a l mine.  What the method does p r o v i d e i s an i n d i c a t i o n of  the p r o j e c t ' s a c c e p t a b i l i t y to the host government which i s u s e f u l f o r a t l e a s t two  reasons.  Firstly,  the more  favourable the net s o c i a l b e n e f i t s a c c r u i n g to the host n a t i o n from the p r o j e c t , the g r e a t e r the o p p o r t u n i t y to e x t r a c t improved o p e r a t i n g and government before investment Secondly,  f i n a n c i a l concessions  from  commitments are made.  the value of the Canadian i n v e s t o r ' s i n t e r e s t  i n a f o r e i g n p r o j e c t w i l l be i n f l u e n c e d by the magnitude of  the net s o c i a l b e n e f i t s .  l i k e l y to reduce  Large net b e n e f i t s are more  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  l e v e l s concerning the s t a b i l i t y s e r v i n g to reduce  of a f o r e i g n  investment  u n c e r t a i n t y over the d u r a t i o n of a  project. A p r i v a t e s e c t o r view of a p r o j e c t i n a f o r e i g n country i s q u i t e d i f f e r e n t from the host government's view o f the same investment.  The two p a r t i e s have d i s -  s i m i l a r o b j e c t i v e s and the n a t u r a l tendency to  a r r i v e a t independent  project.  i s f o r each  and d i f f e r e n t v a l u e s f o r the  The c o s t and b e n e f i t items have d i f f e r e n t  values f o r i n d i v i d u a l n a t i o n s depending on t h e i r p o l i t i c a l , economic and other p r e s s u r e s and  special  priorities.  Experience obtained i n one country does not n e c e s s a r i l y help the v a l u a t o r i n a s s i g n i n g values to c o s t and  benefit  103 items i n another  country. Some governments may be anxious  to a v o i d p l a c i n g an i s s u e i n the l a p s o f o p p o s i t i o n p a r t i e s by being seen t o concede too much t o f o r e i g n i n v e s t o r s o r by i n c u r r i n g a l o s s through p r o j e c t w i t h too high a business r i s k .  accepting a These and other  f a c t o r s can be brought t o the a t t e n t i o n o f the d e c i s i o n maker when a s s e s s i n g the v i a b i l i t y o f a p o t e n t i a l mine o u t s i d e Canada.  The method s t r i v e s t o value  externali-  t i e s not captured i n a s e t o f f i n a n c i a l statements but the importance attached t o p a r t i c u l a r items o f c o s t o r b e n e f i t can m a t e r i a l l y a l t e r the o v e r a l l net r e s u l t and the user o f a v a l u a t i o n has to a l l o w f o r t h i s  limitation.  The very a c t o f c a r e f u l l y c o n s i d e r i n g the e x t e r n a l i t i e s surrounding the p o t e n t i a l mine i s l i k e l y t o l e a d t o an improved understanding  o f the views o f host country i n -  v e s t o r s , both p u b l i c and p r i v a t e , by the Canadian i n v e s tor.  N e g o t i a t i o n s r e l a t i n g t o the p o t e n t i a l mine,  p a r t i c u l a r l y on the matter o f the a l l o c a t i o n o f the (28) value o f p r o d u c t i o n from the mine,  will  undoubtedly  be h e l d i n a b e t t e r environment when the p a r t i e s have an understanding  o f one another's t a r g e t s and the best (29  p o s s i b l e case made f o r the p r o j e c t can be put forward. E x t e r n a l i t i e s have been mentioned and they r e f e r t o c o s t s and b e n e f i t s not g e n e r a l l y c o n s i d e r e d i n the cash flows and o t h e r f i n a n c i a l records o f a b u s i n e s s . can be d e s c r i b e d as the s i d e e f f e c t s o r i n d i r e c t of making an investment  They effects  and t y p i c a l l y a r e o f d i r e c t con-  104 c e r n to persons other than the p r i v a t e s e c t o r i n v e s t o r s . There i s a wide range of items to examine when e v a l u a t i n g 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 t o the host n a t i o n  r e l a t e to employment, job t r a i n i n g , technology, s t r u c t u r e , f o r e i g n exchange, backward and  infra-  forward  link-  ages, r e g i o n a l development, the dynamic e f f e c t o f i n v e s t ment on f u t u r e investment,  savings and consumption h a b i t s ,  p o l l u t i o n and the supply o f e n t r e p r e n e u r s h i p and  capital.  The net b e n e f i t amount e s t a b l i s h e d by the v a l u a t o r of s o c i a l items i s the maximum p r i c e a host government i s l i k e l y t o pay  i n terms of a c c e p t i n g i n f e r i o r economic  r e t u r n s from a p r o j e c t and the extent a government w i l l make concessions Is dependent on i t s v a r i o u s non-economic p r i o r i t y objectives.  Frequently, a high p r i o r i t y t a r g e t  i s p o s i t i v e f o r e i g n currency flows to the -host n a t i o n and, although a complete c a l c u l a t i o n i n v o l v e s guesses of the e f f e c t s a t the more remote ends of the backward and  for-  ward l i n k a g e s to the p r o j e c t , the answer whether p o s i t i v e or negative i s probably r i g h t p r o v i d i n g reasonable gence i s a p p l i e d to the currency c a l c u l a t i o n  dili-  effort.  I t i s l a r g e l y a matter of f a i t h t o assign, a;, s o c i a l b e n e f i t value to the dynamic e f f e c t o f a c u r r e n t i n v e s t ment on f u t u r e investment.  T r a n s p o r t a t i o n and power  supply are e s s e n t i a l p r e c o n d i t i o n s f o r economic development of a r e g i o n .  These elements sometimes l e a d and a t  other times f o l l o w development.  In the case o f the  105 p o t e n t i a l Mexican mine t r a n s p o r t a t i o n  leads the  investment  but power a r r i v e s i n the area as a r e s u l t of the investment.  The  project  s u b j e c t i v e value depends on the degree  o f f a i t h t h a t the p r o j e c t w i l l be  followed  by  investment  elsewhere u s i n g p a r t of the newly c r e a t e d i n f r a s t r u c t u r e . The  s o c i a l c o s t / b e n e f i t method of c a l c u l a t i n g a value  of a p o t e n t i a l mine i n a f o r e i g n country i s simple i n concept but d i f f i c u l t i n a p p l i c a t i o n . which has  a p r a c t i c a l use  I t i s a method  to Canadian i n v e s t o r s i n f o r e i g n  ventures as i t p r o v i d e s a means of a s s e s s i n g  the  level  acceptance or welcome of both the p r o j e c t i t s e l f and  of  the  i n v e s t o r , f o r i t i s o f t e n the same method t h a t i s used host governments to judge them.  I f the Canadian  by  investor  promotes the advantages to the host n a t i o n which can  be  brought to the n a t i o n  the  through e x t e r n a l  p r o j e c t , then the chance of a c h i e v i n g success i s enhanced.  linkages with the  project's  D i f f i c u l t i e s a r i s e i n the  a p p l i c a t i o n o f the method owing to i n d i v i d u a l of the worth of e x t e r n a l i t i e s .  perceptions  However, once the  items r e l a t e d to the p r o j e c t are i d e n t i f i e d and it  i s a simple matter to sum  the values and  social  valued,  determine  the  net amount.  5.10  V a l u a t i o n method:  a preference  Four v a l u a t i o n methods to be used by a Canadian i n vestor  f o r a p o t e n t i a l mine are d i s c u s s e d  i n t h i s chapter:  methods based on cash flow, a p p r a i s a l o f a s s e t s ,  capitali-  106  z a t i o n of earnings and  s o c i a l c o s t s and  benefits.  a p p r a i s a l o f a s s e t s method i s not considered  an  The  acceptable  v a l u a t i o n method owing to the l a c k of c o n f i d e n c e assigned to the c o s t of e x p l o r a t i o n a s s e t and t h a t may  the method's d i s r e g a r d  the p o t e n t i a l mine  f o r f u t u r e net  accrue once the property  feasibility The  to r e p l a c e  benefits  i s taken beyond  the  stage.  s o c i a l c o s t / b e n e f i t method seeks to e s t a b l i s h a  value to a host government and  i s not based on  of the Canadian i n v e s t o r .  use  i s to be put may  The  have a b e a r i n g  objectives  to which the  valuation  i f , f o r example,  i n t e r e s t i n the p o t e n t i a l mine i s to be  sold.  the  In such  a case the p r o j e c t ' s value to t h i r d p a r t i e s i s important and  the value placed  on the a s s e t by government i s but  view of the p o t e n t i a l mine.  The  r e a l advantage of  one  the  s o c i a l c o s t / b e n e f i t method l i e s . i n i t s a b i l i t y to f i n d a range of v a l u e s which can  form the b a s i s o f requests to  government f o r economic concessions to the Canadian i n v e s t o r and and  i t s partners.  The  advantage can be s i g n i f i c a n t  f o r t h a t reason the net s o c i a l c o s t / b e n e f i t should  established. v i t y i n any  However, the  be  i n h e r e n t weakness of s u b j e c t i -  v a l u a t i o n method i s overwhelming i n a r r i v i n g  a t value amounts f o r s o c i a l items.  The  r e s u l t i s that  the s o c i a l c o s t / b e n e f i t , method, w h i l s t u s e f u l , i s not . a c c e p t a b l e to a Canadian i n v e s t o r f o r the purpose of f i x i n g a value upon a p o t e n t i a l mine. Except f o r the r i s k of l o s s p r o v i d i n g  political  107 ammunition t o the o p p o s i t i o n p a r t i e s , r i s k i s ignored i n the c a l c u l a t i o n o f s o c i a l c o s t s and b e n e f i t s but i s cons i d e r e d i n both the cash flow and earnings methods.  capitalization  The ad hoc approach t o 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 o f the m u l t i p l i e r number i s c o n s i d e r e d i n f e r i o r t o the combinat i o n o f the c h o i c e o f d i s c o u n t r a t e and r e c o g n i t i o n of r i s k over time t h a t i s t i e d t o the cash flow method o f valuation.  The cash flow and earnings  capitalization  methods use much the same i n f o r m a t i o n as the base f o r v a l u a t i o n but the l a t t e r method does not adequately account  f o r the time value o f money.  Three of the f o u r methods should be employed by the Canadian i n v e s t o r i n a v a l u a t i o n o f a p o t e n t i a l mine p r o p e r t y but the cash flow method i s p r e f e r r e d .  The  earnings c a p i t a l i z a t i o n method should be used to c o r r o borate the value e s t a b l i s h e d through d i s c o u n t i n g f o r e c a s t cash flows by a s c e r t a i n i n g the necessary and being s a t i s f i e d as t o i t s reasonableness.  multiplier The  s o c i a l c o s t / b e n e f i t method should be used t o e s t a b l i s h both the l e v e l o f host country acceptance  o f the p r o j e c t  and the p o s s i b l e amount o f economic concessions t h a t may be a v a i l a b l e t o the i n v e s t o r s :  again the r e s u l t  will  support the v a l u a t i o n a r r i v e d a t v i a the cash flow method.  108  CHAPTER FIVE REFERENCES 1.  H.D. D r e c h s l e r , J.B. Stevenson, "The e f f e c t o f i n f l a t i o n on the e v a l u a t i o n o f mines" C.T.M. B u l l e t i n , February 1977, pp 76-82  2.  R.F. M i k e s e l l , " F i n a n c i a l c o n s i d e r a t i o n s i n n e g o t i a t i n g mine development agreements" Mining Magazine, A p r i l 1974, page 259  3.  A. Drory, "Economic e v a l u a t i o n s f o r the d e c i s i o n maker" Cost and Management, July-August 1978, page 20  4.  D.B. H e r t z , "Risk a n a l y s i s i n c a p i t a l investment" Harvard Business Review, January-February 1964, pp 95-106  5.  H.K. T a y l o r , "Mine v a l u a t i o n and f e a s i b i l i t y s t u d i e s " M i n e r a l i n d u s t r y c o s t s , Northwest Mining A s s o c i a t i o n , Spokane, 1977, page 8  6.  B. Schwab, H.D. D r e c h s l e r , " E v a l u a t i o n o f new mining v e n t u r e s : average c o s t versus net p r e s e n t v a l u e " C.I.M. B u l l e t i n , January 1978, page 54  7.  D.W. Gentry, T . J . O ' N e i l , "A s h o r t course on f i n a n c i a l m o d e l l i n g and e v a l u a t i o n o f new mine p r o p e r t i e s " Colorado School o f Mines, A p r i l 1974, page 82  8.  H.D. D r e c h s l e r , "Mining f i n a n c e " M i n e r a l p r o c e s s i n g p l a n t d e s i g n , S o c i e t y o f Mining Engineers o f the AIMMPE Inc., New York 1978, page 23  9.  A. Drory, "Economic e v a l u a t i o n s f o r the d e c i s i o n maker" Cost and Management, July-August, page 25  10.  J.M. Valenzano, "Economic a n a l y s i s o f c a p i t a l investment projects" F i n a n c i a l E x e c u t i v e , September 1978, page 22  11.  D.W. Gentry, T.J. O ' N e i l , "A s h o r t course on f i n a n c i a l m o d e l l i n g and e v a l u a t i o n o f new mine p r o p e r t i e s " Colorado School o f Mines, A p r i l 1974, page 91  12.  IBID, page 97  13.  H.D. D r e c h s l e r , B. Schwab, "Economic e v a l u a t i o n o f mining ventures with c a p i t a l c o n s t r a i n t s : interrelationships between net present v a l u e , payback and r e g r e t due t o investment d e l a y " . Paper presented a t IXth World Mining Congress, D u s s e l d o r f , Germany, May 1976, page 3  109 H. D. D r e c h s l e r , "Mining f i n a n c e " M i n e r a l p r o c e s s i n g p l a n t d e s i g n , S o c i e t y o f Mining Engineers o f the AIMMPE.Inc., New York 1978, page 29 R.N. Anthony, "Accounting f o r the c o s t o f i n t e r e s t " Lexington Books, Mass. , U.S.A. , 1975, Pages 18, 6~9~ and 76 J.F. C h i l d s , "Undecided about a new p r o j e c t ? Choose I t s p r o f i t g o a l by your c o s t o f c a p i t a l " E n g i n e e r i n g and Mining J o u r n a l , December 1970, page 75 J.C. Van Home, C.R. Dipchand, J.R. Hanrahan, Fundamenta1s of F i n a n c i a l Management, P r e n t i c e H a l l o f Canada L i m i t e d , 2nd Canadian e d i t i o n , 1975, Chapter 10, pp 184-203 D. Ross-Watt, B. MacKenzie, " R e a l i s t i c e v a l u a t i o n o f r i s k s of mining p r o j e c t investment and managements' a b i l i t y t o c o n t r o l them" A.G.M. o f C.I.M., Vancouver, A p r i l 1978, page 1 D.B. H e r t z , "Risk a n a l y s i s i n c a p i t a l investment" Harvard Business Review, January-February 1964, page 98 L.T. Wells J n r . , " N e g o t i a t i n g w i t h t h i r d world governments" Harvard Business Review, January-February 1977, page 73 Supra, page 95 G.A. Brown, "The e v a l u a t i o n o f r i s k i n mining v e n t u r e s " Paper presented a t the A.G.M. o f C.I.M. Toronto, 21 A p r i l 1970, pp 1-5 C. Pegels, "A comparison o f d e c i s i o n c r i t e r i a f o r c a p i t a l Investment d e c i s i o n s " The E n g i n e e r i n g Economist, Volume 13, No. 4, 1968, page 212 D. W. Gentry, T . J . O ' N e i l , "A s h o r t course on f i n a n c i a l m o d e l l i n g and e v a l u a t i o n o f new mine p r o p e r t i e s " Colorado School o f Mines, A p r i l 1974, page 96 W.F. A t k i n s , " F a i r market v a l u e o f a mining p r o p e r t y " C. I.M. B u l l e t i n , . September 1977, page 115 J . J . Dran, H.N. McCarl, "An examination o f i n t e r e s t and t h e i r e f f e c t on v a l u a t i o n o f m i n e r a l d e p o s i t s " Mining E n g i n e e r i n g , June 1977, page 47  rates  D. W. Gentry, T . J . O ' N e i l , "A s h o r t course on f i n a n c i a l m o d e l l i n g and e v a l u a t i o n o f new mine p r o p e r t i e s " Colorado School o f Mines, A p r i l 1974, pp 87-88 W.F. A t k i n s , " F a i r market v a l u e o f a mining p r o p e r t y " 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 e t a l , c i p a t i o n i n marginal computer methods i n I n s t i t u t e of Mining pp 51-64  " P o s s i b l e modes o f government p a r t i mining o p e r a t i o n s " A p p l i c a t i o n of the m i n e r a l i n d u s t r y , South A f r i c a n and M e t a l l u r g y , Johannesburg, 1973,  29.  L.T. Wells, J n r . , " S o c i a l c o s t / b e n e f i t a n a l y s i s f o r MNC's" Harvard Business Review, M a r c h - A p r i l 1975, page 40  30.  D.N. Smith, L.T. W e l l s , J n r . , N e g o t i a t i n g t h i r d world m i n e r a l agreements, B a l l i n g e r P u b l i s h i n g , Mass., USA, 1975, page 98  Ill CHAPTER SIX PARTNERS AND THE POTENTIAL MINE IN MEXICO 6 .1  The p a r t n e r s A c o n d i t i o n o f doing business  i n Mexico's mining i n -  d u s t r y t o be met by a f o r e i g n i n v e s t o r i s t o operate i n a m i n o r i t y ownership p o s i t i o n .  I t i s an important  part  of the " M e x i c a n i z a t i o n " p o l i c y f o l l o w e d by s u c c e s s i v e Mexican f e d e r a l governments which r e q u i r e s non-Mexicans to own l e s s than f i f t y percent of the i s s u e d shares o f c o r p o r a t i o n s i n the mining b u s i n e s s .  In cases where  s p e c i a l l a n d , such as n a t i o n a l lands, a r e t o be i n c l u d e d i n areas o f mining a c t i v i t y , the percentage t h a t may be owned by f o r e i g n n a t i o n a l s o r f o r e i g n c o r p o r a t i o n s i s r e s t r i c t e d to a maximum o f t h i r t y - f o u r p e r c e n t . investment i n Mexico f a l l s w i t h i n the l a t t e r although  Placer's  category  f o r t y - n i n e percent was h e l d o r i g i n a l l y .  The  change from f o r t y - n i n e down t o t h i r t y - f o u r percent came about when i n t e r e s t i n g prospects were brought to P l a c e r ' s a t t e n t i o n and the company was persuaded t o reduce i t s i n t e r e s t by t r a n s f e r r i n g p a r t ownership to a Mexican government agency. The  requirement t o f i n d j o i n t v e n t u r e r s  meant P l a c e r needed a p a r t n e r i t c o n s i d e r e d  from Mexico compatible  and one with which i t c o u l d work f o r many y e a r s . t i a l l y a p a r t n e r has t o have the d e t e r m i n a t i o n  to invest  time and money i n e x p l o r a t i o n e f f o r t which i n most w i l l prove f r u i t l e s s .  Ini-  cases  In the event the e x p l o r a t i o n p r o -  112 gramme i s s u c c e s s f u l 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 owners h i p share of the c o s t .  Furthermore,  a p a r t n e r has to  possess business experience and the p e r s o n n e l to devote to the j o i n t venture as and when r e q u i r e d .  The  willing-  ness to e n t e r the j o i n t venture together w i t h the  finan-  c i a l and business c a p a b i l i t y to c a r r y the share of the j o i n t venture o b l i g a t i o n s i s important.  Long term  business ventures i n the e x p l o r a t i o n and mining business are u n l i k e l y to succeed i f the goals of the p a r t i e s not mesh.  Common goals have to be sought out and  do  esta-  b l i s h e d by the p o t e n t i a l j o i n t v e n t u r e r s to ensure obvious areas of c o n f l i c t o f i n t e r e s t do not e x i s t . Business methods of a c h i e v i n g the v e n t u r e r s ' o b j e c t i v e s a l s o have to be c o n s i d e r e d p a r t i c u l a r l y with regard to c o r r u p t p r a c t i c e c o n t r o l s implemented by the S e c u r i t i e s and Exchange Commission  (the S.E.C.) i n Washington.  P l a c e r ' s shares are quoted on the American Stock Exchange and as a r e s u l t the Canadian  company i s s u b j e c t to the  r e p o r t i n g requirements of the S.E.C. and i t s s u p p o r t i n g legislation.  In the e a r l y s e v e n t i e s , t a x law i n Mexico  i n c l u d e d the use of s p e c i a l n e g o t i a t e d agreements with government which s e t the tax and other o p e r a t i n g terms of business f o r a mine b e f o r e commitments to b u i l d a mine were made.  T h i s type of agreement and a l l o t h e r  d e a l i n g s w i t h government which the f o r e i g n i n v e s t o r i s concerned with,means t h a t the a t t r i b u t e s of the  ideal  113 j o i n t v e n t u r e r have to i n c l u d e the a b i l i t y to n e g o t i a t e w e l l with government.  These requirements  of a Mexican  j o i n t venture p a r t n e r are what Canadian f i r m s such  as  P l a c e r ought to look f o r i n the process of seeking a partner.^ The  f i r s t Mexican p a r t n e r t h a t P l a c e r became asso-  c i a t e d with was  a bank who  saw  i n P l a c e r a company  p e r i e n c e d and w e l l r e s p e c t e d i n the mining  ex-  business  on  an i n t e r n a t i o n a l s c a l e , keen.to f i n d and operate a mine i n Mexico and p o s s e s s i n g the necessary so.  resources to do  The p a r t n e r s h i p f l o u r i s h e d u n t i l the government  entered the j o i n t venture and r e l a t i o n s between ment and P l a c e r became d i f f i c u l t . the p a r t n e r s h i p and  The bank withdrew from  t r a n s f e r r e d i t s i n t e r e s t i n the ven-  t u r e to a Mexican mining the requirements  govern-  company.  The new  p a r t n e r meets  o f P l a c e r d i s c u s s e d 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 shareholder wealth maximization as the prime m o t i v a t i o n .  companies  and  w i t h the p u r s u i t of p r o f i t  J o i n t ventures n e a r l y always  i n v o l v e a s u b s t a n t i a l s h a r i n g of p r o j e c t c o n t r o l 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 companies i n the p a r t n e r s h i p as opposed to one  and mining  mining  company and a bank d e f i n i t e l y i n c r e a s e s the r i s k t h a t the a l l o c a t i o n of p r o j e c t management w i l l ship.  The  s t r a i n the p a r t n e r -  s i z e of the Mexican mining  company measured  i n terms of o p e r a t i n g mines, value of a s s e t s i n i t s b a l ance sheet and number of personnel employed i s c o m f o r t i n g  114 to P l a c e r .  Not  so small  of i t s r e s o u r c e s and danger to the  not  stability  as to be  stretched  so l a r g e as to be  to the  seen as a  of the p a r t n e r s h i p .  Management  a t t i t u d e s toward the r o l e o f p r i v a t e e n t e r p r i s e , need f o r p r o f i t s and harmony and  for exploration  the  appear to be  the business f i t of the two  limit  in  mining companies  seems good. 1979  has  witnessed an improvement i n r e l a t i o n s between  the two  p r i v a t e s e c t o r p a r t n e r s and  cracy.  A l l p a r t i e s changed t h e i r n e g o t i a t i o n  t i v e s and and  the Mexican bureaurepresenta-  progress i s evidenced by a r e s o l u t i o n to review  up-date the  1975  feasibility  study.  Mexican govern-  ment p u b l i c announcements on the r e s o l u t i o n added a s t a t e ment to the e f f e c t the mine w i l l be b u i l t future, despite  the  i n the  near  l a c k 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 d e c i s i o n . The  statement  t o the d i s p a r i t y between the o b j e c t i v e s  of government  the  two  mining companies. P r o f i t i s not  the primary  for  the  former. The  1975  feasibility  j e c t t e c h n i c a l l y f e a s i b l e and government. Government can  points and  factor  study found the  pro-  t h a t i s good enough f o r  therefore  t u r n to i t s o b j e c t i v e s  of employment c r e a t i o n 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 o u t s i d e  the major urbanized areas of the  country,  the promotion of f o r e i g n investment, the g e n e r a t i o n of revenues and  the c r e a t i o n of new  n a t i o n a l advantage.  The  two  f o r c e s w i t h a g i a n t they may  i n f r a s t r u c t u r e to  mining companies have  tax  the joined  have d i f f i c u l t y i n h a n d l i n g .  115 They w i l l be wary o f the p a r t n e r who has no f e a r o f bank(3) ruptcy and o f h i s c a p i t a l t h a t demands no d i v i d e n d s . Both mining companies w i l l be aware o f the c r e e p i n g n a t i o n a l i z a t i o n o f mining i n Mexico and know there a r e r i s k s t h a t government's t h i r t y - t h r e e percent  interest  c o u l d become much l a r g e r i f the bureaucracy d i s l i k e s some a c t i o n o r i n a c t i o n on the p a r t o f I t s p r i v a t e (4) enterprise partners.  The Mexican p u b l i c a l r e a d y owns  s u b s t a n t i a l p o r t i o n s o f i t s p r o d u c t i o n and s e r v i c e i n d u s t r i e s and, as Table  IX i n d i c a t e s , t o a c o n s i d e r a b l y  g r e a t e r extent than the e q u i v a l e n t i n Canada. TABLE IX P u b l i c l y Owned P r o d u c t i o n and S e r v i c e I n d u s t r i e s i n Mexico and Canada Mexico Canada Electricity 100% 100% Gas 100% O i l production 100% _ Coal 100% Shipbuilding 100% Posts 100% 100% Telecommunication s 100% 25% Railways 100% 75% —  —  —  Notes:  Steel  75%  -  Airlines  50%  75%  Automobiles  25%  (1)  P u b l i c l y owned means any government owned and/or c o n t r o l l e d business s e l l i n g goods and s e r v i c e s t o the p u b l i c on a l a r g e s c a l e .  (2)  Percentages a r e approximate and the l i s t o f indust r i e s i s n o t comprehensive.  Source: Adapted from a c h a r t i n The Economist 30 December 1978 and r e p r i n t e d i n Harvard Business Review, M a r c h - A p r i l 1979, page 161.  116 6.2  Ownership i n the p o t e n t i a l mine M i n e r a l r i g h t s c o v e r i n g the orebody and the s u r rounding area necessary  f o r mining  are h e l d by a company  i n c o r p o r a t e d i n Mexico which f o r purposes of t h i s paper i s c a l l e d Mexican Mining Company S.A.  de C.V.  four percent of Mexican Mining Company S.A. owned by P l a c e r .  S.A.  de C.V.  Thirty-  de C.V.  (Sociedad Anonima de  C a p i t a l V a r i a b l e ) i s a c o r p o r a t e v a r i a t i o n on the (Sociedad Anonima) company which most c l o s e l y the Canadian p u b l i c company.  The  S.A.  s i g n i f i c a n t d i f f e r e n c e s from S.A.: S.A.  de C.V.  de C.V.  resembles has  two  f o r i n c r e a s i n g or  secondly, t h a t the S.A.  cannot i s s u e bearer shares and may  S.A.  f i r s t l y , t h a t the  offers greater f l e x i b i l i t y  d e c r e a s i n g c a p i t a l and  is  de  C.V.  only i s s u e shares  r e g i s t e r e d i n the names of the owners.  There are no r e -  quirements t h a t labour be represented on the Board of Directors.  A m i n o r i t y shareholder with t w e n t y - f i v e per-  cent or more of the company has the r i g h t to appoint  one  d i r e c t o r and a t s h a r e h o l d e r s ' meetings to appoint examiners  (comisarios) to supplement examiners appointed  by  (5) the m a j o r i t y h o l d e r s . of  An examiner i s a r e p r e s e n t a t i v e  s h a r e h o l d e r s ; a p o s i t i o n h e l d by d i r e c t o r s i n Canada  but not by d i r e c t o r s i n Mexico. A mining  law passed  l a t e i n 1975  cuts the maximum  f o r e i g n e q u i t y allowed i n Mexican mining renewal of t w e n t y - f i v e year mining  companies upon  concessions  from  f o r t y - n i n e percent to f o r t y percent f o r r e g u l a r concess-  117 ions and from t h i r t y - f o u r percent t o t w e n t y - f i v e for " s p e c i a l concessions".  percent  At the same time a new "net  c a p i t a l " concept was i n t r o d u c e d under which the f o r e i g n e q u i t y o f m a j o r i t y Mexican-owned firms i s p r o r a t e d i n c a l c u l a t i n g the n e t f o r e i g n p a r t i c i p a t i o n i n a new ven(6) t u r e w i t h a p a r t l y o r wholly two  foreign-owned f i r m .  These  laws serve t o reduce the value o f P l a c e r ' s i n t e r e s t  i n Mexican Mining Company S.A. de C.V. as t h a t company's a c t i v i t i e s now bear a d d i t i o n a l r e s t r i c t i o n s on t h e i r freedom t o do business i n Mexico. 6.3  Partnership p o l i c i e s At the time the p a r t i e s come together i n j o i n t vent u r e , few p r o c e d u r a l problems e x i s t and the r e l a t i o n s h i p between them i s good.  I t i s the most opportune time t o  s e t out the a c c e p t a b l e r u l e s governing and i t s t e r m i n a t i o n .  their  relationship  C e r t a i n c o n d i t i o n s can be agreed  and i n c l u d e d i n the documents f o r m a l l y i n c o r p o r a t i n g the company through which the j o i n t venture  i s c a r r i e d out.  Such c o n d i t i o n s w i l l cover the i s s u e o f shares,  necessary  shareholder approvals, m i n o r i t y r i g h t s t o p r o - r a t a a c q u i s i t i o n o f new shares on the same terms as o f f e r e d to o t h e r s , d i v i d e n d 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 r e d u c t i o n s , r e s t r i c t i o n s on borrowing the very important  and l e n d i n g power and  v o t i n g r i g h t s a t shareholder meetings.  The agreed p o l i c i e s and r i g h t s s e t out i n the i n c o r p o r a t i o n papers are an e s s e n t i a l p a r t o f the e v a l u a t i o n p r o -  118 cess as they determine the l e v e l of p r o t e c t i o n a f f o r d e d the m i n o r i t y s h a r e h o l d i n g .  Inadequate safeguards  area c o n t r i b u t e unnecessary  r i s k s f o r a p r o s p e c t i v e pur-  chaser o f a m i n o r i t y i n t e r e s t i n the c o r p o r a t e  in this  joint  venture and the value of the m i n o r i t y shares i n the mine w i l l be reduced.  The c o r p o r a t e r u l e s governing  Mining Company S.A.  de C.V.  Mexican  c o n t a i n the r e q u i r e d c o n d i -  t i o n s and no problems are a n t i c i p a t e d . There are many o t h e r matters o f b u s i n e s s p o l i c y which i d e a l l y are agreed venture  i s struck.  upon i n w r i t i n g as soon as the  joint  Such an agreement o f t e n c a l l e d a  "shareholders' agreement" ought to cover p o l i c i e s conc e r n i n g accounting standards, d i v i d e n d (7) a v a i l a b i l i t y of f o r e i g n exchange, dules i n general  maximization,  loan repayment  ( f o r example 80% or 100%  sche-  of a v a i l a b l e  c a s h ) , management s h a r i n g , v o t i n g r i g h t s , i n f o r m a t i o n d i s s e m i n a t i o n , approval l e v e l s and m i n o r i t y i n t e r e s t r i g h t s concerning expenditure  and c a l l s f o r funds.  p o l i c i e s serve to r e s t r i c t the o b l i g a t i o n s t h a t may imposed on the m i n o r i t y h o l d e r s i n the j o i n t corporation. venture  These be  venture  Other p o l i c i e s j u s t as important  to the  seek to a v o i d one p a r t y w i t h h o l d i n g approval to  go ahead w i t h or operate e f f i c i e n t l y the very p r o j e c t which brought the v e n t u r e r s t o g e t h e r .  These i n c l u d e  minimum l e v e l s o f a c t i v i t y i n areas such as mine f e a s i bility  s t u d i e s , mine and m i l l design c a p a c i t i e s , e x p l o r a -  t i o n , o p e r a t i n g l e v e l s of p r o d u c t i o n , s a l e s and  inventory  119 and r u l e s governing matters  t o be a r b i t r a t e d .  Another area o f i n t e r e s t t o i n d i v i d u a l v e n t u r e r s i s the r i g h t t o s e l l t h e i r h o l d i n g s and the r i g h t t o approve new members o f the c o r p o r a t e j o i n t venture p r i o r to s a l e by one o f the s h a r e h o l d e r s .  Any new v e n t u r e r ought t o  be bound by the same terms i n the "shareholders' agreement" acceded  t o by the vending  s h a r e h o l d e r . The share-  h o l d e r s ' 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 v e n t u r e r s a l l come from Canada but the agreement i s c o n s i d e r e d adequate under Mexican b u s i n e s s circumstances.  6.4  Negotiations N e g o t i a t i o n s between the v e n t u r e r s are a v i t a l p a r t o f the process l e a d i n g t o the s u c c e s s f u l c o n c l u s i o n o f mine c o n s t r u c t i o n and o p e r a t i o n s . understanding  In any n e g o t i a t i o n s ,  the viewpoint o f the other p a r t y i s the  key to success and o b t a i n i n g 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 discussions.  An attempt  t a r g e t d u r i n g the  should be made t o determine the  o b j e c t i v e s o f each o f the o t h e r v e n t u r e r s and some government o b j e c t i v e s are mentioned i n Chapter  five.  Placer's  i n t e r e s t i n Mexico means d e a l i n g with another c u l t u r e and it  i s to be expected  business w i l l a r i s e .  t h a t d i f f e r e n c e s i n methods o f doing The a r t o f n e g o t i a t i n g i s one such  area o f d i f f e r e n c e which i n p a r t can be a t t r i b u t e d t o the  120 macho s o c i e t y i n Mexico r e f e r r e d t o i n Chapter  three.  A n e g o t i a t o r who understands the ways o f n e g o t i a t i n g by h i s opponent w i l l have l e s s chance o f misreading  signals  (8) of concession,  i n t r a n s i g e n c e or d e l a y .  T h i s i s a two  way matter as the Mexican n e g o t i a t o r s encounter the same c u l t u r e gap i n t h e i r d e a l i n g s with Canadians. t i a t i o n s surrounding  The nego-  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 o f the blame, the main o b s t a c l e s have been problems o f n e g o t i a t i o n . S e v e r a l rounds o f n e g o t i a t i o n s are t o be expected f o r a f o r e i g n investment p r o j e c t .  I n i t i a l l y t h e r e i s the  j o i n t venture t o s e t up and g e n e r a l l y no problems a r i s e . As t a r g e t mining p r o p e r t i e s are i d e n t i f i e d i t i s a wise group t h a t f o r m a l i z e s more d e t a i l e d p o l i c i e s on how to go about implementing the j o i n t venture and how t o a l l o c a t e the gross value o f p r o d u c t i o n  from a mine.  A l l parties (9)  s t r i v e f o r t r o u b l e - f r e e l o n g e v i t y o f agreements  and  to t h a t end i t i s e s s e n t i a l n e g o t i a t o r s a t the b a r g a i n i n g t a b l e do not attempt to impose a r i g i d on o t h e r s .  set of conditions  The next major stage i n n e g o t i a t i o n s  i s per-  haps when a f e a s i b i l i t y study i s planned and the p a r t i e s have t o agree on the t i m i n g and s h a r i n g o f work c o n t r i b u tions.  I t i s a t t h i s time t h a t any e x i s t i n g misunder-  standings  on what c o n s t i t u t e s p r o f i t g e n e r a l l y come t o  the s u r f a c e and t h i s i s p a r t i c u l a r l y so when governments d e a l with  foreign investors. ^  ^  Government n e g o t i a t o r s  121 are o f t e n lawyers o r economists with a l i m i t e d understanding  o f accountancy who experience d i f f i c u l t y with  concepts o f d e p r e c i a t i o n and p r o f i t s versus cash On the other hand, p r i v a t e s e c t o r n e g o t i a t o r s  flow.  usually  know l i t t l e o f governments c o s t / b e n e f i t a n a l y s i s ,  implicit  exchange r a t e s , shadow wage r a t e s and e x t e r n a l i t i e s . ^ ' ' ' ^ A l i k e l y cause f o r the three year delay on the p o t e n t i a l mine property  i n progress  h e l d 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 f u t u r e p r o d u c t i o n the other  between government and  two p r i v a t e s e c t o r p a r t n e r s ,  i n c l u d i n g repay-  ment o f a l l f i n a n c i a l o b l i g a t i o n s o f the j o i n t l y corporation.  held  A s i g n i f i c a n t measure o f agreement has now  been made and, as s t a t e d e a r l i e r , a new up-dating bility  feasi-  study i s i n p r o g r e s s .  Future n e g o t i a t i o n s may be a n t i c i p a t e d f o l l o w i n g recoupment o f a l l o u t l a y s  f o r the c o n s t r u c t i o n and opera-  t i o n of the mine and a reasonable r e t u r n on investment has been earned.  The t i m i n g o f f u t u r e  renegotiations  w i l l depend on the government's p e r c e p t i o n tutes and  "reasonable".  o f what c o n s t i -  Not o n l y does the i s s u e o f p r o f i t s  cash flow a r i s e but a l s o the thorny problems o f i n -  f l a t i o n and f l u c t u a t i n g exchange r a t e s and t h 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 f o r e i g n i n v e s t o r c a l c u l a t i o n s o f the f i n a n c i a l r e s u l t s o f the p r o j e c t , whether p r o f i t s ,  cash  flow o r r e t u r n on investment, i s very d i f f i c u l t owing to  122 divergent  viewpoints.  case i n the f u t u r e  The f o r e i g n i n v e s t o r can h e l p h i s  i f , a t the time a mechanism i s formu-  l a t e d whereby a d e c i s i o n to go-ahead with the p r o j e c t i s agreed upon by the j o i n t v e n t u r e r s ,  the f o r e i g n  sets a minimum r a t e o f r e t u r n on investment. feasibility  investor  When the  study i n d i c a t e s the minimum i s not expected  to be achieved the p r o j e c t i s shelved but i f r e s u l t s are f o r e c a s t t o improve on the minimum then one o f the c o n d i t i o n s needed f o r a p o s i t i v e d e c i s i o n t o b u i l d the mine i s met.  The method o f computing  the r a t e o f r e t u r n should  be s p e c i f i e d and, f o r reasons d i s c u s s e d the  "investment d e c i s i o n " a l l e q u i t y  to be used.  i n Chapter  financed  five,  case ought  A review o f the f o r e i g n i n v e s t o r ' s  rewards  from a mining p r o j e c t may come a t any time but a t e n year operating  period  i s o f t e n h a l f way through the t o t a l mine  l i f e and perhaps t h r e e o r four years a f t e r investment funds have been recouped. of a project's f o r e c a s t  An a r b i t r a r y t e n year c u t - o f f  f i n a n c i a l r e s u l t s i s useful to  a s c e r t a i n the exposure to economic h a r d s h i p i n the event the  foreign investor's  of t h a t  asset  i s l o s t t o him a t the end  time.  R e n e g o t i a t i o n s may be prompted by e x c e l l e n t r e s u l t s o r p o l i t i c a l events.  financial  Other causes may r e l a t e t o  r i s k s reduced over time by s u c c e s s f u l mining, h i g h e r than expected i n f r a s t r u c t u r e c o s t s borne by government t o s e r v i c e the mine, the need f o r i n c r e a s e d d e s i r e f o r reduced f o r e i g n ownership..  t a x revenue o r the The terms nego-  123 t i a t e d to a t t r a c t a f o r e i g n i n v e s t o r i n i t i a l l y  are  q u i t e d i f f e r e n t from those r e q u i r e d to r e t a i n him c a p i t a l i s l o c k e d - i n the disadvantage.  Any  usually and  as  foreign investor i s at a clear  v a l u a t i o n of a Canadian's investment  i n Mexico must a l l o w  f o r the p o s s i b i l i t y t h a t the  finan-  c i a l ground r u l e s w i l l d e t e r i o r a t e over time.  6.5  The  p o t e n t i a l mine i n Mexico The  orebody i s l o c a t e d i n the south-east of the  of Zacatecas i n Mexico, about one kilometres  from San  hundred and  L u i s P o t o s i and  State  f o r t y road  thirty-seven  kilo-  metres on secondary roads from the highway 4 9 main road to Zacatecas eighty-seven The  kilometres  orebody l i e s a t the 2 200  d e l i n e a t e d down to the serves  2 000  from the orebody.  metre e l e v a t i o n and metre l e v e l .  The  ore  is re-  as shown i n Table X are determined u s i n g c u t - o f f  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. metals are l e a d and  z i n c and  the mine product i s f o r e c a s t  to be i n separate c o n c e n t r a t e s : and  a zinc concentrate.  Other economic  a l e a d - s i l v e r concentrate  A c u t - o f f grade i s an  operating  c o n t r o l which i s a minimum grade s p e c i f i e d f o r the purpose of d e c l a r i n g the more general reserves. reserves  tonnes of ore i n g e o l o g i c a l  A c a l c u l a t e d c u t - o f f i s used f o r mineable  ore  based on assumed economic data f o r s a l e a b l e con-  c e n t r a t e values k e t i n g c o s t s and  net of smelter taxes.  The  costs, operating  operating  and mar-  control lies in  124 TABLE X Mexican Mining Company S.A. de C.V. Ore Reserves t o 2 000 Metres E l e v a t i o n Ore Geological ore reserves C u t o f f 25 g/t,Ag  Reserves OOOt  Silver(Ag) g/t  Lead(Pb) %  Zinc(Zn) %  54 000  77  1.05  0.96  51 000  78  1.06  0.97  Mineable ore reserves C u t o f f 25 g/t,Ag Note:  For i m p e r i a l measurement e q u i v a l e n t s  Source:  r e f e r t o Appendix 2  P l a c e r Development L i m i t e d  the f a c t t h a t the c u t - o f f grade i s used i n s e p a r a t i n g two choices  o f a c t i o n ; i n rock breaking  and i n the drawing  (12) and  d i s p o s a l o f broken m a t e r i a l .  grades are a l s o o p e r a t i n g  Inverse c u t - o f f  c o n t r o l s and they r e l a t e t o  maximum contents o f i m p u r i t i e s i n ores and  concentrates  which are o f p a r t i c u l a r importance economically smelters  demand p e n a l t i e s where c o n t r a c t maximum  t i e s a r e exceeded. optimize  Mineable ore r e s e r v e s  when impuri-  calculated to  the s i z e and c o s t o f the p l a n t t o provide a  predetermined r a t e o f r e t u r n on investment w i l l e s t a b l i s h a c u t - o f f grade which i s not n e c e s s a r i l y a c c e p t a b l e .  Op-  t i m a l output to o b t a i n the d e s i r e d r e t u r n on investment may w e l l exhaust the mineable ore r e s e r v e s with  undesirable  too q u i c k l y  s o c i a l e f f e c t s on the workforce.  On  the one hand, the aim i s to capture the economies o f s c a l e o f t e n present  i n mining but,  on the other,  relatively  high  p r o d u c t i o n may  not a l l be r e a d i l y s a l e a b l e a t a t t r a c t i v e  p r i c e s without the n e c e s s i t y f o r heavy i n v e n t o r i e s .  Pro-  d u c t i o n l e v e l s a t l e s s than o p t i m a l l e v e l s leads to the d e f e r r a l of cash flow otherwise a t t a i n a b l e but the present value of d e f e r r e d cash flow has to be weighed a g a i n s t the s o c i a l b e n e f i t s of o p e r a t i n g a mine with a f i f t e e n to (13) twenty year l i f e .  P l a c e r ' s aim i s to e s t a b l i s h  eco-  n o m i c a l l y v i a b l e mines f o r e c a s t to operate a minimum of (14) approximately twenty y e a r s .  The mining and  r a t e s s e l e c t e d by management and recorded i n the feasibility  study, unchanged f o r the purposes  paper, are as shown i n Table XI. year mine l i f e with an average  milling 1975  of t h i s  The r a t e s a l l o w a twenty  s t r i p r a t i o of 1.45:1.00  waste to ore which exhausts the mineable r e s e r v e s . TABLE XI Mexican Mining Company S.A. de Mining and M i l l i n g Rates Operating Years  Mining:  1- 5 6-14 15-20  Milling: 6 900 tonnes average d a i l y Source:  C.V.  M i l l i o n s of tonnes a n n u a l l y Mined Waste Ore 4.5 7.4 4.0  to to to  5.0 8.6 4.9  2.0 4.9 1.5  1-20  to to to  2.5 6.1 2.4  2.5 2.5 2.5  2.5  P l a c e r Development L i m i t e d  C l e a r l y , the p r i n c i p a l c o n s t r a i n t on p l a n t s i z e to o p t i mize the present value of f o r e c a s t cash flows from the p o t e n t i a l 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 o f (15) ore m i l l e d i s maximized.  To a r r i v e a t estimated ore  r e s e r v e s , the orebody i s t h e o r e t i c a l l y d i v i d e d i n t o q u i t e s m a l l b l o c k s and each b l o c k i s assigned i t s revenue v a l u e , p r o c e s s i n g and marketing taxes.  c o s t s , a minimum p r o f i t and  The minimum p r o f i t i s i n c l u d e d so t h a t those  b l o c k s i n c l u d e d i n mineable r e s e r v e s c o n t r i b u t e s u f f i c i e n t cash to meet the t a r g e t r e t u r n on investment ject.  f o r the pro-  In p r a c t i c e , d i f f i c u l t i e s a r i s e i n determining the  amount o f p r o f i t r e q u i r e d from a block t o be c l a s s i f i e d as ore and s e v e r a l c a l c u l a t i o n s o f ore r e s e r v e s may be necessary t o reach a f e a s i b l e s o l u t i o n w i t h a s a t i s f a c t o r y (16) r e t u r n on investment.  I t i s i n t e r e s t i n g t o note t h a t  the o r e r e s e r v e s and grades a c c o r d i n g t o Table X i n d i c a t e s t h a t o n l y 2% o f the orebody c o n t a i n s economic metals and t h e r e f o r e the c o s t o f t r a n s f o r m i n g the economic metals to a s a l e a b l e c o n d i t i o n i s l a r g e l y the c o s t o f h a n d l i n g the gangue thrown away. The average  s e l e c t e d m i l l s i z e i s f o r e c a s t t o achieve an throughput  o f 6 900 tonnes o f ore d a i l y assuming  shutdowns on e i g h t l e g a l h o l i d a y s a n n u a l l y . a twenty-four  Operating on  hour day b a s i s f o r n i n e t y - f i v e percent o f  the time, the m i l l c a p a c i t y needed has t o be r a t e d a t 7 250 tonnes per day.  Laboratory t e s t work by P l a c e r on  d r i l l cores and bulk samples from the Zacatecas  property  prove t h a t two c o n c e n t r a t e s w i l l be necessary to o p t i m i z e the p r o j e c t cash flow and the f o r e c a s t output i s shown i n  127 Table X I I .  A p r o j e c t may  be t e c h n i c a l l y f e a s i b l e of  becoming an o p e r a t i n g mine but, as mentioned above, one of the v a r i a b l e s h i g h l y c o r r e l a t e d to mineable r e s e r v e s i s the metal p r i c e .  Metal p r i c e s have g r e a t s i g n i f i c a n c e  both a t the beginning of the mining process and a t the more obvious end of the process when s a l e s are r e a l i z e d . As p r i c e s r i s e and or  fall,  so mineable r e s e r v e s are c r e a t e d  lost. TABLE XII  Mexican Mining Company S.A. de C.V. Concentrate Output Concentrate Operating '000 tonnes Year Total Lead-Silver 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20  Note:  60.5 70.0 78.3 78.6 66.7 73.4 74.2 72.1 75.1 66.6 65.5 64.4 69.3 72.3 73.5 75.7 75.3 70.7 79.8 107.2  31.6 35.4 40.5 38.1 31.9 36.6 38.0 37.6 38.6 33.2 31.7 31.7 34.7 36.5 36.9 39.1 39.5 38.0 42.1 59.0  1469.2  750.7  Zinc 28.9 34 .6 37.8 40.5 34.8 36.8 36.2 34.5 36.5 33.4 33.8 32.7 34.6 35.8 36.6 36.6 35.8 32.7 37.7 48.2 718.5  Metal contained i n ore i s f o r e c a s t to be recovered as f o l l o w s although i n i t i a l years r e c o v e r i e s are l e s s : Lead to l e a d - s i l v e r c o n c e n t r a t e 90% S i l v e r t o l e a d - s i l v e r concentrate 85% Zinc t o z i n c concentrate 80%  Source:  P l a c e r Development L i m i t e d  128 TABLE XIII Mexican Mining Company S.A. de C.V. Metal P r o d u c t i o n i n Concentrates S i l v e r ( A g ) i n Concentrates tonnes .: Lead(Pb) i n Operating Lead Concentrates Year Total Silver Zinc '000 tonnes 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20  Note:  Source:  6.6  147 175 201 209 164 169 161 176 186 184 147 146 154 139 161 195 157 139 132 179  131 163 192 202 157 164 156 171 181 179 143 142 150 134 156 190 152 135 127 173  16 12 9 7 7 5 5 5 5 5 4 4 4 5 5 5 5 4 5 6  3321  3198  .123  Zinc(Zn) i n Concentrates *000 tonnes  19.4 21.6 24.5 23.1 19.4 22.0 23.0 22.8 23.3 20.0 19.2 19.2 21.0 22.0 22.3 23.7 23.9 23.0 25.4 35.6  17.0 19.6 21.1 22.3 19.1 20.2 19.9 19.0 20.2 18.4 18.6 18.0 19.0 19.7 20.1 20.2 19.8 18.1 20.9 26.8  454.4  398.0  The l e a d - s i l v e r concentrate c o n t a i n s more than 99% of the l e a d and 96% of the s i l v e r p r o d u c t i o n but l e s s than 7% of the z i n c p r o d u c t i o n . The balance of the metals i s i n the z i n c c o n c e n t r a t e . P l a c e r Development L i m i t e d  Metal revenue f o r e c a s t s The p o t e n t i a l mine has three payable metals two  concentrates:  s i l v e r , l e a d and  zinc.  amount of l e a d i n the z i n c concentrate however, not expected  The  i n the small  ( l e s s than 1%) i s ,  to be p a i d f o r by the customer.  Many o r g a n i z a t i o n s devote much time  and e f f o r t to the  129 matter of f u t u r e p r i c e trends f o r metals marketing  experts who  p r o v i d e t h e i r f o r e c a s t s f o r the  short-term and long-term f o r e c a s t s may  and P l a c e r has  trends In p r i c e s .  The  price  be used f o r d i f f e r e n t purposes and so  may  be s t a t e d with v a r y i n g l e v e l s of confidence t h a t they w i l l be e q u a l l e d or b e t t e r e d a t the r e l e v a n t 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 a t , say, f i f t y  as more d r i l l i n g may  percent,  be r e q u i r e d to d e l i n e a t e the orebody  and the p o s s i b i l i t y of e s t a b l i s h i n g g r e a t e r mineable r e serves i s s t r o n g .  The  and c a r e f u l l y prepared  feasibility  study i s a d e t a i l e d  document which r e q u i r e s g r e a t e r  c e r t a i n t y of i n p u t data than i t s predecessor; economic study.  the  Perhaps seventy or n i n e t y percent  levels  of c e r t a i n t y of p r i c e s are r e q u i r e d by management.  It is  recommended t h a t metal p r i c e f o r e c a s t s used i n economic and  feasibility  s t u d i e s be kept simple; f i r s t l y ,  minor f l u c t u a t i o n s are d i f f i c u l t to j u s t i f y and, because n e g o t i a t i o n s w i t h venture p a r t n e r s and  because secondly,  government  agencies have l e s s cause to become bogged down i n d e t a i l e d (18) price discussions. seventy-nine  Mexico has p r i c e c o n t r o l s on  consumer goods or i n d u s t r i a l m a t e r i a l s (as  of 1 March, 1978) g e n e r a l heading  which i n c l u d e s "minerals" under the f o r items c o n t r o l l e d termed " b a s i c (19)  i n d u s t r i a l products." p r i c e s f o r the metals  Although  s i l v e r , l e a d and  zinc  i n concentrate form are not s u b j e c t  to c o n t r o l s , the r i s k i s r e a l owing to the e x i s t e n c e of  130 the law which covers m i n e r a l s . The payable metals  from the Zacatecas mine are ex-  pected t o be s o l d a t p r i c e s based on the d a i l y q u o t a t i o n s f o r the i n d i v i d u a l metals on the London Metal Exchange (the LME) over the q u o t a t i o n a l p e r i o d s s p e c i f i e d i n the s a l e s c o n t r a c t s from time t o time. the payable metals determined  The s e l l i n g p r i c e s f o r  r e c e i v a b l e by c o n c e n t r a t e producers are  i n two p a r t s .  the f i r s t and the second  The LME p r i c e f o r the metal i s i s the deduction from the LME  p r i c e by the customer f o r s m e l t i n g and r e f i n i n g the concentrate.  The supply and demand c y c l e s f o r the s i l v e r  metal and the s i l v e r i n concentrate do not n e c e s s a r i l y run p a r a l l e l and the same can be s a i d f o r l e a d and z i n c . Any  f o r e c a s t s o f mine revenue from p r o d u c t i o n o f concen-  t r a t e ought t o take both f a c t o r s i n t o c o n s i d e r a t i o n . Long-term c o n t r a c t s w i t h smelter customers have become much l e s s common and those t h a t remain c o n t a i n c l a u s e s c a l l i n g f o r e a r l y t e r m i n a t i o n o r r e n e g o t i a t i o n under c e r t a i n c o n d i t i o n s , such as h a r d s h i p .  The smelters  o p e r a t i n g c o s t i n c r e a s e s due t o i n f l a t i o n are being passed  along t o the miner i n keeping with the t r a d i t i o n a l  concept o f the smelter as a s e r v i c e p r o v i d e r , and the (21) miner as the r i s k t a k e r .  P a r t i c i p a t i o n i n the p r i c e  of the metal has been a f e a t u r e o f the c o n c e n t r a t e market f o r z i n c but as the r e l a t i v e s t r e n g t h o f the zinc i n c r e a s e d over the miners i n the second  smelters  h a l f o f the 1970's,  so the r i s k i s being removed from the smelter and r e t u r n e d  131 to the miner through  f i x e d charges.  A f i x e d charge  favours the miner i n a s t r o n g market and the smelter i n a weak market. The metal p r i c e and  smelter c o s t f o r e c a s t s i n the  i n i t i a l years of mine p r o d u c t i o n d u r i n g the  investment  payback p e r i o d are e s p e c i a l l y important owing to the e f f e c t on present values o f cash flows i n the e a r l y years.  The  can handle  supply and demand f o r smelter c a p a c i t y which the concentrate expected  the mine has to be reviewed saleable.  to be produced from  to ensure the product i s  The a n t i c i p a t e d c h a r a c t e r i s t i c s of the  concentrate to be produced by the p r o j e c t may  zinc  prevent  Mexican smelters buying i t as twelve percent i r o n a l s o i n the concentrate cannot a t t h i s time be handled However, o t h e r smelters i n the USA,  Japan, Canada and  Europe have the t e c h n i c a l c a p a b i l i t y so the is saleable.  concentrate  Both c o n c e n t r a t e s are expected  i n terms of United States c u r r e n c y . expressed  i n s t e r l i n g and  by them.  The LME  to be  sold  p r i c e s are  sales contracts provide for  t r a n s l a t i o n o f the s t e r l i n g to d o l l a r s .  Smelter  charges  are o f t e n c o n t r a c t e d f o r i n United States currency  by  mines i n Mexico and North America thereby r e d u c i n g the miner's r i s k of exchange l o s s .  However, the d e c l i n e i n  the v a l u e of the American currency i n terms of European and Japanese c u r r e n c i e s i s l e a d i n g to p r e s s u r e by f o r miners to accept g r e a t e r r i s k of currency The p r i c e c y c l e common to most metals  smelters  fluctuation.  encourages the  completion  o f new mines on the upswing o f the p r i c e c y c l e  and p r i c e f o r e c a s t s p l a y an important of  a go-ahead d e c i s i o n t o b u i l d .  r o l e on the t i m i n g  The hazards  o f metal  p r i c e swings a r e emphasized when the planned mining sequence r e q u i r e s the h i g h grading o f the orebody t o maximize cash flows i n the e a r l y y e a r s .  I f high grading  c o i n c i d e s w i t h the trough i n the p r i c e c y c l e , the economic v i a b i l i t y o f the p r o j e c t can be endangered. grading can a r i s e through  High  the nature o f the orebody  where a "plum" i n the orebody i s mined f i r s t ,  itself  or by i n -  c r e a s i n g the amount o f p r o f i t i n c e r t a i n b l o c k s o f the orebody and c o n s i g n i n g some otherwise  good o r e t o waste.  P a r t o f the concentrate revenue f o r e c a s t s f o r metal p r i c e and smelter charges r e c e i p t o f funds sale.  i s concerned  with the t i m i n g o f  from the customer and the other terms o f  Again i t i s the i n i t i a l o p e r a t i n g years which are  important when l o a n i n t e r e s t i s a major c o s t o f the b u s i ness.  Perhaps the term o f g r e a t e s t s i g n i f i c a n c e i s the  p e n a l t y f o r i m p u r i t i e s contained i n the concentrate which the s m e l t i n g and r e f i n i n g processes have t o remove.  The  a d d i t i o n t o smelter c o s t s has t o be weighed a g a i n s t the c o s t o f meeting the p e n a l t y metal(s) maximum grade i n dec i d i n g on the mining milling  sequence and the design o f the  process.  F o r e c a s t product p r i c e s and forms o f s a l e s f o r Mexican Mining Company S.A. de C.V. are g i v e n i n Table XIV.  The  p r i c e o f s i l v e r i s a f f e c t e d by the d u a l r o l e the metal  133 plays:  t h a t of an i n d u s t r i a l commodity and a monetary  s t o r e of v a l u e .  At times the p r i c e may  r e f l e c t condi-  t i o n s of the i n d u s t r i a l market and a t others the s p e c u l a t o r s view of world p o l i t i c a l and economic c o n d i t i o n s . TABLE XIV Mexican Mining Company S.A. de C.V. F o r e c a s t Product P r i c e s and Terms of Sale (Expressed  i n 1979  constant United S t a t e s d o l l a r s )  Average P r i c e : L i f e of Mine L e a d / S i l v e r Concentrate: S i l v e r ( A g ) US $193/kg  Lead(Pb)  US  $750/t  Zinc c o n c e n t r a t e : Zinc(Zn) US $882/t S i l v e r ( A g ) US Notes:  Source:  $193/t  Payable metal and smelter deductions 1 grade % deduction 95% of Ag R e f i n i n g $0.04/kg Ag  payable  90% of Pb R e f i n i n g $54/t Pb payable Treatment $35/t concentrate 85% of Zn Treatment 37% of payable 60% of Ag above 155  Zn  g/t  1) The above p r i c e s are used i n the base cases. 2) Average p r i c e s are s t a t e d to be 70% of being e q u a l l e d or surpassed. 3) For i m p e r i a l measurement e q u i v a l e n t s r e f e r to Appendix 2. P l a c e r Development L i m i t e d  Demand f o r s i l v e r f a l l s i n t o three broad i n d u s t r i a l demand, d e c o r a t i v e and vestment or s p e c u l a t i v e demand.  c a t e g o r i e s of  jewelry demand and i n O v e r a l l , s i l v e r consump-  t i o n i s c l o s e l y r e l a t e d to i n d u s t r i a l p r o d u c t i o n economic growth i n developed  countries.  The  of world c u r r e n c i e s i n the s i x t i e s accounted  and  debasement for a  134 dramatic d e c l i n e i n consumption i n t h a t decade but s i n c e 1970,  consumption of s i l v e r f o r c o i n s has remained  low  (22) but r e l a t i v e l y c o n s t a n t . economies i s now  The h e a l t h of the world  a more s i g n i f i c a n t f a c t o r on  silver  p r i c e s than a t any time t h i s century and the OPEC induced world economic c r i s i s p r e s e n t l y being played out i s b r i n g i n g s p e c u l a t i v e demand to bear on s i l v e r p r i c e s a t t h i s time  (August  1979)  as the United S t a t e s d o l l a r goes  through a c r i s i s o f c o n f i d e n c e .  On the other s i d e of the  balance, supply from mines has been o u t s t r i p p e d by  total  (23) demand  and o n l y above ground supply has  been a b l e to b r i n g i n the remainder  m  r e c e n t years  to meet the consump-  (24) tion.  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 of above ground s i l v e r running a t s i x hundred to hundred tonnes a n n u a l l y , or approximately  dramatic r i s e i n the p r i c e of  twelve  f i v e percent  of consumption, has added another dimension 1979  source  to the mid (25)  silver.  S i l v e r p r i c e s were i n the range US  $45/kg to US  $100/  kg f o r years p r i o r to the meteoric r i s e i n l a t e 1973 the time of the f i r s t OPEC o i l c r i s i s . stayed i n the range US 1979  $125/kg to US  and the p r i c e i s now  (August  1979).  The p r i c e  then  $200/kg u n t i l  t r a d i n g i n the US  at  mid  $300/kg area  P l a c e r Development L i m i t e d p r e d i c t e d a  long-term average  p r i c e f o r s i l v e r expressed  constant United S t a t e s d o l l a r s of US  $193/kg  i n mid  1979  ($6.00/troy  ounce) w i t h a 70% l e v e l of confidence t h a t t h a t p r i c e  w i l l be e q u a l l e d or surpassed. US  In a mining  $193/kg w i l l be low f o r f o u r t e e n years out of the  twenty year mine l i f e remaining s i x .  In Zacatecas but too h i g h f o r the  The r i s k l i e s i n the f a c t t h a t the  ment p e r i o d f o r the recoupment of investment 6.7  context,  repay-  funds i s  years f o r P l a c e r i n the base f i n a n c i n g d e c i s i o n  (Table  case  XX).  S i l v e r p r o d u c t i o n i n Mexico w i l l be boosted  signifi-  c a n t l y i n the event, the Zacatecas, p r o p e r t y i s developed and i t w i l l ensure Mexico remains one o f the l a r g e s t s u p p l i e r s o f the metal. Mexico was  i n c r e a s e d by new  world's  Production of s i l v e r i n  or expanded mines i n the mid  (26) seventies  but s t i l l  smelter c a p a c i t y i s s u f f i c i e n t  w i t h i n the country t o handle any a n t i c i p a t e d new The  supply.  Zacatecas p r o p e r t y w i l l r e p r e s e n t about t e n p e r c e n t  o f the t o t a l n a t i o n a l s i l v e r p r o d u c t i o n .  Similarly,  lead  and z i n c p r o d u c t i o n from the p r o p e r t y w i l l each r e p r e s e n t about t e n p e r c e n t of the t o t a l Mexican p r o d u c t i o n of those metals. Lead supply and demand i s f o r e c a s t to be i n near balance i n the 1980's w i t h a reduced growth r a t e i n demand (27) i n the two percent annual range.  Small d i f f e r e n c e s  can have a very s i g n i f i c a n t impact on p r i c e , however the long-term d e l i c a t e supply/demand balance i s a n t i c i p a t e d to keep average  l e a d p r i c e s somewhat lower than 19 79 p r e -  v a i l i n g p r i c e s as c u r r e n t l y there i s a supply  shortage.  P l a c e r Development L i m i t e d f o r e c a s t i n e a r l y 1979  long-  136 term l e a d p r i c e s to average US of  $750/tonne d u r i n g the  life  the Zacatecas mine w i t h a 70% l e v e l of confidence t h a t  the p r i c e w i l l be e q u a l l e d or  surpassed.  The d i f f e r e n c e between z i n c 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  w i t h annual world demand of approximately tonnes.  four m i l l i o n  Again, p r i c e movements can be s i g n i f i c a n t d u r i n g (28)  short-term i n b a l a h c e s . ment f o r e c a s t long-term  In e a r l y 1979,  P l a c e r Develop-  z i n c p r i c e s to average US  $882/  tonne over the twenty year p r o j e c t l i f e w i t h a 70% of  level  confidence. Smelter  deductions a l t e r f r e q u e n t l y i n tune w i t h  v o l a t i l e concentrate markets f o r each metal.  Character-  i s t i c s of i n d i v i d u a l c o n c e n t r a t e s have t h e i r e f f e c t smelter  the product.  The  lead/silver  concentrate i s a s t r a i g h t - f o r w a r d marketing the smelter deduction to account concentrate to r e f i n e d metals f o r e c a s t long-term  grade percentage  payable  silver.  problem  i s regarded  as normal.  by the smelter  of the s i l v e r i n c o n c e n t r a t e ,  The  s i l v e r and  and  f o r the p r o c e s s i n g of  average deductions  percent of the payable of  on  terms a l s o and sometimes r e s t r i c t the number o f  smelters able to handle  one  the  The are  five  four cents per k i l o g r a m  l e a d smelter c o s t to the mine i s  f o r e c a s t to be ten percent of the l e a d c o n t a i n e d , $54 tonne of l e a d payable and concentrate.  The  $35 per tonne of  lead/silver  z i n c c o n c e n t r a t e i s expected  high i r o n i m p u r i t y and consequently  per  to have a  low net r e t u r n s are  137 forecast.  Although the z i n c concentrate  recoverable  include  s i l v e r and cadmium, the net smelter  from those two metals w i l l be s m a l l . will  will  s u f f e r a f i f t e e n percent  The z i n c  return itself  o f metal, o r minimum  eight  grade percentage p o i n t s , deduction and then a t h i r t y seven percent life.  r e f i n i n g charge on average over the mine  However, d u r i n g  smelter  the o p e r a t i n g  p e r i o d the b a s i s o f  and/or r e f i n i n g charges may a l t e r .  An example  mentioned i s the tendency f o r z i n c r e f i n i n g charges to switch  6.7  from f i x e d charges t o a p r i c e s h a r i n g  formula.  Mine c o s t s A company i s never sure o f i t s mineable ore r e s e r v e s u n t i l expensive mining o p e r a t i o n s The  give i t access to them.  c o s t o f mining i s i n c u r r e d i n two stages:  c o n s t r u c t i o n and t h a t o f o p e r a t i o n s .  that of  Table XV shows t h a t ,  i g n o r i n g the time value o f money, the major p o r t i o n o f c o s t s w i l l be i n c u r r e d d u r i n g Zacatecas mining prospect. attached  the o p e r a t i o n s  stage o f the  There i s c o n s i d e r a b l e  risk  t o the mine's c o n s t r u c t i o n and i t i s t h a t phase  of the p r o j e c t which gets the l i o n ' s share o f a t t e n t i o n . The  p l a n t must be capable o f producing a s a l e a b l e product  e f f i c i e n t l y and meet a l l the r e g u l a t o r y a t the same time.  J u s t ten percent  c o n t r o l standards  o f the t o t a l  costs  f o r e c a s t to be i n c u r r e d on the p r o j e c t are committed to operation's why h e a l t h y  commencement  prior  which i l l u s t r a t e s the reason  growth and c o n f i d e n t p l a n n i n g  (or s t a b l e r u l e s  138 of business)  a r e v i t a l t o the mining  i n d u s t r y which i n -  v e s t s many m i l l i o n s o f d o l l a r s over a long p e r i o d o f time before r e c o r d i n g a s i n g l e cent o f r e t u r n on t h a t i n v e s t (29) ment.  The Zacatecas mine r e q u i r e s a c o n s t r u c t i o n  p e r i o d o f t h i r t y months which, when added t o the base loan case payback p e r i o d o f 6.7 o p e r a t i n g y e a r s , means recoupment o f the f i r s t d o l l a r i n v e s t e d on a l a s t out b a s i s w i l l take 9.2 y e a r s .  Even 9.2 years excludes the  sunk c o s t s o f e x p l o r a t i o n and other resources devoted to l o c a t i n g a v i a b l e orebody i n Mexico. TABLE XV Mexican Mining Company S.A. de C.V. Mine Costs (Expressed i n 1979 constant United S t a t e s d o l l a r s ) C a p i t a l expenditures Preproduction - a c q u i s i t i o n s - finance costs Table XVI Postproduction - a c q u i s i t i o n s Table XVII  Operations expenditures Operating c o s t s Table XVIII Finance c o s t s 13% p.a. Table XXI Taxes Table XXIII  T o t a l mine c o s t s Note:  $75 105 4 975 80 080  000 000 000  67% 4% 71%  10%  33 010  000  29%  4%  113  090  000  100%  389  010  000  57%  21 650 278 158  000 000  3% 40%  688  000  100%  $801  818  908 000  The above c o s t s are used i n the loan base case 14) Source: P l a c e r Development L i m i t e d  86% 100% (Appendix  139  $75  The  c a p i t a l c o s t of mine c o n s t r u c t i o n i s f o r e c a s t as  105  000  1979  preproduction $4 975  000  United  d o l l a r s plus  c o s t of f i n a n c i n g the p r o j e c t of  a t 13%  Interest.  given i n Table XVI. are estimated  States constant  The  the  US  A summary breakdown i s  c o s t s expressed i n 1979  on the b a s i s of 1975  values  c a p i t a l cost  calcula-  t i o n s u p l i f t e d f o r Mexican i n f l a t i o n a t v a r y i n g r a t e s f o r labour, m a t e r i a l , equipment and other f o r the new  exchange r a t e s .  items and  Import d u t i e s otherwise pay-  able are f o r e c a s t to be reduced to twenty-five t h e i r normal l e v e l ^ r e s u l t i n g $1 700  000  expenditure  adjusting  percent  i n a "saving" of  i n construction costs.  Postproduction  i s f o r e c a s t to be i n c u r r e d throughout  of  US capital the  mine l i f e but with, l a r g e r amounts a r i s i n g i n o p e r a t i n g years  s i x , eleven and  Table  XVII.  twelve.  TABLE  A summary i s given i n  XVI  Mexican Mining Company S.A. de C.V. C a p i t a l C o n s t r u c t i o n Expenditures (Expressed i n 1979 constant United States d o l l a r s ) Open p i t p r e p a r a t i o n and equipment E l e c t r i c a l equipment and i n s t a l l a t i o n Concentrator and t a i l i n g s Townsite Contractors Design, e n g i n e e r i n g and r e s e a r c h Overhead, Vancouver and Mexico Start-up operations  $ 7 500 000 10 000 000 32 000 000 4 000 000 6 000 000 6 000 000 8 000 000 1 605 000 $75 105 000 Finance c o s t s to end of c o n s t r u c t i o n - 13% 4 975 000 T o t a l c o n s t r u c t i o n c o s t - Table XV $80 080 000 C o n s t r u c t i o n c o s t per tonne m i l l i n g annual c a p a c i t y $32.50 Note: The above c o s t s are used i n the base cases Source: P l a c e r Development L i m i t e d - amended by the author f o r i n f l a t i o n and exchange r a t e s .  140 TABLE XVII Mexican Mining Company S.A. de C.V. P o s t p r o d u c t i o n C a p i t a l Expenditures (Expressed i n 197 9 constant United S t a t e s d o l l a r s ) Operating Year 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20  Expenditure $845 750 650 1 110 1 955 3 680 2 235 1 110 1 250 2 235 4 010 2 820 2 165 935 1 825 2 100 1 680 1 330 195 130 $33  010  000 000 000 000 000 000 000 000 000 000 000 000 000 000 000 000 000 000 000 000 000  Note: The above c o s t s are used i n the base cases. Source: P l a c e r Development L i m i t e d - amended by the author f o r i n f l a t i o n and exchange r a t e s . An understanding w i t h government has to be reached on the p r o v i s i o n of i n f r a s t r u c t u r e necessary.to b u i l d and ate  a mine.  The  oper-  Zacatecas p r o p e r t y a t p r e s e n t l a c k s the  power, f a c i l i t i e s and townsite r e q u i r e d and government agencies w i l l be asked to schedule t h e i r c o n s t r u c t i o n i n harmony with the c r i t i c a l path s e t f o r the o v e r a l l proj e c t c o n s t r u c t i o n . N e g o t i a t i o n s w i l l take p l a c e conc e r n i n g the share of i n f r a s t r u c t u r e c o s t s to be assumed by the g e n e r a l taxpayers as w e l l as the t i m i n g of payment by the mine f o r the p o r t i o n to be borne by i t .  141 Operating c o s t s 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 c o s t s , water, townsite, road maintenance and a d m i n i s t r a t i o n . In a d d i t i o n , the concentrates t r a n s p o r t a t i o n c o s t s t o smelt e r s are i n c l u d e d here and they r e p r e s e n t e l e v e n percent o f the t o t a l .  Operating c o s t s e x c l u d i n g  t r a n s p o r t a t i o n o f c o n c e n t r a t e s average of ore m i l l e d throughout c o s t s average  approximately  US $7.27 per tonne  the mine l i f e and t r a n s p o r t a t i o n  US $20 and US $43 per tonne o f l e a d / s i l v e r  and z i n c concentrate  respectively. TABLE XVIII  Mexican Mining Company S.A. de C.V. Operating Costs (Expressed i n 1979 constant United S t a t e s d o l l a r s ) Operating Year 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20  Transportation $1 769 000 2 072 000 2 300 000 2 364 000 2 012 000 2 182 000 2 185 000 2 111 000 2 207 000 1 984 000 1 972 000 1 925 000 2 059 000 2 141 000 2 180 000 2 223 000 2 198 000 2 044 000 2 325 000 3 072 000 $43 325 000  Operating Costs $16 250 000 16 250 000 16 250 000 16 250 000 16 250 000 18 012 000 18 873 000 18 873 000 18 873 000 18 873 000 18 873 000 18 873 000 18 012 000 18 012 000 16 250 000 15 831 000 15 645 000 15 645 000 15 645 000 18 145 000 $345 685 000  Per tonne o f ore m i l l e d Per tonne - Pb/Ag c o n c e n t r a t e $2 0 - Zn c o n c e n t r a t e $43 Source:  Total $18 019 18 322 18 550 18 614 18 262 20 194 21 058 20 984 21 080 20 857 20 845 20 798 20 071 20 153 18 430 18 054 17 843 17 689 17 970 21 217  000 000 000 000 000 000 000 000 000 000 000 000 000 000 000 000 000 000 000 000  $389 010 000  $7.27  P l a c e r Development L i m i t e d - amended by the author f o r i n f l a t i o n and exchange r a t e s .  142 P o s t p r o d u c t i o n f i n a n c e c o s t s are c a l c u l a t e d on the o u t s t a n d i n g l o a n balance a t the beginning o f the o p e r a t i n g p e r i o d a t t h i r t e e n percent assuming p r i n c i p a l repayments are made a t each year end o u t o f the e n t i r e a v a i l a b l e flow.  The c o s t s o f f i n a n c e other than i n t e r e s t i t s e l f i s  i n c o r p o r a t e d i n an o v e r a l l r a t e o f t h i r t e e n  6.8  cash  Feasibility  percent.  study  C o n s i d e r a b l e e f f o r t and resources a r e needed t o comp 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 e x e r c i s e i s worthwhile by p r e p a r i n g a p r e l i m i n a r y economic study f i r s t . economic study deals with broad concepts  and o f t e n has  unproven data based on experience and f a i t h . bility (a)  The  study aims t o prove beyond reasonable  The f e a s i doubt t h a t :  s u f f i c i e n t economically r e c o v e r a b l e ore r e s e r v e s are a v a i l a b l e on m i n e r a l p r o p e r t i e s h e l d , and  (b)  the mineable ore r e s e r v e s can be transformed  into a  s a l e a b l e product and s o l d i n t o the market. Data assembled f o r ore r e s e r v e s , l e g a l r i g h t s , cons t r u c t i o n and o t h e r c a p i t a l c o s t s , o p e r a t i n g c o s t s , r e venues and taxes i s used t o prepare cash flows f o r the project. of  The cash flows are i n t u r n submitted  to lenders  funds t o support the request f o r loans t o f i n a n c e the  project.  A f u l l y documented f e a s i b i l i t y study o f the  e n t i r e mine process  from ore i n the ground t o cash i n the  bank does much t o minimize the f i n a n c i a l c o s t s o f funding  143 agreements, c o n s t r u c t i o n completion guarantees, performance bonds and most of a l l the r a t e s of The  f e a s i b i l i t y study prepared i n 1975  tecas property  d i d prove p o i n t s  reasonable doubt. and lity  However one  (a) and  operating interest.  f o r the  (b) above beyond  more i n g r e d i e n t i s needed  t h a t i s t h a t there must be a w i l l i n g n e s s and among owners and  viable.  The  Zaca-  capabi-  government to make the mine p r o j e c t  l a c k of a common purpose s t a l l e d the p r o j e c t  i n Zacatecas f o r three  years.  144 CHAPTER SIX REFERENCES 1.  J.W.C. Tomlinson, M. Thompson "A Study o f Canadian J o i n t Ventures i n Mexico" D i v i s i o n o f I n t e r n a t i o n a l Business S t u d i e s , F a c u l t y o f Commerce and Business A d m i n i s t r a t i o n , U n i v e r s i t y o f B r i t i s h Columbia, 1977, page 11  2.  P.J. P e r i l l e , F . J . S a a t h o f f , "Why Not P r o j e c t Management Accounting , October 1978, page 15  3.  K.D. Walters, R.J. Monsen "State-owned business abroad: new c o m p e t i t i v e t h r e a t . " Harvard Business Review, MarchA p r i l 1979, pp 165-170  4.  D.G. Bradley "Managing a g a i n s t e x p r o p r i a t i o n " , Harvard Business Review, July-August 1977, pp 75-83  5.  I n v e s t i n g , l i c e n s i n g and t r a d i n g c o n d i t i o n s abroad: Mexico Business I n t e r n a t i o n a l Corp., 1978, pp 9-10  6.  IBID, page 8  7.  R.F. M i k e s e l l , " F i n a n c i a l c o n s i d e r a t i o n s i n n e g o t i a t i n g mine development agreements." Mining Magazine, A p r i l 1974, page 265  8.  L.T. W e l l s , J n r . , " N e g o t i a t i n g with t h i r d world governments" Harvard Business Review,January-February 1977, page 79  9.  IBID, page 7 3  Financing?"  10.  R.F. M i k e s e l l , " F i n a n c i a l c o n s i d e r a t i o n s i n n e g o t i a t i n g mine development agreements." Mining Magazine, A p r i l 1974, page 259  11.  Supra, page 7 9  12.  H.K. T a y l o r , "General background theory o f c u t o f f grades" T r a n s a c t i o n s o f the I n s t i t u t i o n o f Mining and M e t a l l u r g y , Volume 81, 1972, S e c t i o n A, page 160  13.  H.K. T a y l o r , "Mine v a l u a t i o n and f e a s i b i l i t y s t u d i e s " M i n e r a l Industry Costs, Northwest Mining A s s o c i a t i o n , Spokane, 1977  14.  R.G. Duthie (President o f P l a c e r Development Limited) statement t o author on 10 August 197 9, Vancouver, B.C.  15.  M.R.L. B l a c k w e l l , "Some aspects o f the e v a l u a t i o n and p l a n n i n g o f the B o u g a i n v i l l e copper p r o j e c t " D e c i s i o n making i n t h e M i n e r a l Industry, C.I.M. S p e c i a l Volume No. 12, 1971, page 266  145 16.  J.L. H a l l s , D.P. Bellum, C.K. Lewis, "Determination of optimum ore r e s e r v e s and p l a n t s i z e by i n c r e m e n t a l f i n a n c i a l a n a l y s i s " , I n s t i t u t i o n o f M i n i n g and M e t a l l u r g y T r a n s a c t i o n s 78, P a r t A, 1969, page 20  17.  H.K. T a y l o r , "General background theory o f c u t o f f grades" T r a n s a c t i o n s o f the I n s t i t u t i o n of Mining and M e t a l l u r g y , Volume 81, 1972, S e c t i o n A, page 163  18.  J.B. U t l e y , "Doing business w i t h 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.  I n v e s t i n g , L i c e n c i n g and T r a d i n g C o n d i t i o n s Abroad: Business I n t e r n a t i o n a l Corp., 1978, page 11  20.  R.H. Lesemann, "Commercial and p r i c e c o n s i d e r a t i o n s i n mine f e a s i b i l i t y and c o s t s t u d i e s : s m e l t i n g and r e f i n i n g charges", M i n e r a l Industry C o s t s , Chapter 12, Northwest Mining A s s o c i a t i o n , Spokane, 1977, page 200  21.  IBID, page  22.  A. McQuire, " S i l v e r " unpublished memo dated 2 May, P l a c e r Development L i m i t e d  23.  " S i l v e r " Annual Review and Outlook, J . Aron Commodities C o r p o r a t i o n , P r e c i o u s Metals Research Department, New York, January 1979, page 39  24.  World Metal S t a t i s t i c s , World Bureau o f Metal S t a t i s t i c s , London, January 1979, pp 9-10  25.  S.P. Rana, "Precious metals advance s h a r p l y " Northern Miner, 10 May 1979, page 10  26.  " S i l v e r mining a t Las T o r r e s " 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 f o r l e a d " , A paper i s s u e d by Cominco L i m i t e d , Vancouver, February 197 9, page 3  28.  "Outlook f o r z i n c " , A paper i s s u e d by Cominco L i m i t e d , Vancouver, May 197 9, page 4  29.  " P l a c e r p o l i c y " Western Miner, Volume 49, No. 1976, page 55  30.  Gonzalez V i l c h i s y C i a , B o l e t i n Informativo No. 2 January 1978, page 5  Mexico  201  8,  1978,  August 1 issued  146 CHAPTER SEVEN PROJECT ECONOMIC RESULTS AND 7.1  VALUATION  Cash flow f o r e c a s t s Assumptions used to compile the cash flows f o r the base cases are d e s c r i b e d i n Chapter Tables X to XVIII.  s i x and summarized i n  Four base case s e t s of cash flow r e -  s u i t s are g i v e n i n Tables XIX and XX together with three s e l e c t e d cash flows f o r each o f : 1) 2) 3) 4)  the investment d e c i s i o n case f o r the p r o j e c t and, f o r P l a c e r Development L i m i t e d ' s s h a r e h o l d i n g i n the Mexico p r o j e c t , the f i n a n c i n g d e c i s i o n case f o r the p r o j e c t and, f o r P l a c e r Development L i m i t e d ' s s h a r e h o l d i n g i n the f i n a n c i n g case of the p r o j e c t . Cash flow r e s u l t s f o r o t h e r cases are g i v e n i n Appen-  d i c e s 3, 4, 7 and  8 and the r e s u l t s of a l l cash  coupled with p r o b a b i l i t i e s of t h e i r occurrence 11 and  12) e s t a b l i s h expected  Chapter s i o n s and  flows (Appendices  results.  f i v e r e f e r s t o the need f o r investment  deci-  f i n a n c i n g d e c i s i o n s t o be kept separate:  the  f i r s t to a s s i s t d e c i d i n g whether p r o j e c t s are a c c e p t a b l e and meet the investment  c r i t e r i a and the second t o decide  on the method of f i n a n c i n g an a c c e p t a b l e p r o j e c t .  Table  XIX data shows t h a t the base case f o r the c o r p o r a t e veh i c l e , Mexican Mining Company S.A.  de C.V.,  assuming a l l  e q u i t y f i n a n c i n g throws o f f t o t a l cash flow, a f t e r ment of the investment  cost, of US  $196  726  000.  d i s c o u n t e d at 15% a n n u a l l y back t o March 1979 US  $577 000  f o r a r e t u r n on investment  recoupThat  i s just  of 15.2%.  The  e q u i v a l e n t data f o r P l a c e r ' s 34% s h a r e h o l d i n g i n the  sum  TABLE XIX Mexican Mining Company S.A. de C.V. R e s u l t s o f S e l e c t e d Cash Flows - The P r o j e c t (Expressed i n 1979 constant United States d o l l a r s ) Probability Production Return on Net Present Values d i s Case of Case Years t o counted a t Mar.1979($000) Investment Number occurrence Description Payback A f t e r Tax 15% 20% 0^ Investment D e c i s i o n Cases 1 0.224 Base 5 .2 15 9 9196 726 577 (14 424) 3 0.160 - minus 10% o f metal p r i c e s 12 9 & 6 .4 147 817 (10 585) (22 340) 0.112 14 - no p r o d u c t i o n tax f o r 5 years and 20% accel e r a t e d d e p r e c i a t i o n 3 .6 18 . 6 % 12 469 210 297 ( 3 845) 15 0.017 - no p r o d u c t i o n t a x and 22 .7% income tax f o r 5 years 3 .3 251 904 27 723 7 569 Expected 5 .1 14 .9% 176 537 305) 294) (14 ( Financing Decision Cases 101 0.1613 Base 6 .5 17 • 9^ S-o 180 927 6 060 ( 5 592) 103 0.1440 - minus 10% o f metal p r i c e s 7 .8 13 .4% 130 457 ( 4 279) (12 470) 114 0.1008 - no p r o d u c t i o n t a x f o r 5 years and 20% accel e r a t e d d e p r e c i a t i o n 4 .4 21 .1% 196 543 15 441 2 065 115 0.0151 - no p r o d u c t i o n t a x and income tax f o r 5 years 3 .9 25 7 9231 601 27 564 10 985 Expected 6 .5 16 163 338 4 570 ( 6 173) Notes:  1) 2)  The above data i s s e l e c t e d from case r e s u l t s l i s t e d i n Appendices 3 and 4 f o r investment d e c i s i o n and f i n a n c i n g d e c i s i o n cases r e s p e c t i v e l y . Expected r e s u l t s are based on r e s u l t s l i s t e d i n Appendices 3 and 4 together w i t h p r o b a b i l i t i e s o f occurrence a c c o r d i n g to Appendices 11 and 12.  148 p r o j e c t shown on Table XX i s US $47 r e t u r n on investment  of 10.5%.  s i g n i f i c a n t drop to 10.5%  018  Q00. f o r a, reduced  The primary cause f o r the  i s the 21% w i t h h o l d i n g tax on  d i v i d e n d remittances to Canada from Mexico. These i n v e s t ment d e c i s i o n s t a t i s t i c s are d i s c u s s e d more f u l l y in this  later  chapter.  The  f i n a n c i n g d e c i s i o n base case r e s u l t s i n Table  XIX  where two-thirds of the p r o j e c t i s l o a n f i n a n c e d show a p r o j e c t payback p e r i o d of 6.5  p r o d u c t i o n years with a  m i n e - l i f e net cash flow of US  $180  15% to a March 1979  927  000 d i s c o u n t e d a t  present value of US  $6 060  000.  Once  again, the impact of 21% w i t h h o l d i n g taxes r e s t r i c t s P l a c e r ' s 34% share of the p r o j e c t to US  $47  the twenty years which, d i s c o u n t e d at 15%, US  $234 000  788  000  over  i s only  (Table XX).  P r o j e c t cash flows are d i s c o u n t e d a t 20% a n n u a l l y as it  i s a more l i k e l y h u r d l e r a t e f o r a p r i v a t e e n t e r p r i s e  mining  i n v e s t o r i n Mexico f o r investment  poses.  Two  decision  pur-  i n c e n t i v e tax s t r u c t u r e cases are s e l e c t e d  from Appendices 3 and 4 t o demonstrate the extent of i n c e n t i v e s needed to push the present v a l u e s to p o s i t i v e amounts a t March 1979.  The p r o j e c t needs i n c e n t i v e s of  c o n s i d e r a b l e magnitude and case number 15 i n Table  XIX  takes advantage of a f i v e year p e r i o d w i t h income tax and p r o d u c t i o n tax exemptions t o r e c o r d a p r e s e n t v a l u e of US  $569 000 a f t e r d i s c o u n t i n g the mine l i f e  $251  904  000  20% a n n u a l l y .  The  flow of  US  same tax s t r u c t u r e f a i l s  TABLE XX P l a c e r Development L i m i t e d R e s u l t s o f S e l e c t e d Cash Flows - Shareholder i n Mexican P r o j e c t (Expressed i n 1979 constant United States d o l l a r s ) Production Return on Net Present Values d i s Probability Years t o Investment counted a t Mar.1979 ($000) ease Case of Number occurrence Description Payback A f t e r Tax 0% 8 15', 20% Investment D e c i s i o n Cases 1 0.224 Base 6, 10, 5% 47 018 764 (6 499) (10 684) 3 0.160 - minus 10% o f metal p r i c e s 8, 8, 2% 33 881 357 (12 811) (9 497) 14 0.112 - no p r o d u c t i o n t a x f o r 5 years and 20% accelerated depreciation 4. 9 12 R 9- 50 663 ~9 407 (3 305) ( 7 843) 15 0.017 - no p r o d u c t i o n tax and income t a x f o r 5 y e a r s 3. 9 15 .6% 61 839 15 759 792 ( 4 777) Expected 6. 8 10 .0% 41 583 4 498 (6 751) (10 665) Financing Decision Cases 101 0.1613 Base 6. 7 15 "3 9- 47 788 10 427 234 ( 2 959) 103 0.1440 - minus 10% o f metal p r i c e s 8. 3 11 33 537 4 628 (2 842) ( 5 036) 114 0.1008 - no p r o d u c t i o n tax f o r 5 years and 20% accelerated depreciation 4 .6 18 7 9- 51 982 13 865 2 919 733) ( 115 0.0151 - no p r o d u c t i o n tax and income tax f o r 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) Notes 1) The above data i s s e l e c t e d from case r e s u l t s l i s t e d i n Appendices 7 and 8 f o r investment d e c i s i o n and f i n a n c i n g d e c i s i o n cases r e s p e c t i v e l y . 2) Expected r e s u l t s are based on r e s u l t s 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 o f occurrence a c c o r d i n g t o Appendices 11 and 12. !  150 to  reach the 20% t a r g e t f o r P l a c e r ' s 34%  b a r e l y makes the 15% marker. 15 achieves a 15.6% Expected  s h a r e h o l d i n g and  Table XX shows case number  r e t u r n on  investment.  r e s u l t s are c l o s e to the base case  but examination  results  of the cases s e l e c t e d and the w r i t e r ' s  d e t e r m i n a t i o n of case p r o b a b i l i t i e s i n d i c a t e a s t r o n g b i a s i n the expected r e s u l t s .  Cash flows f o r the p r o j e c t  are very m e t a l - p r i c e s e n s i t i v e and 0.3  probability i s  assigned to p r i c e s below base case p r i c e s and none to p r i c e s i n excess.  The p r i c e e f f e c t i s counterbalanced  by the predominance of cases which i n c l u d e tax i n c e n t i v e s .  7.2  Earnings f o r e c a s t s It  i s assumed t h a t the Mexican c o r p o r a t e v e h i c l e  undertaking the mining venture i n Zacatecas has no other business.  The base l o a n case cash flow  (Appendix  used to prepare a f o r e c a s t earnings statement p r o d u c t i o n years one  to f i v e  (Table XXI)  and  14) i s  f o r each of assumptions  r e q u i r e d i n the c o n v e r s i o n process are g i v e n i n notes 1 and 2 of Table XXI.  The  first  few years of o p e r a t i o n are  c h a r a c t e r i z e d by r e l a t i v e l y high s a l e s revenue and h i g h d e p r e c i a t i o n expense. $41  532  The  f i r s t year s a l e s of US  000 are lower than l a t e r years owing to the  m i l l i n g of oxide zone ore a t the s u r f a c e of the orebody and i t s e f f e c t on concentrate p r o d u c t i o n i s shown by comparison i n Table X I I .  The combined e f f e c t of oxide  ore and d e p r e c i a t i o n on net earnings of Mexican Mining  151 Company S.A. de C.V. i s t o produce a l o s s . the importance  Recognizing  o f the non-cash expense f o r d e p r e c i a t i o n  i n t h a t l o s s leaves the a n a l y s t unconcerned.  The planned  mining sequence w i t h i n the orebody to o p t i m i z e the cash flow's present value means t h a t net earnings w i l l tend t o d e c l i n e over time:  the d e c l i n e slowed  by the f a l l i n  d e p r e c i a t i o n expense on the r e d u c i n g book value o f the mine.  Good earnings years can be f o r e c a s t f o r the high  revenue years o f s i x through t e n (Appendix c i a t i o n f a l l s t o lower  14) as depre-  levels.  TABLE XXI Mexican Mining Company S.A. de C.V. F o r e c a s t Earnings Statement - P r o d u c t i o n Years 1 t o 5 ($000 1979 constant United S t a t e s d o l l a r s ) Note 1 2 3 4 . 5 46 716 58 043 56 445 49 387 41 532 Sales Operating c o s t s 18 019 18 322 18 550 18 614 18 262 Table XVIII 350 350 350 350 350 State p r o p e r t y taxes I n t e r e s t expense 6 664 4 832 2 847 472 6 835 Table XV D e p r e c i a t i o n , deplet i o n and a m o r t i z a 7 4 00 10 600 . 8 7.0013 100 1 16 200 tion 41 404  38 436  34 332  30 511  26 484  128  10 951  22 113  27 532  20 232  2  3 379  4 217  4 983  4 685  3 748  3 4  (1 625)  2 729 638  9 845 (1 280)  11 673 ( 250)  8 443 ( 201  5  1 754  7 584  13 548  16 108  11 990  3 367  8 565  11 424  8 242  Earnings b e f o r e taxe s Taxes On p r o d u c t i o n On income Current Deferred  Net earnings  (loss)  Average annual net earnings  -  US $ d 6  Average t o shareholders  626)  5 994 4 7 35  over 5 years over 5 years  152 Notes:  1)  A combined r a t e of 20% d e c l i n i n g balance d e p r e c i a t i o n r a t e i s assumed.  2)  Includes e x p l o r a t i o n expense which would have to be i n c u r r e d i n o r d e r t o reduce p r o d u c t i o n taxes.  3)  Current taxes on income r e p r e s e n t payments of both income tax (42% of t a x a b l e income) and employee tax (8% of t a x a b l e income).  4)  Deferred tax i s an accounting adjustment t o r e f l e c t t i m i n g d i f f e r e n c e s between c o r p o r a t e and government r e c o g n i t i o n of t a x a b l e income. A combined e f f e c t i v e r a t e of taxes on income of 50% i s assumed.  5)  The Mexican c o r p o r a t e e f f e c t i v e tax r a t e s f o r prod u c t i o n years 1 to 5 are 1400%, 69%, 61%, 58% and 59% f o r years 1 to 5 r e s p e c t i v e l y .  6)  Before w i t h h o l d i n g taxes not borne by Mexican Mining Company S.A. de C.V.  7)  M i n e - l i f e average annual net earnings t o shareh o l d e r s are US $7 146 000 c a l c u l a t e d as f o l l o w s : 20 year p r o j e c t net cumulative cash flow Table XIX, Case 101 l e s s 21% w i t h h o l d i n g tax  Average  7.3  A l l o c a t i o n of mine generated  $180 927 37 995  000 000  $142  932  000  7 146  000  US $  cash  The cash b e n e f i t s of the mine p r o j e c t are not buted t o the owners of Mexican Mining Company S.A. C.V.  i n the p r o p o r t i o n t h a t share ownership  distride  i s held.  An  a n a l y s i s of the a l l o c a t i o n of cash generated by the mine, assuming the u n d e r l y i n g c o n d i t i o n s o f the base l o a n case cash flows  (Appendix  14), shows t h a t 80% of the earnings  are p a i d to the Mexican government  (Table XXII, item C i i ) .  TABLE XXII Mexican Mining Company S.A. de C.V. F o r e c a s t A l l o c a t i o n o f Mine Generated Cash-Loan Base Case ($000 1979 constant United States d o l l a r s ) Goods and Services, Loan Repayment  Totals A  Mine L i f e Cash Outflows Equity Owners Canadian Mexican Private Public Private  984 168 82 580  Cash Inflow - Sales Capital  1 066 748 B  Cash Outflow Preproduction corporate costs C a p i t a l expenditure Operating c o s t s and i n t e r e s t Taxes on income,employee tax,duty on c a p i t a l equipment d u r i n g c o n s t r u c t i o n and s t a t e t a x Loan repayment D i s t r i b u t i o n o f earnings Withholding taxes - 21%  1 333 111 118 410 659  1 333 111 118 410 659  280 131 52 580 210 927  52 580  US $ 1 066 748  575 690  54^  D i s t r i b u t i o n o f Cash (i) A l l cash revenue ( i i ) A l l earnings,before taxes,after c a p i t a l i n p u t recovery ( i i i ) A l l net e a r n i n g s , a f t e r withholding tax .(iv) A l l net e a r n i n g s , a f t e r w i t h h o l d i n g t a x and c a p i t a l i n p u t recovery  280 131 69 606 (14 617)  71 715 (15 060)  379 414  54 989  56 655  35%  5%  6%  100%  80%  10%  10%  100%  47%  26%  27%  100%  49%  25%  26%  0  100%  69 606 29 677  Ul  Totals E f f e c t i v e Tax Rate (i) E f f e c t i v e t a x r a t e on a l l earnings, before taxes, a f t e r c a p i t a l i n p u t recovery s u f f e r e d by (a) Mexican Government (b) Mexican p a r t n e r and Canadian i n v e s t o r ( i i ) . E f f e c t i v e t a x r a t e on a l l earnings, b e f o r e taxes, a f t e r c a p i t a l i n p u t recovery, assuming Mexican Government holds no e q u i t y i n Mexican Mining Company S.A. de C.V.  0% 70%  155 80% appears unreasonably  large at f i r s t ,  but i t i s im-  p o r t a n t t o r e c o g n i z e t h a t the government would take approximately 72%  (Table XXII, item D i i ) through  without p a r t ownership  i n the mine.  The  taxation  government's  72% would be from taxes on p r o d u c t i o n and income, employee tax  and duty on i n i t i a l  US $280 131 000 of  US $44  294  c a p i t a l expenditure amounting to  (Table XXIII) p l u s 21% w i t h h o l d i n g taxes  000 on d i v i d e n d s from 100%  b u t i o n s to owners ( i n s t e a d of US $29 ownership  i n Table X X I I ) .  677  of cash 000  distri-  from a 67%  The Mexican government w i l l  focus on t h e i r 33% c o n t r i b u t i o n t o c a p i t a l investment earn an i n c r e m e n t a l 8% of e a r n i n g s .  to  T h i s too i s mis-  l e a d i n g because the 8% i s an a f t e r tax change as taxes have a l r e a d y been i n c l u d e d t o o b t a i n the f i r s t The p r i v a t e e q u i t y owners w i l l  72%.  f i n d i t useful during  n e g o t i a t i o n s f o r f i n a n c i a l c o n s i d e r a t i o n of tax concessions and p o s s i b l e government a s s i s t a n c e towards the mine c o n s t r u c t i o n c o s t , to emphasize the s i g n i f i c a n t 35% of  share  a l l cash outflow d u r i n g the p r o j e c t e d mine l i f e which  i s taken by government i n Mexico  (Table XXII, item C i ) .  I f c a p i t a l c o n t r i b u t i o n s and repayments are ignored, the government i s shown to take a huge 37.5% revenue  of a l l s a l e s  (33% i f government had no e q u i t y i n t e r e s t i n the  project).  These percentages do not c o n s i d e r the tax  revenue from smelter, r e f i n e r y and t r a n s p o r t a t i o n c o s t s taken out of gross s a l e s amounts and the tax revenue generated out of payments f o r goods and  services.  156  The  a l l o c a t i o n of mine generated cash i s h e a v i l y i n  favour o f government and  i t seems there i s n e g o t i a t i n g  room f o r the government to ease the burden. t i v e l y small change, say US  $10  A  rela-  m i l l i o n , i n the  construc-  t i o n c o s t o f the mine w i l l make the p r o j e c t much more a t t r a c t i v e to the p r i v a t e s e c t o r h e l d e q u i t y owners. This p o s s i b i l i t y  i s r e f e r r e d to l a t e r i n t h i s paper  and  the r e l a t e d cash flow r e s u l t s are d e t a i l e d i n Appendices 7 and  8, cases 16 and  The  60%  XXIII) and  116.  e f f e c t i v e r a t e of tax f o r the p r o j e c t 70%  f o r shareholders  (Table XXII) over  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 e a r l y years o f o p e r a t i o n s .  (Table the  over  the  Appendix 14 p o i n t s to a  s i t u a t i o n a t the end of o p e r a t i n g year s i x at which time the e q u i t y owners have y e t to achieve t h e i r investments  (US $6 731  000  is s t i l l  payback of to be recouped)  but government i n i t s c a p a c i t y as a c o l l e c t o r of taxes has  e x t r a c t e d US  $69  883  000.  E i g h t years of r i s k  no p r o f i t w h i l s t government reaps n e a r l y US  $70  and  million  i s h a r d l y encouragement to the domestic p r i v a t e s e c t o r and  f o r e i g n i n v e s t o r s i n the mining i n d u s t r y .  VII r e f e r s to a combined d e f e r r e d and  current  Table effective  tax r a t e of 42.66% i n the e a r l y years of a B r i t i s h Columbia mine.  However, the c u r r e n t tax s i t u a t i o n i s  markedly d i f f e r e n t i n t h a t a t the end o f year s i x 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 b e f o r e taxes-Appendix Add back e x p l o r a t i o n as i t r e p r e s e n t s p r o d u c t i o n tax  14  $563 946  000  2 562 566 508  00 0 000  Less c a p i t a l expenditure, i n c l u d i n g d u t y , f u l l y d e p r e c i a t e d and p r e p r o d u c t i o n c o r p o r a t e costs 114  42 3 000  Earnings b e f o r e taxes below  452 085  000  100%  P r o d u c t i o n taxes Income tax Employee tax T o t a l taxes (see notes below)  81 159 30 271  238 533 387 158  000 000 000 000  18.0 35.3 6.7 60.0%  E f f e c t i v e tax r a t e over the mine l i f e - p r o j e c t ( N o t e 1). P r o j e c t net cash flow (Appendix 14) US $ 180 927  000  Notes: 1) T o t a l taxes of $271 158 000 are of the type u s u a l l y . r e c o r d e d as "taxes" i n Canadian f i n a n c i a l statements. 2) Taxes as above S t a t e p r o p e r t y taxes  $271 158 7 000  000 000  278 158 1 973  000 000  Table XXII  280 131 30 387  000 000  Table XXIV  $249 744  000  Table  XV  Duty l e s s employee tax  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 d i v i d e n d s not i n c l u d e d above amount to $29 677 000 (Table XXII).  158  B r i t i s h Columbia t h a t same US  $69  883  gone to repay the investment funds and  000 would have a l l taxes d e f e r r e d .  No mention has been made of the p r e p r o d u c t i o n porate sum  c o s t s of US  i s an estimated  p r i o r to p r o d u c t i o n  $1 333  000  shown i n Table XXII.  amount of c o s t s i n c u r r e d by  by P l a c e r .  The  " E x p l o r a t i o n c o s t s recovered" of P l a c e r  (Appendix 16)  withholding Canada.  The  The  Placer  year minus-two f o r e x p l o r a t i o n i n  Mexico f o r the b e n e f i t of the p a r t n e r s h i p be r e c o v e r a b l e  cor-  f o r e c a s t to  amount appears as  i n the Canadian cash  i n production  year f i v e .  No  tax i s s u f f e r e d on the cash remittance recovery  flow  to  o f the sunk c o s t by P l a c e r reduced  the cash a v a i l a b l e f o r p r o j e c t d i v i d e n d s  and  i s there-  f o r e a l e g i t i m a t e charge a g a i n s t the p r o j e c t ' s revenue (Appendices 13 and  14).  on f o r e c a s t net earnings XXI)  However, the item has no i n production  year f i v e  effect (Table  as the payment s e t t l e s a l i a b i l i t y assumed to  be  c a r r i e d on the balance sheet of Mexican.Mining Company S.A.  de  C.V.  159 7.4  Sensitivities Base case cash flow r e s u l t s are summarized  earlier  i n t h i s chapter and s e l e c t e d r e s u l t s f o r p r o j e c t  and  shareholder cash flows are l i s t e d i n Tables XIX and  XX.  S i x t e e n v a r i a t i o n s from the a l l e q u i t y base case f o r the investment  d e c i s i o n are d e s c r i b e d in.Appendices  f o r the p r o j e c t and shareholder r e s p e c t i v e l y . 6 and  5 and 9 Appendices  10 p r o v i d e s i m i l a r i n f o r m a t i o n f o r the twenty  f i n a n c i n g d e c i s i o n case Case 109  variations.  i n Appendix 6 r e l a t e s to Mexican tax i n -  c e n t i v e circumstances where 100% d e p r e c i a t i o n allowances assumed.  a c c e l e r a t e d r a t e s of  f a m i l i a r to Canadian miners i s  When comparing the r e s u l t s of case 109  with  case 108 which assumes a l e s s e r a c c e l e r a t e d r a t e of 33-1/3%, i t i s found t h a t the advantage t o be gained f o r the p r o j e c t by n e g o t i a t i n g f o r the h i g h e r 100%  rate i s  not s u f f i c i e n t t o make the p r o j e c t t h a t much more a t t r a c t i v e to the i n v e s t o r s .  The  33-1/3% " f a s t " r a t e a l r e a d y  p e r m i t t e d by tax law i n Mexico appears  adequate and, i f  n e g o t i a t i o n s w i t h government look f a v o u r a b l y upon a c c e l e r a t e d r a t e s , government "concessions", i f any  are  sought or forthcoming, should be found i n o t h e r areas the temptation to accept the 100%  rate resisted.  and  Appen-  d i x 10 shows t h a t the same case r e s u l t s when 100% i s a v a i l a b l e versus 33-1/3% r a t e s improves shareholder payback by 0.3 ment and US  p r o d u c t i o n years, 0.4%  $201  r e t u r n on  invest-  000 present value a f t e r annual d i s -  160 c o u n t i n g a t 20%.  I f a c o n c e s s i o n i s sought  from  govern-  ment, d e p r e c i a t i o n r a t e s do not appear to p r o v i d e an p o r t a n t boost t o the p r o j e c t ' s economics.  im-  Given present  tax law i n Mexico, there i s danger t h a t l o s s e s f o r tax purposes,  i n c l u d i n g h i g h d e p r e c i a t i o n deductions,  will  f a l l o f f the s h e l f a f t e r three years no longer a v a i l a b l e for set o f f against future p r o f i t s . r a t e reduces t h i s  A 33-1/3% a c c e l e r a t e d  risk.  The o n l y cases which produce r e s u l t s a t s u i t a b l e l e v e l s assume major tax concessions f o r f i v e y e a r s ; cases not c o n s i d e r e d t o have a h i g h p r o b a b i l i t y of occurrence.  Cases 15, 16,  115  and  116  significantly  improve the economic p i c t u r e f o r the p r o j e c t and s e c t o r shareholders but s t i l l  private  do not manage to top the  20% r e t u r n on investment mark or p r o v i d e i t s e q u i v a l e n t p o s i t i v e present value of cash flow to P l a c e r discounted a t 20% i n the investment  d e c i s i o n cases  (Appendix  9).  A  $10 m i l l i o n r e d u c t i o n i n the t o t a l c o n s t r u c t i o n c o s t v i a d i r e c t subsidy or c o n t r i b u t i o n to i n f r a s t r u c t u r e c o s t s i n c l u d e d i n cases 16 and  116  l i k e l y concessions t h a t may  i s perhaps one of the more be a v a i l a b l e but combined  w i t h the f i v e year tax exemption p e r i o d i s c o n s i d e r e d remote.  $10 m i l l i o n i s a l a r g e p o r t i o n of the c o s t and  not a l l items of mine c o n s t r u c t i o n l e n d themselves government c o n t r o l .  to  Perhaps the c o s t s of townsite,  t a i l i n g s impoundment and power supply are the candidates f o r government a b s o r p t i o n .  The  primary  government  161 appears t o favour  s u b s i d i z e d power charges t o a s s i s t new  i n d u s t r y but as s u b s i d i e s o f t h a t nature can be w i t h drawn l a t e r , a d i r e c t i n f r a s t r u c t u r e c o s t r e d u c t i o n i s preferable. Cases 2 and 102 r e s t r i c t the ownership l i f e o f the mine t o t e n y e a r s .  C l e a r l y , no p o s i t i v e d e c i s i o n t o i n -  v e s t i n the p r o j e c t w i l l ever be taken on the b a s i s o f a ten year l i f e when the r e t u r n on investment t o P l a c e r i s a dismal  5.7%.  What i s important i n t h i s i n s t a n c e i s  t h a t the f i n a n c i n g d e c i s i o n case 102 o f f e r s a 10% r a t e r e t u r n on investment a f t e r a c h i e v i n g  loan payback a f t e r  6.7 p r o d u c t i o n  than P l a c e r ' s  years;  a rate greater  cal-  c u l a t e d c o s t o f c a p i t a l i n 1980. The  r i s k o f severe l o s s e s through poor metal p r i c e s  do not appear great as cases 3, 4, 103 and 104 show r a t e s o f r e t u r n s on investment c l o s e t o o r i n excess o f Placer's cost of c a p i t a l . well-being  However, the mine economic  i s q u i t e d e f i n i t e l y s e n s i t i v e t o metal pro-  duct p r i c e s as Appendices 5 and 6 i n d i c a t e .  Ten percent  increases  c o s t s and  i n c o n s t r u c t i o n c o s t s or o p e r a t i n g  an i n c r e a s e d ployed  i n t e r e s t r a t e over the payback p e r i o d  em-  i n cases 5, 6, 105, 106 and 120, w h i l s t worthy o f  a t t e n t i o n , do n o t g i v e cause f o r concern when compared w i t h r e s u l t s o f the base  7.5  cases.  S o c i a l b e n e f i t s and c o s t s Chapter f i v e advises  o f the d i f f i c u l t y  i n determining  162 a net f i g u r e f o r s o c i a l b e n e f i t s l e s s c o s t s owing to the s u b j e c t i v e nature  of the u n d e r l y i n g assumptions used i n  the v a r i o u s c a l c u l a t i o n s . What to value and what i n f l u e n c e s the value are the questions tor to  needs answers.  Government w i l l  tax revenues, f o r e i g n currency  f o r which the likely  assign  earnings,  valuavalues  employment,  i n f r a s t r u c t u r e and a c a t c h - a l l group which c o u l d i n c l u d e r e g i o n a l development, the e f f e c t s of changes i n savings and  consumption h a b i t s , c r e d i t supply, p o l i t i c a l  tage and the dynamic e f f e c t of the p r o j e c t on f o r e i g n investment.  Costs c o u l d i n c l u d e the  advan-  future effects  of p o p u l a t i o n movement, l o s s of a g r i c u l t u r a l l a n d , vironment c o n t r o l , f o r e i g n ownership of m i n e r a l political  r i s k and  infrastructure.  to reduce the  e r r o r , c e r t a i n b e n e f i t s and c o s t s are weighted e s t a b l i s h i n g the net s o c i a l value to Mexico.  f o r e i g n currency  earnings.  before An  i s t h a t of tax revenues  and  Both numbers are d e r i v e d  from the same s a l e s r e c e i p t s number and add  resources,  There i s a danger  of double counting b e n e f i t s and c o s t s and  example of double counting  en-  can  conceivably  to an amount g r e a t e r than s a l e s . Tax revenues are estimated  i n Table XXIV and  t i o n i s drawn to the assumptions i n making the No data i s a v a i l a b l e to the w r i t e r concerning s o n a l marginal comes.  atten-  estimates. the  per-  tax r a t e s on p r o s p e c t i v e employees i n -  Not o n l y w i l l  i n d i v i d u a l mine employees have  v a r i o u s l e v e l s of wages and  s a l a r i e s from Mexican  Mining  163 Company S.A. of income.  de C.V. The  but some w i l l have o u t s i d e sources  same p r i n c i p l e s apply to i n d i r e c t  a t t r i b u t a b l e to the mine.  jobs  A present value c a l c u l a t i o n  i s i n c l u d e d i n Table XXIV which shows t h a t $42  392  000  i s the approximate amount government should c o n s i d e r the a b s o l u t e maximum i t may  s u b s i d i z e the p r o j e c t out of tax  revenue based on assumptions l i s t e d i n the same t a b l e . A d i s c o u n t r a t e of 20% i s used to f i n d the present value of the stream o f f o r e c a s t tax revenue.  I t can be  argued  t h a t as shareholders have an i n t e r e s t i n a v a i l a b l e  cash  flow subordinate to the tax c o l l e c t o r , the a p p r o p r i a t e d i s c o u n t r a t e should be l e s s than the h u r d l e r a t e f o r the s h a r e h o l d e r s .  O f f s e t t i n g t h a t f a c t o r i s the  govern-  ment r i s k of tax d e f e r r a l f o r such causes as new  capital  investment  by Mexican Mining Company S.A.  de C.V.  mine p r o j e c t 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 and the a d d i t i o n of tax d e f e r r a l p o s s i b i l i t i e s use of a high d i s c o u n t r a t e of  The loss  justifies  20%.  F o r e i g n exchange r e s e r v e s of hard c u r r e n c i e s w i l l  be  boosted handsomely by the Zacatecas mine; probably i n US d o l l a r s but p o s s i b l y yen.  No l e s s important than the  magnitude of the c o n t r i b u t i o n i s the f o r e c a s t t h a t even d u r i n g the i n i t i a l years of c o n s t r u c t i o n and o p e r a t i o n , the mine w i l l be a p o s i t i v e c o n t r i b u t o r to Mexico's reserves.  The  s o c i a l value of f o r e i g n currency i n f l o w  l i e s i n the a b i l i t y to purchase value without borrowing  imported  goods of s i m i l a r  on i n t e r n a t i o n a l markets.  164 TABLE XXIV S o c i a l B e n e f i t s and Costs - Tax Revenue (Expressed i n 1979 constant United S t a t e s d o l l a r s ) Direct inflow: Mexican Mining Company S.A. de C.V. P r o j e c t exc l u d i n g the employee s h a r i n g tax (Table XXIII) Employees: : Estimated a t 1.5% o f d i r e c t labour content of c o n s t r u c t i o n c o s t s (7 5%) 3  15%  20%  $249 744 000  1  126  000  as an assumed marginal tax r a t e on the 38% labour cont e n t of o p e r a t i n g c o s t s (Appendix 17, item 26) 22 174 000 as an assumed marginal pers o n a l tax r a t e on the employee s h a r i n g tax o f $30 387 000 6 077 000 D i r e c t T o t a l Inflow $279 121 000  Indirect inflow Incremental p a y r o l l s f o r smelter and r e f i n e r y , product s h i p p i n g o r g a n i z a t i o n s and the s e r vice industry. The mine p r o j e c t labour f o r c e w i l l be 400 persons and, assuming 1.5 jobs are c r e a t e d o u t s i d e the mine f o r each d i r e c t mine j o b , 600 i n d i r e c t jobs w i l l g i v e r i s e t o tax revenue. 600 jobs a t an assumed annual tax per person of $2 000 f o r twenty y e a r s . 600 x 2 000 x 20 Incremental business e a r n i n g s , assuming a tax r a t e of 42% and earnings before taxes of 5% on the p r o j e c t ' s 34% domestic purchases (Appendix 17, item 26) o f $132 263 000 (see Table XV) w i l l g i v e r i s e t o tax revenue of Add an assumed marginal tax r a t e o f 20% on the 8% employee s h a r i n g tax f o r the same business earnings b e f o r e taxes I n d i r e c t T o t a l Inflow Outflow: Increase i n government s e r v i c e s r e l a t e d t o the c o n s t r u c t i o n and o p e r a t i o n o f the mine. Serv i c e s i n areas such as tax a d m i n i s t r a t i o n , environmental o f f i c e r s f o r water, a i r and land use c o n t r o l , mining p r a c t i c e s i n s p e c t o r s , labour administration., l e g a l work and o t h e r s .  24 000 000  2 7 78 000 106 000 $ 26 884 000  165 Estimated government jobs c r e a t e d - 10% of new i n d i r e c t jobs - a t an annual estimated c o s t per job of US $20 000 i n c l u d i n g wages, b e n e f i t s , o f f i c e accommodation and o t h e r o p e r a t i n g c o s t s , but l e s s p e r s o n a l taxes on income. 60 x 20 000 x 20 T o t a l Outflow  24 000  000  T o t a l estimated tax revenue a t t r i b u t e d to the mine over 20 years  $282 005  000  Present value of the flow of tax revenue count r a t e 20%)  $ 42 .392  000  (dis-  I t i s assumed t h a t tax revenue i s c o l l e c t e d a t r a t e s a c c o r d i n g to the base loan case cash flow. A d i s c o u n t r a t e of 20% i s used because of cons i d e r a b l e r i s k t h a t t a x a b l e income w i l l not a r i s e and t h a t r a t e i s l i k e l y to be used by the mining p r o j e c t owners i n t h e i r assessment of the p r o j e c t . Note 3 to Table XXIII a d v i s e s t h a t 32% o f 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 a c c o r d i n g l y there i s l e s s r i s k of n o n - c o l l e c t i o n by government.  Table XXV  shows f o r e i g n currency earnings  f o r e i g n currency c o s t s by a margin of 4.3  exceed  to 1.  The  2 t o 1 r e l a t i o n s h i p d u r i n g c o n s t r u c t i o n demonstrates t h a t the mine i s not f o r e c a s t to be a d r a i n on the n a t i o n ' s r e s e r v e s a t any time; a f a c t o r of c o n s i d e r a b l e 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 i n c l u d e d i n the cash flow case s t u d i e s , none of the concessions w i l l d e t r a c t from statements  the  j u s t made concerning the net i n f l o w of hard  foreign currencies.  Numbers i n Table XXV  which are can-  d i d a t e s f o r change as a r e s u l t of concessions are the i n f l o w and outflow e q u i t y and l o a n funds and the d i s t r i b u t i o n s to the Canadian i n v e s t o r .  The  l a c k of  166 i n f o r m a t i o n a v a i l a b l e r e l a t i n g to the f o r e i g n exchange content of smelter deduction c o s t s , c a p i t a l and o p e r a t i n g c o s t s n e c e s s i t a t e d making assumptions to a r r i v e a t f o r e i g n exchange o u t f l o w s .  The  important  assumptions are given  i n Appendix 17 which l i s t s i n g r e a t e r d e t a i l the mation summarized i n Table TABLE  infor-  XXV. XXV  S o c i a l B e n e f i t s and Costs - F o r e i g n Currency Inflow and Outflow (Expressed i n 1979 c o n s t a n t United S t a t e s d o l l a r s )  Inflow E q u i t y and l o a n Product v a l u e  20 year Mine L i f e funds Appendix  $ 17  Outflow C a p i t a l expenditure Interest Loan repayments D i s t r i b u t i o n s to the Canadian investor - Placer Operating c o s t s Appendix  17  Mine Construction Period  67 285 1 114 647  000 000  $67  285 -  000  932  000  $67  285  000  42 067 26 625 57 085  000 000 000  28 863 4 975  000 000  68 188 81 692  000 000  $1 181  657  000  33 838  000  T o t a l estimated net f o r e i g n currency inflow US $906 275  000  33 447  000  Present value o f the i n f l o w ( d i s count, r a t e 20%) F o r e i g n currency i n f l o w : outflow ratio Note:  275  $149  Assumptions are g i v e n i n Appendix  548  000  4.3:1  2.0:1  17  Employment f o r f o u r hundred persons d u r i n g mine o p e r a t i o n s i s a n t i c i p a t e d a t the Zacatecas mine s i t e  and  an a d d i t i o n a l s i x hundred jobs are assumed to be c r e a t e d independently.  The c a p i t a l c o s t of each d i r e c t job a t  the mine s i t e i s f o r e c a s t to be US  $200 000 and  even  167 spread over the estimated . t o t a l . o f one and  thousand d i r e c t  i n d i r e c t jobs the c a p i t a l c o s t of US  approximately  US  $80  000.  $80 m i l l i o n i s  I n d i r e c t jobs c r e a t e d w i l l  need a d d i t i o n a l c a p i t a l o u t l a y s however, so $80 misleading.  000 i s  Such h i g h c a p i t a l o u t l a y per job has, i n  Canada, l e a d to an improved standard of l i v i n g . t a l s and  schools f o l l o w new  available.  The  Hospi-  mines and modern housing i s  improvement of l i v i n g standards  f o r the  p o p u l a t i o n i s a high p r i o r i t y t a r g e t of the Mexican government and the c r e a t i o n of jobs i n l e s s areas o f the n a t i o n , such as Zacatecas, long term s t a b i l i t y of the country. one  The  developed  are v i t a l to the s o c i a l value of  thousand jobs i s not n e c e s s a r i l y the high c o s t der-  i v e d from a c a p i t a l i n t e n s i v e i n d u s t r y . i n t e n s i v e i n d u s t r i e s may  Less  capital  be a t t r a c t e d to the s t a t e but  b e f o r e a l t e r n a t i v e s are found v a l u a b l e time w i l l lost.  For these two  reasons,  be  the s o c i a l value of the  jobs i s taken a t f i f t y percent of the c a p i t a l c o s t of jobs c r e a t e d and s e t a t US  $40  million.  I n f r a s t r u c t u r e improvements can be a c c u r a t e l y costed but the s o c i a l value beyond the needs of the mine are again s u b j e c t i v e .  Improvements may  be extensions to the  mine of e x i s t i n g i n f r a s t r u c t u r e , such as 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 stock and  such as r a i l w a y r o l l i n g  f r e s h water supply.  i n f r a s t r u c t u r e may  electrical  Extensions and  upgraded  improve u t i l i z a t i o n of c u r r e n t  168 f a c i l i t i e s and p r o v i d e economies which have a p o s i t i v e s o c i a l value t h a t i s d i f f i c u l t to assess without to d e t a i l e d i n f o r m a t i o n .  access  The road to the mine s i t e i s  adequate but some improvements w i l l be made and the c o s t i s i n c l u d e d i n the c a p i t a l c o s t of c o n s t r u c t i o n . Other s o c i a l b e n e f i t s and c o s t s are more d i f f i c u l t to v a l u e , p a r t i c u l a r l y so as the w r i t e r i s not Mexican. However, the p o s i t i o n i s s i m i l a r f o r a Canadian corporat i o n w i s h i n g to e v a l u a t e s o c i a l net b e n e f i t s . An needs to be made.  The  l i s t of n a t i o n a l p r i o r i t i e s f o r  Mexico r e f e r r e d to i n Chapter tion  (#2), water resources  three p l a c e d r u r a l educa-  (#3)  i n the top ten p r i o r i t i e s behind trol.  attempt  and  infrastructure  (#5)  t h a t of p o p u l a t i o n con-  The p o t e n t i a l mine i s seen as a p o s i t i v e  contri-  butor to the three mentioned as s t a t e p r o p e r t y taxes metal p r o d u c t i o n taxes from the mine w i l l be f o r new  available  e d u c a t i o n a l 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 p r o v i d e new lities  and  water storage c a p a b i -  i n excess of mine needs, and heavy  industrial  power supply w i l l be extended to an area h i t h e r t o unserviced.  These p r i o r i t i e s have been "costed" f o r s o c i a l  purposes i n Table XXVI concerning i n f r a s t r u c t u r e but a p o l i t i c a l value i s a l s o a p p r o p r i a t e .  The  political  value r e l a t e s to the improved chance of popular  goodwill  being d i r e c t e d toward the f e d e r a l government and the p a r t y a r i s i n g from Zacatecas  r e g i o n a l devleopment,  p o p u l a t i o n movement to the major urban areas and  PRI  reduced  job  169 creation activity improvement.  w i t h attendant l i v i n g  These b e n e f i t s  standards  are reduced by the c o s t of  the p o l i t i c a l r i s k o f p r o j e c t f a i l u r e  f o r any  o p p o s i t i o n p o l i t i c a l party advantage t h a t may  cause, be  con-  ceded owing to the presence of f o r e i g n owners i n the p r o j e c t or apparently  favourable  treatment a f f o r d e d  the  project. TABLE XXVI S o c i a l B e n e f i t s and Costs - I n f r a s t r u c t u r e (Expressed i n 1979 constant United States d o l l a r s ) Up-grading of e l e c t r i c a l power to mine s i t e , the nearby town and l o c a t i o n s along the new powerl i n e route. $1 m i l l i o n f o r f i v e years and $200 000 a n n u a l l y t h e r e a f t e r Maintenance of extended p o r t i o n of power f a c i l i t i e s , $100 000 per year C o n t r i b u t i o n to c o s t of new power g e n e r a t i o n f a c i l i t i e s needed to r e p l a c e the mine's maximum draw when the next new demand f o r power i s required  $8  000  000  (2 000  000)  (6 000 0  000)  Road improvements, not r e q u i r e d other than f o r mine purposes Road maintenance i n c r e a s e r e l a t e d to g r e a t e r usage, $100 000 per year (2 000 Townsite i n c l u d i n g housing, h o s p i t a l , s c h o o l , h o t e l and other f a c i l i t i e s , a t approximate c o s t (Table XVI) as the l o c a l p o p u l a t i o n w i l l witness t h a t improved l i v i n g c o n d i t i o n s can be provided o u t s i d e the major urban centres 4 000 Fresh water supply to surrounding d i s t r i c t perm i t t e d by the t a i l i n g s impoundment pond. Approximate c o s t of necessary dams and a n c i l l a r y equipment, net of c o s t of a d d i t i o n a l s e r v i c e l i n e s not r e q u i r e d f o r the mine 2 000 Railway revenue, l e s s o p e r a t i n g c o s t s , from .. t r a n s p o r t i o n of mine products, l e s s c o s t of r a i l w a y maintenance i n c r e a s e owing to g r e a t e r t r a c k and engine usage: assume breakeven s o c i a l v a l u e , e x c l u d i n g employment Railway r o l l i n g stock r e q u i r e d to r e p l a c e equipment a l l o c a t e d to the new mine p r o j e c t . Estimated 78 000 tonnes of concentrate a n n u a l l y , (Table XII) w i l l r e q u i r e 25 r a i l wagons on a ten day t u r n round at an estimated c o s t per wagon of $40 000 (1 000  0 000)  000  000  0  000)  170 Estimated net s o c i a l b e n e f i t - i n f r a s t r u c t u r e $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 b e n e f i t s and c o s t s are as valued by the w r i t e r . No c o n s u l t a t i o n w i t h Mexican government o f f i c i a l s was attempted. The b e n e f i t s are l i k e l y to be long-term g i v e n the f a i t h t h a t new  o p p o r t u n i t i e s f o r employment w i l l  a t t r a c t e d t o the area b e f o r e the orebody i s  be  exhausted.  The c o s t s are not seen to be s i g n i f i c a n t f o r the same l e n g t h of time e s p e c i a l l y as f o r e i g n ownership does not extend to c o n t r o l of management.  The employment  i s regarded as the most important p o l i t i c a l  factor  advantage  p o s s e s s i n g a v a l u e i n excess o f the a c t u a l " c o s t " o f c r e a t i n g approximately of the jobs proposed  one  thousand  jobs.  Replacement  w i l l take time and e f f o r t .  The  net  p o l i t i c a l b e n e f i t i s a r b i t r a r i l y p r e s e n t l y valued a t $10  million. The proposed  mine's output i s expected  at world p r i c e s and no adjustment  to be  exported  i s necessary to b r i n g  cash flow s a l e s v a l u e s i n t o l i n e with the s o c i a l value of the products.  In other words, e q u i v a l e n t products may  be  a c q u i r e d a t the same c o s t a t i d e n t i c a l moments i n time. Mine i n p u t c o s t s are d i s t o r t e d by t a r i f f s and other trade b a r r i e r s and p r i c e r e v i s i o n s f o r those and other  reasons  f o r f a c t o r s o f i n p u t are necessary to e s t a b l i s h a more refined social evaluation. l i k e l y be reduced  The c o s t o f l a b o u r would  as a l t e r n a t i v e employment, even f o r  many s k i l l e d and s e m i - s k i l l e d persons,  i s l i m i t e d and  the  171 t r u e market value of labour to be employed a t the mine may  be very low.  I f the mine's m a t e r i a l i n p u t r e q u i r e -  ments have a l t e r n a t i v e uses or are i n s h o r t supply, m a t e r i a l i n p u t c o s t may  need adjustment to the  the  social  value and government e v a l u a t o r s of the p r o j e c t w i l l c o n s i d e r the aspect  in detail.  The  feasibility  study  f o r 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 i n p u t supply p o s i t i o n s but d i s c u s s i o n s with P l a c e r personnel domestic supply project.  An  c o n f i r m t h a t there are no s i t u a t i o n s known t h a t may  difficult affect  the  improved p r o j e c t s o c i a l value i s the f o r e -  c a s t outcome of a d e t a i l e d examination of the t r u e c o s t s of f a c t o r s of i n p u t f o r the mine.  As the purpose of  this  paper i s to determine the value of P l a c e r ' 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 p r o j e c t ' s s o c i a l value ought to be  increased  owing to adjustments to the c o s t s of i n p u t s .  However,  it  i s worth n o t i n g the unadjusted  p r o j e c t from the viewpoint outflows  s o c i a l value of  of f a c t o r s of i n p u t .  equal i n f l o w s i n Table XXII and  the The  as mentioned  above the value of i n f l o w s do not r e q u i r e adjustment. C e r t a i n of the outflows  do not have a s o c i a l c o s t as  they r e p r e s e n t domestic t r a n s f e r s .  Accordingly,  net s o c i a l value of the mine p r o d u c t i o n as f o l l o w s :  the  i s $404 403  000  172 Taxes - Table XXII Dividends l e s s e q u i t y c a p i t a l - domestic shareholders - Table XXII ($210 927 000, l e s s $30 000 000, l e s s $56 655 000) Unadjusted net s o c i a l value o f mine production  $280 1.31 000 124 272  000  US $404 4 03 00 0  The above s o c i a l value i s once again p a r t o f the mine product value and, i f assigned a s o c i a l v a l u e , due r e c o g n i t i o n needs t o be g i v e n to values p l a c e d on tax r e venue and f o r e i g n currency net i n f l o w to a v o i d d u p l i c a tion.  Here, the c h o i c e has been made t o ignore the above  $404 403 000 and i n s t e a d p l a c e values on tax revenue and f o r e i g n currency  earnings.  Table XXVII summarizes  the s o c i a l net b e n e f i t s ex-  pressed i n present v a l u e terms which t o t a l s  US  $148 970 000. The p o s i t i v e value o f such magnitude, a l though i t i s a s u b j e c t i v e assessment o f the p r o j e c t , i n d i c a t e s a c l e a r advantage to Mexico i n the event the mine i s b u i l t and operated under the base case stances.  circum-  The l a r g e s o c i a l values a t t r i b u t e d to tax  revenue, f o r e i g n currency earnings and employment the p o t e n t i a l advantages to be gained by a which i s able t o choose between  reflect  government  lowering the t o t a l tax  burden and p r o v i d i n g improved s e r v i c e s ; by the n a t i o n b e t t e r a b l e to f i n a n c e f u t u r e imports  o f goods and  s e r v i c e s and the c o n t r i b u t i o n t o i n c r e a s e d job o p p o r t u n i t i e s i n r u r a l areas o f Mexico.  The r e l a t i v e l y  low  p o s i t i v e value o f i n f r a s t r u c t u r e means the p r o j e c t i s  173 socially self  " f i n a n c i n g " y e t i t does not appear to  o f f e r major b e n e f i t s t h a t I n i t i a l thoughts j e c t i n d i c a t e d . The  on the pro-  l a s t category of s o c i a l  interest  d e a l s with p o l i t i c a l b e n e f i t s p o t e n t i a l l y a v a i l a b l e .  The  c r e a t i o n of a town w i t h modern f a c i l i t i e s may  new  form a  f o c a l p o i n t f o r the a g r i c u l t u r a l community, f o r example, and h e l p i n the n a t i o n a l 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 a v a i l a b l e by the p r o j e c t and spread to a l a r g e r segment of the p o p u l a t i o n w i l l c o n t r i b u t e to national stability,  p r o v i d i n g of course, the p r o j e c t i s not  to be an i s o l a t e d area o f improvement f o r an e l i t e The  s i z e of the p r o j e c t ' s s o c i a l value leads to the  c l u s i o n t h a t the Mexican government a c t i n g i n the est  group. con-  inter-  of the n a t i o n w i l l encourage the i n v e s t o r s to under-  take the mine commitment. TABLE XXVII Mexican Mining Company S.A. de C.V. S o c i a l B e n e f i t s and Costs - Summary (Expressed i n 1979 constant United S t a t e s d o l l a r s ) Net S o c i a l Value Tax revenue Table XXIV 50% of 42 392 000 21 196 000 F o r e i g n currency i n f l o w and outflow 74 774 000 Table XXV 50% of 149 548 000 Employment 40 000 000 Infrastructure Table XXVI 3 000 000 Other, mostly p o l i t i c a l value 10 000 000 Present value of estimated net s o c i a l Note: 1)  benefit  148  970  000  14% 50% 27% 2% 7% 100%  Tax revenue and f o r e i g n currency net i n f l o w are d e r i v e d from the same source of mine product v a l u e . Both are v i t a l t o the government f o r economic s t a b i l i t y and f o r purposes of t h i s paper are assigned equal weight. Hence, t h e i r present values are r e duced to 50% i n a r r i v i n g a t the cumulative net soc i a l v a l u e of the mine p r o j e c t .  174 7.6  V a l u a t i o n of the p o t e n t i a l mine The  two  s i g n i f i c a n t questions r a i s e d i n Chapter  one  r e l a t e to a p o r t i o n o n l y of the p o t e n t i a l mine i n Zacatecas:  a t h i r t y - f o u r percent m i n o r i t y i n t e r e s t .  The value of the p a r t depends on the value of the e n t i r e p r o j e c t and t h i s s e c t i o n i s devoted  to a v a l u a t i o n of  the orebody h e l d by Mexican Mining Company S.A.  de  C.V.  The next s e c t i o n s w i l l answer the q u e s t i o n s : What i s the value of P l a c e r Development L i m i t e d ' s m i n o r i t y i n t e r e s t i n Mexican Mining Company S.A. de C.V., and should P l a c e r i n v e s t a d d i t i o n a l funds and o t h e r resources i n Mexico to b u i l d and operate the proposed s i l v e r mine? The q u e s t i o n s are assumed to be posed by P l a c e r Development L i m i t e d i n an atmosphere o f improved  rela-  t i o n s w i t h i t s p a r t n e r s i n Mexico, mid-1979 mining i n d u s t r y g e n e r a l c o n d i t i o n s and a completed study on the Zacatecas  feasibility  property.  Four methods of v a l u a t i o n are d i s c u s s e d i n Chapter five.  The a s s e t a p p r a i s a l method i s r e j e c t e d as  having  no r e l e v a n c e to a m i n e r a l orebody, but three o t h e r s , i t i s suggested, One  can be used t o e s t a b l i s h a mine v a l u e .  of the three methods i s used i n the p r e v i o u s s e c t i o n  to a r r i v e a t a mine s o c i a l value of US Mexico.  $148  970  000  to  However, i t does not p r o v i d e the b a s i s of a  commercial value of the orebody; i n s t e a d i t i n d i c a t e s a high l e v e l of acceptance government.  The  of the p r o j e c t i n the eyes of  s i z e of the p o s i t i v e s o c i a l value  leads  one t o the c o n c l u s i o n t h a t government w i l l not stand i n the way  of development of the orebody and, p r o v i d i n g po-  litical  f a c t o r s do not assume major p r o p o r t i o n s , the  l i k e l y s u c c e s s f u l o p e r a t i o n of the mine u n t i l the h a u s t i o n o f ore i n approximately of  grave  twenty y e a r s .  ex-  The  risk  f i n a n c i a l l o s s through government i n t e r f e r e n c e  i s not c o n s i d e r e d h i g h owing to the avowed p o l i c y of government to a t t r a c t f o r e i g n investment, of  the h i s t o r y  reasonable compensation f o r p r o p e r t y n a t i o n a l i z e d ,  and the 12.1%  r e t u r n on investment  f o r e c a s t to be  earned  a f t e r ten o p e r a t i n g years under base l o a n case c o n d i t i o n s (Appendix to  4, case 102).  In the twenty-two years needed  prepare the mine and e x t r a c t a l l the known ore r e s e r v e s ,  f i v e p r e s i d e n t s of Mexico w i l l have been i n power.  Fore-  c a s t s of p r e s i d e n t i a l treatment of m i n e r a l resources  and  the Zacatecas p r o p e r t y i n p a r t i c u l a r have l i t t l e b a s i s in  f a c t and i t i s b e l i e v e d nobody can p r o v i d e a r e l i a b l e  prediction.  The  f u t u r e p o l i t i c a l t r e n d i n Mexico r e p r e -  sents a r i s k the shareholders are w i l l i n g t o take. remaining two v a l u a t i o n methods; earnings  The  capitalization  and cash flow methods, take account of i n f l u e n c e s on  the  value of the orebody and a review of the f i n a n c i a l r e s u l t s , t h e i r u n d e r l y i n g assumptions and the  surrounding  circumstances, i s needed p r i o r to making the v a l u a t i o n s . F o r e c a s t r e s u l t s are d e s c r i b e d e a r l i e r i n t h i s and Table XIX expected  summarizes s e l e c t e d cash flows and  r e s u l t s based  Chapter  the  on p r o b a b i l i t i e s of case o c c u r r -  176 ence s e t by the w r i t e r .  As p r e v i o u s l y noted, the ex-  pected r e s u l t s c o n t a i n a b i a s toward a p e s s i m i s t i c view as metal p r i c e s h i g h e r than those used i n the base case are not i n c l u d e d i n any o t h e r cases.  N e v e r t h e l e s s , ex-  pected v a l u e s 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 v a l u e s . over the f i r s t  Earnings f o r e c a s t s average  US $5 994 000  f i v e years a c c o r d i n g t o Table XXI, a f t e r  a l l o w i n g f o r a l o s s o f US $1 626 000 i n the i n i t i a l o p e r a t i n g year d e s p i t e a v i r t u a l breakeven before taxes. However, the w i t h h o l d i n g tax o f 21% borne by the shareholders  (not Mexican Mining Company S.A. de C.V.)  the f i v e - y e a r annual average  reduces  t o US $4 735 000.  Key assumptions made i n e s t a b l i s h i n g the f i n a n c i a l r e s u l t s r e l a t e t o data f o r ore r e s e r v e s , s a l e a b l e metal p r o d u c t i o n , c o n s t r u c t i o n and o p e r a t i n g c o s t s and metal prices.  Tables X t o XVIII c o n t a i n the d e t a i l s w i t h notes.  A d r i l l i n g programme has p r o v i d e d i n f o r m a t i o n t o determine t h a t s u f f i c i e n t proven mineable ore r e s e r v e s e x i s t and t e s t s on ore samples have shown t h a t i t i s f e a s i b l e to produce the concentrates i n s a l e a b l e form from the ore reserves.  The f e a s i b i l i t y study has been prepared by  P l a c e r personnel and p r o d u c t i o n t a r g e t s h o r t f a l l s are not a n t i c i p a t e d as wide s a f e t y margins have been allowed for  to ensure  achieved.  the f o r e c a s t l e v e l s o f p r o d u c t i o n are  A c c o r d i n g l y , performance guarantees  and cus-  tomer c o n t r a c t s f o r minimum c o n c e n t r a t e q u a n t i t i e s t o be s o l d do not r e p r e s e n t major r i s k s t o the owners o f the  177 orebody a t the time o f the c o n s t r u c t i o n go-ahead d e c i s i o n . Metal p r i c e s i n the base case are s a i d t o be 70% c e r t a i n of being e q u a l l e d or b e t t e r e d and they a r e a t l e v e l s much below c u r r e n t p r i c e s .  Sales w i l l not begin  until  the t h i r d year f o l l o w i n g the d e c i s i o n t o i n v e s t so current p r i c e s are of l i t t l e  i n t e r e s t except t o the ex-  t e n t they hasten a d e c l i n e i n p r i c e s t o c o i n c i d e with the e a r l y years o f the mine's o p e r a t i o n s .  Mining com-  panies accept a 70% c e r t a i n l e v e l i n metal p r i c e s as conservative.  C o n s t r u c t i o n c o s t s a r e estimated  based  on d i s c u s s i o n s w i t h s u p p l i e r s o f m a t e r i a l s and s e r v i c e s u s i n g broad d e s i g n concepts.  Although  some design  changes w i l l occur t o amend c o s t e s t i m a t e s , c o n s t r u c t i o n c o s t s g r e a t e r than 110% o f the base case c o s t o f $75  105 000 are not c o n s i d e r e d a h i g h r i s k  (Appendix  5,  case 5 ) . Operating c o s t f o r e c a s t s are based on l a b o r a t o r y t e s t s and d e t a i l e d c o s t estimates o b t a i n e d  through  c o n s u l t a t i o n between m i l l i n g e x p e r t s and m a t e r i a l s suppliers.  Again a 10% i n c r e a s e above f o r e c a s t c o s t s  does not r e p r e s e n t an important r i s k  (Appendix  5, case 6 ) .  There are two o t h e r assumptions worthy o f a t t e n t i o n . F i r s t l y , the use o f constant d o l l a r s i n f i x i n g c o s t s , revenues and b e n e f i t s and, secondly, the r i g h t to conduct mining o f the orebody.  I t i s accepted t h a t Mexico w i l l  continue t o experience p r i c e l e v e l i n f l a t i o n . adjustments  However,  f o r p r i c e l e v e l changes i n the p r o j e c t ' s  f i n a n c i a l c a l c u l a t i o n s are d i f f i c u l t i f not i m p o s s i b l e  178 to q u a n t i f y with an acceptable  degree o f accuracy.  i s the p r a c t i c e o f both P l a c e r and t h e i r p r i v a t e Mexican p a r t n e r  t o express f e a s i b i l i t y  t i o n data i n terms o f constant  It  sector  study and evalua-  currency,  using i n t e r e s t  r a t e s unadjusted f o r t h a t p o r t i o n o f the r a t e thought t o represent  i n f l a t i o n a r y expectations.  The r i g h t t o con-  duct mining o f the orebody i s h e l d by Mexican Mining Company S.A. de C.V. but j u s t as r i g h t s are given, so they can be withdrawn. not considered  great whether i t be i n the form o f new  mining c o n d i t i o n s met  The r i s k o f l o s i n g the r i g h t i s  imposed which f o r some reason are not  o r a method o f n a t i o n a l i z a t i o n .  I f the Zacatecas  orebody i s s i n g l e d out f o r such treatment f o r e i g n i n vestment i n Mexico w i l l be a f f e c t e d A l l mining p r o j e c t f e a s i b i l i t y  detrimentally. s t u d i e s i n v o l v e the  use o f u n c e r t a i n data and the i n d u s t r y has l e a r n e d d e c i s i o n s and operate with i t .  I t i s believed  t o make  that  assumptions r e f e r r e d t o i n t h i s and p r i o r Chapters are w i t h i n l i m i t s acceptable  t o the i n d u s t r y as a whole.  There are c o n d i t i o n s which can be foreseen  leading to a  much improved f i n a n c i a l p i c t u r e such as higher p r i c e s , higher  production  r a t e s based on a s h o r t e r mine  l i f e and the removal o f w i t h h o l d i n g which represent introduced  tax on  "dividends"  recoupment o f the i n i t i a l e q u i t y  v i a an i n t e r e s t f r e e l o a n .  capital  There i s always the  hope o f f i n d i n g new mineable ore r e s e r v e s . negative  metal  A possible  f a c t o r r e l a t e s t o changes i n r e a l wages i n  Mexico.  Although no i n c r e a s e s i n r e a l wages a r e i n -  cluded i n the c a l c u l a t i o n o f c o n s t r u c t i o n and o p e r a t i n g c o s t s , an assessment o f t h e i r p o s s i b l e impact on the p r o j e c t ' s v i a b i l i t y has been made.  Past experience has  shown t h a t as employee c o s t s r i s e , changes i n mining and p r o c e s s i n g methods occur which o f f s e t the labour c o s t i n creases.  The s i z e o f the work f o r c e planned  f o r Mexico  leaves p l e n t y o f leeway t o make the p r o j e c t l e s s labour intensive. Mexico's economic and p o l i t i c a l circumstances cussed i n Chapter  dis-  three from a mining viewpoint are i n  a more f a v o u r a b l e p o s i t i o n i n 1979 than f o r s e v e r a l years p a s t .  The time f o r s u b s t a n t i a l investment  i s judged to be now.  there  The orebody i s ready f o r develop-  ment and the way i s c l e a r to. do so. A l l l e g a l  matters  of consequence are s e t t l e d , l a b o u r , equipment and s u p p l i e s can be obtained to complete c o n s t r u c t i o n e f f i c i e n t l y and f o r e i g n exchange i s a v a i l a b l e to a c q u i r e necessary imports.  Mexican government resource p o l i c y  i s c l e a r l y s u p p o r t i v e o f mining development and, although the t a x b i t e o u t o f the v a l u e o f p r o d u c t i o n i s h i g h , the f o r e c a s t net cash flow i s adequate t o p r o v i d e a 15.2% r e t u r n on an a l l e q u i t y  investment.  The r i s k t h a t base case c o n d i t i o n s w i l l prove m i s t i c over the mine l i f e , p e r i o d o f investment  opti-  i n p a r t i c u l a r d u r i n g the  payback, i s a t an a c c e p t a b l e  level  180 to most experienced mining companies i n the medium large size categories.  The  assumptions i s l i k e l y to be  most c o n t e n t i o u s of the  p e r i o d s of s t a b l e s i l v e r p r i c e s ,  ions on the  subject  discuss-  of long term average s i l v e r  w i l l open a wide range of v a l u e s .  mic  a l l - t i m e highs and  p i c t u r e unclear,  In 1979,  $1.50  are  sometimes s t r a i n e d to t h i n k  the world-wide econo-  to $5.00 per ounce range.  change i n metal markets.  mid  1979  XXVIII). but  but  not  The  1979  prices in  Mining companies  soberly i s one  i n times of  such p e r i o d  rapid  and  the  ($6/oz) of s i l v e r appears very low  so i f viewed i n h i s t o r i c  terms  s i l v e r p r i c e i s c u r r e n t l y on the  an i n v e s t o r  silver  the temptation i s to assume s i l v e r  the  $193/kg  prices  with  p r i c e s w i l l remain w e l l above the t r a d i t i o n a l  p r i c e of US  the  f o r e c a s t metal p r i c e s .  Even d u r i n g  p r i c e s at new  and  i n the  Zacatecas mine has  to  in  (Table up-swing  consider  where i n i t s p r i c e c y c l e w i l l s i l v e r be at the time of the  f i r s t c o n c e n t r a t e shipment more than two  an investment d e c i s i o n i s made. d e c i s i o n to hedge the  years a f t e r  As mentioned e a r l i e r ,  s i l v e r p r i c e of f u t u r e  production  i s c o n s i d e r e d very r i s k y owing to the  l a c k of  majeure i n the  $193/kg of  f u t u r e s market.  l e s s 9% p r o d u c t i o n tax,  the  At US  costs  s i l v e r i n the penultimate year of o p e r a t i o n s . XVIII  refer).  silver  i n the range of  $105/kg of s i l v e r produced i n year 2 to US  XIII and  force  Zacatecas mine i s v i a b l e w i t h  a s u b s t a n t i a l margin over o p e r a t i n g US  a  $136/kg of (Tables  181 TABLE XXVIII Silver - Historic Prices S e l e c t e d New York Average Annual P r i c e s - US $/kg (US $/troy oz) US $/kg 1910 1920 1930 1940 1950 1960 1970 1975 1978  US $/troy oz  17.20 32.44 12.27 11.18 23.85 29.38 56.93 142.06 173.64  0.53 1.01 0.38 0.35 0.74 0.91 1.77 4.42 5.40  S i l v e r i s regarded w i t h i n the mining i n d u s t r y as a good metal t o be i n d u r i n g the 19 80's and, as the margin of long term p r i c e over o p e r a t i n g c o s t s i s wide, the r i s k o f mine c l o s u r e owing t o depressed market c o n d i t i o n s i s not h i g h . ahead  The r i s k o f bankruptcy assumed a f t e r a go-  investment d e c i s i o n t o b u i l d i n Zacatecas i s low  and the s i z e o f the p r o j e c t i s such t h a t many medium and l a r g e mining companies c o u l d , under d i r e circumstances, absorb the shock o f a complete  l o s s o f the p r o j e c t .  The  s i z e o f the p r o j e c t and the low r i s k o f bankruptcy coupled with the cash flow f o r e c a s t s and s u p p o r t i n g data, suggests t h e r e i s a l a r g e number o f p o t e n t i a l should the orebody be o f f e r e d f o r s a l e .  buyers  P o t e n t i a l pur-  chasers o f m i n e r a l a s s e t s are t o be found i n the o i l and gas i n d u s t r y as w e l l as the mining i n d u s t r y i t s e l f .  The  major o i l companies have made major a c q u i s i t i o n s i n mining d u r i n g the l a t e 1970's and p r i c e c o m p e t i t i o n f o r a proven s i l v e r orebody  i n Mexico c o u l d be i n t e n s e .  Even  the Mexican government c o u l d be a w i l l i n g buyer. However,  182 non-Mexican p o t e n t i a l 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 v a l u a t i o n , s u f f i c e i t to say the orebody i s readily 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  f a c t o r which has  to c o n s i d e r the average annual f o r e c a s t  earnings and  i n e a r l y years, the long-term t r e n d i n  the l i f e of the mine.  years  The  initial  are f o r e c a s t to r e c o r d earnings  owners o f the orebody of US  $4 735  annual average i s US  000  $7 146  five  earnings  operating  a f t e r taxes to  000  and  (Table XXI,  the m i n e - l i f e note 7).  Both averages are p r i o r to d e p l e t i n g the c o s t of a c q u i r i n g the orebody but a f t e r mine c o n s t r u c t i o n c a p i t a l expenditure. XIX,  The  case number 101)  of any 8.5  payback p e r i o d of 6.5  production  w i l l delay i n i t i a l  years  (Table  cash recoupment  p o r t i o n of the orebody a c q u i s i t i o n c o s t a t o t a l of  years  a f t e r a d e c i s i o n to a c q u i r e the orebody i s made.  At t h a t time the orebody i s approximately one  third  ex-  hausted and Mexico i s under the guidance of i t s second p r e s i d e n t f o l l o w i n g the incumbent, P r e s i d e n t Lopez.... I t may  be p o s s i b l e to f i n d a purchaser of the orebody i n  a p o s i t i o n to o b t a i n a deduction  from t a x a b l e  the amount p a i d to a c q u i r e the orebody.  income f o r  In such a case  the net c o s t of a c q u i s i t i o n i s lower per d o l l a r of purchase c o n s i d e r a t i o n and if  the m u l t i p l i e r may  be  increased  the purchaser wants the orebody badly enough.  d u c t i o n i s p o s s i b l e i n Canada but Mexican tax law  A  de-  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  a g a i n s t Mexican t a x a b l e income i s more d i f f i c u l t arrange.  For t h i s v a l u a t i o n , i t i s assumed no  i s a v a i l a b l e to reduce  to  deduction  the net c o s t of a c q u i r i n g the  orebody. A m u l t i p l i e r of f o u r a p p l i e d to the average  annual  net earnings f o r the i n i t i a l  f i v e years of o p e r a t i o n s  p l a c e s a value of US  000 on the orebody but the  $18  940  investment would not be recovered u n t i l 7.8  years of o p e r a t i o n s had elapsed  ten  years a f t e r purchase.  average  (Table XXIX);  On an earnings b a s i s ,  almost the  net earnings would be reduced by d e p l e t i o n of  the purchase  p r i c e of US  $947 000  i n c r e m e n t a l c o n s o l i d a t e d average owner of the orebody are US $947 000) an average  $6 199  000  Therefore,  net earnings to the  $3 788  over each of the f i r s t of US  annually.  000  (US $4 735  new  000  less  f i v e o p e r a t i n g years  (US $7 146  over the e n t i r e mine o p e r a t i n g l i f e . of  approximately  000  l e s s $947  and 000)  A recovery p e r i o d  almost e i g h t o p e r a t i n g years i s a h i g h r i s k f a c t o r f o r  a mine w i t h proven ore r e s e r v e s s u f f i c i e n t f o r twenty years and s t e a d i l y r i s i n g o p e r a t i n g c o s t s per k i l o g r a m of  s i l v e r produced  as the ore r e s e r v e s approach exhaustion.  A m u l t i p l i e r of two earnings f o r the i n i t i a l  a p p l i e d to the average  annual  net  f i v e years of o p e r a t i o n s d e t e r -  mines a value f o r the orebody of US  $9 470  m u l t i p l i e r of f i v e o b t a i n s a value of US  000 and a  $23  675  000.  The  range o f these two values delays recoupment of a l l i n v e s t -  184 ment expenditure to  by between 0.7 o f a year and 1.6 years  7.2 and 8.1 years o p e r a t i o n s r e s p e c t i v e l y .  Whether  the delay i s 0.7 or 1.6 y e a r s , the q u e s t i o n appears immaterial  as the d i f f e r e n c e i s l e s s than one year and  few purchasers  o f the orebody w i l l be concerned  such a minor e x t e n s i o n o f the payback p e r i o d .  over Greater  emphasis w i l l be assigned t o the r e l a t i o n s h i p o f p r i c e to  u l t i m a t e n e t earnings o f US $180 927 000 (Table XIX,  case  101) over the whole mine l i f e .  Two years n e t  earnings o f US $9 470 000 r e p r e s e n t s 5%; a m u l t i p l i e r o f three r e p r e s e n t s  8%; four times average net earnings o f  US $4 735 000 r e p r e s e n t s  10% and a f a c t o r o f f i v e  raises  the percentage o f mine l i f e net earnings p a i d f o r t o 13% (Table XXIX). I t has been s a i d above t h a t e i g h t o p e r a t i n g years out of  a t o t a l mine l i f e o f twenty to achieve  back i s h i g h .  investment  pay-  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 o f aggregate n e t e a r n i n g s , i t r e p r e s e n t s a purchase p r i c e o f t e n cents f o r every d o l l a r o f f u t u r e net earnings expressed dollars.  i n constant  I t i s a t t h i s p o i n t the v a l u a t o r r e t u r n s t o the  r e a l world and r e i n t r o d u c e s the element o f i n f l a t i o n a r y expectations tions.  so n e a t l y removed i n a l l p r e v i o u s  calcula-  T h i s i s a time o f great i n t e r n a t i o n a l economic  uncertainty.  P r i c e l e v e l i n f l a t i o n i s w e l l entrenched i n  the United S t a t e s o f America, Mexico, Canada and many other c o u n t r i e s .  Anyone who examines the past  behaviour  TABLE XXIX Mexican Mining Company S.A. de C.V. Orebody V a l u a t i o n s Based on M u l t i p l i e r o f Net Earnings (Expressed i n thousands o f 1979 constant United States D o l l a r s ) US $000 Orebody value Production Average Value as % of 20 Purchaser s annual net p l a c e d on Years to Return on year t o t a l earnings orebody i n Investment Payback net earnings (Note 1) Zacatecas (Note 4) (Note 2) (Note 3) 1  Value o f Multiplier  US $4 735  0 2  6.  5 Base  US $ 9 470  7. 2  5%  13.0%  11 837  7 3  7%  12.5%  14 205  7 5  8%  12.1%  3.5  16 572  7 6  9%  11.7%  4  18 940  7 8  10%  11.3%  4.5  21 307  8.0  12%  10.9%  5  23 675  8.1  13%  10.5%  2.5 3  Note:  US  1)  Net earnings o f US $4 735 000 are a f t e r loan i n t e r e s t expense (Table XXI) and the 21% w i t h h o l d i n g t a x on dividends to shareholders averaged over the f i r s t f i v e years o f p r o d u c t i o n .  2)  P r o d u c t i o n years t o payback are based on cash flow case number 101, the base l o a n case f o r the f i n a n c i n g d e c i s i o n , i . e . , before the d i v i d e n d w i t h h o l d i n g tax o f 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 . , b e f o r e the d i v i d e n d w i t h h o l d i n g tax of 21%.  4)  The purchasers r e t u r n on investment assumes base e q u i t y case number 1 circumstances b e f o r e the 21% d i v i d e n d w i t h h o l d i n g t a x . OD Ul  186 of s i l v e r and other metal p r i c e s w i l l agree t h a t c u r r e n t h i g h p r i c e s f o r 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 p r i c e f a l l and the t i m i n g of the d e c l i n e .  P o t e n t i a l buyers of  the Zacatecas p r o p e r t y w i l l have i n d i v i d u a l ideas on both the e f f e c t s of i n f l a t i o n on the c u r r e n c i e s of Mexico and the USA  and the s i l v e r metal p r i c e movements.  P l a c e r p a i d Cdn  $5.1 m i l l i o n to purchase a 30%  i n t e r e s t i n a s i l v e r orebody  in central British  (Equity S i l v e r Mine) i n e a r l y 1979. grossed up f o r a 100% f o r the orebody  of Cdn  Columbia  The amount when  i n t e r e s t f i x e s an unadjusted v a l u e $17 m i l l i o n  p r e v a i l i n g exchange r a t e s ) .  (US $14.6  m i l l i o n at  The f o r e c a s t s i l v e r  produc-  t i o n r a t e s , and t o t a l s of o p e r a t i n g c o s t s , income taxes and c a p i t a l expenditures of the two p r o p e r t i e s  suggest  the Mexican mine i s better, aided by g r e a t e r proven r e serves and e a s i e r m e t a l l u r g y .  However, p r o d u c t i o n taxes  and w i t h h o l d i n g taxes on d i v i d e n d s to a l l owners r e verses the r a n k i n g . The  Zacatecas and c e n t r a l B r i t i s h Columbia  mines are  both l a r g e s i l v e r open p i t mines although f o r e c a s t prod u c t i o n r a t e s i n Zacatecas are approximately f i f t y cent g r e a t e r than E q u i t y ' s .  Higher tax r a t e s and  tax payments e l i m i n a t e the advantage the Zacatecas orebody  perearlier  otherwise h e l d by  and the Canadian p r o p e r t y i s f o r e -  c a s t t o be able to achieve g r e a t e r net earnings over the investment payback years of o p e r a t i o n s accompanied by a  187 more r a p i d g e n e r a t i o n of cash a f t e r c o s t s and t a x e s . The l o n g e r l i f e of the Zacatecas p r o p e r t y does much to r e d r e s s i t s p o s i t i o n l e a v i n g i t s r e t u r n on an a l l e q u i t y investment a l i t t l e worse, but i t s undiscounted cash flow to  owners b e t t e r than the E q u i t y s i l v e r mine.  The  p r i n c i p a l d i f f e r e n c e s between the two o r e b o d i e s d i s cussed above are t h e i r l o c a t i o n , the Canadian  orebody's  a b i l i t y to generate cash more r a p i d l y e a r l y i n the mine life,  and the aggregate net e a r n i n g s .  Location d i f f e r -  ences a f f e c t p o l i t i c a l and c l i m a t i c c o n d i t i o n s , water availability, market a c c e s s .  labour supply, equipment a v a i l a b i l i t y  and  The second d i f f e r e n c e serves t o reduce  the r i s k of l o s s e s by s h o r t e n i n g the p e r i o d of debt  ser-  v i c i n g and to improve the a b i l i t y to r e c o v e r from a prolonged market metal p r i c e down t u r n as l o s s e s f o r tax purposes  i n Canada do not f a l l o f f the s h e l f a f t e r three  years as they do i n Mexico.  The t h i r d d i f f e r e n c e favours  the Zacatecas orebody as over the e n t i r e mine l i f e i t generates more than twice the net e a r n i n g s .  Mine  life  net earnings equal mine l i f e aggregate net cash flows. During the o p e r a t i n g p e r i o d the two are d i s s i m i l a r owing to  t i m i n g d i f f e r e n c e s i n r e c o g n i t i o n o f earnings  p r i n c i p a l l y by d e p r e c i a t i o n .  The  caused  longer mine l i f e of the  Zacatecas orebody o f f e r s p r o s p e c t i v e purchasers of the p r o p e r t y g r e a t e r p r o f i t o p p o r t u n i t i e s through of  inflation  p r i c e l e v e l s and through the e x t r a p r i c e c y c l e a t the  end of i t s l i f e when compared with E q u i t y S i l v e r .  188 The  Zacatecas orebody  i s a v i a b l e s i l v e r mine ready  to be developed a t a time when s i l v e r p r i c e s are a t r e c o r d levels.  E x p e c t a t i o n s o f p r i c e l e v e l i n f l a t i o n are  exaggerated when s i l v e r p r i c e s i n 1979 a r e viewed i n h i s t o r i c a l terms and the metal i s seen worldwide investment hedge a g a i n s t i n f l a t i o n .  as an  In mid 1979, a  p r o s p e c t i v e purchaser o f the Zacatecas orebody  knowing  the economic r e s u l t s d e s c r i b e d e a r l i e r i n t h i s  Chapter,  w i l l pay t h r e e , but p o s s i b l y up t o four times the i n i t i a l f i v e years average annual net earnings to p l a c e 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 o f approximately US $14 m i l l i o n w i t h a high value of US $19 m i l l i o n . The v a l u e range o f US $14 m i l l i o n t o US $19 m i l l i o n based on f o r e c a s t net earnings a f t e r l o a n i n t e r e s t expense p r o v i d e s the purchaser with a r e t u r n on an a l l e q u i t y investment o f between 11.3% and 12.1% (Table XXIX). C l e a r l y , the r a t e o f r e t u r n w i l l not surpass the customary hurdle, r a t e s i n the Canadian mining i n d u s t r y which a r e g e n e r a l l y agreed to be c l o s e t o 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  c o n d i t i o n s i n Mexico coupled with a low o p e r a t i n g 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 r e s u l t s f o r base case number 1 (Table XIX) a l l e q u i t y funded f o r investment d e c i s i o n purposes  indicates  the e n t i r e p r o j e c t a l l o w s a p o s i t i v e p r e s e n t value o f the  189 f o r e c a s t cash flow a f t e r d i s c o u n t i n g a t f i f t e e n p e r c e n t . However, the present value i s s m a l l a t US  $577 000.  If  twelve percent i s used the present value i s i n c r e a s e d to US  $14.6  million.  Reasons c i t e d above i n a r r i v i n g a t a  m u l t i p l i e r of three a p p l i e d to net earnings are a l s o r e l e v a n t to a v a l u a t i o n of the orebody based on cash f l o w s . I n f l a t i o n a r y i n c r e a s e s i n annual net cash flow w i l l  permit  e a r l i e r payback of bank indebtedness  will  be used to repay o l d d o l l a r s . undoubtedly  fall  The  as new  dollars  s i l v e r metal p r i c e  will  from i t s present h e i g h t as f a i t h i n the  p r i c e c y c l e i s not l o s t .  Purchasers of the  Zacatecas  orebody w i l l i n g to pay a h i g h b i d p r i c e w i l l do so on the assumption exceed  t h a t the s i l v e r p r i c e i n constant d o l l a r s  the US  $193/kg (US $6/oz) used i n the cash  will  flow,  r e g a r d i n g as too c o n s e r v a t i v e the 70% l e v e l of c o n f i d e n c e in  t h a t long-term average  price.  The mood surrounding s i l v e r i n 1979  suggests t h a t  buyers w i l l a s s i g n value to the l e n g t h of the mine  life  and p o s s i b l e a d d i t i o n s to ore r e s e r v e s as the mine develops. to  The e f f e c t i s to reduce  the investment  the r e g i o n of twelve p e r c e n t and p l a c e a value on the  whole orebody based mately  US  $14.6  on the cash flow method of a p p r o x i -  million.  The e n t i r e orebody i n Zacatecas in  hurdle r a t e  the range US  $14 m i l l i o n to US  w i t h a most l i k e l y v a l u e of US  i s t h e r e f o r e valued  $19 m i l l i o n i n mid  $14.6  million.  1979  190  7.7  V a l u a t i o n o f P l a c e r ' s i n t e r e s t i n the mine P l a c e r Development L i m i t e d holds a t h i r t y - f o u r cent s h a r e h o l d i n g i n t e r e s t i n Mexican Mining  Company  S.A. de C.V. which i n t u r n holds the Zacatecas mining r i g h t s f r e e o f encumbrance.  per-  orebody  The p r o - r a t a value o f  P l a c e r ' s i n t e r e s t i n the e n t i r e orebody ranges from US $4.8. m i l l i o n t o US $6.5 m i l l i o n but, as shareholders s u f f e r a twenty-one percent w i t h h o l d i n g tax on d i v i d e n d s , the value i s reduced US $5.1 m i l l i o n .  to between US $3.8 m i l l i o n and  The most l i k e l y value i s US $3.9 m i l l i o n .  However, P l a c e r ' s p o s i t i o n may vary the p r o - r a t a value r e cognizing special benefits available or p a r t i c u l a r  concerns  of i t s management. P l a c e r ' s s h a r e h o l d i n g c a r r i e s no r e s t r i c t i o n s on t r a n s f e r t o a t h i r d p a r t y ; i t may be h e l d by Mexicans o r non-Mexicans a l i k e .  A maximum d i v i d e n d p o l i c y i s r e -  q u i r e d by the r u l e s o f i n c o r p o r a t i o n of Mexican Mining Company S.A. de C.V. and a l l i t s major p o l i c y d e c i s i o n s and commitments r e q u i r e s i x t y - e i g h t percent o f shareh o l d e r votes b e f o r e a u t h o r i z a t i o n may be g i v e n . have s e t t l e d the important o b j e c t i v e t o develop prise conditions.  Partners  p o l i c i e s i n c l u d i n g the common  the Zacatecas mine under f r e e e n t e r -  P l a c e r has s h i f t e d i t s e x p l o r a t i o n  emphasis t o Canada s i n c e 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 o f America. The poor experience  i n Mexico i n 1976 i s the most l i k e l y  cause o f t h a t s h i f t but P l a c e r ' s long-term  f a i t h i n the  191 Mexican mining i n d u s t r y was when i n 1977  demonstrated p a r t i c u l a r l y  i t s Mexican p a r t n e r s  cash and P l a c e r p a i d the corporate costs.  d i d not and  contribute  orebody h o l d i n g  P l a c e r does have the w i l l to persevere  e f f o r t s to develop the Zacatecas p r o p e r t y  in i t s  although  there  may  be l e s s i n c e n t i v e to r i s k t h e i r c a p i t a l and  ing  r e p u t a t i o n 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  good min-  performance guarantees are  r e q u i r e d of P l a c e r to put the f i n a n c i n g package i n p l a c e . At t h i s time, o f f Balance Sheet p r o j e c t f i n a n c i n g i s a n t i c i p a t e d by P l a c e r and  the small amount of e q u i t y  c a p i t a l needed i s f o r e c a s t to be a v a i l a b l e out of P l a c e r ' s present  cash balances.  I f the Zacatecas p r o j e c t goes  ahead, P l a c e r i s not expected to experience  regret i n  making the investment i n Mexico owing to the needs of subsequent p r o j e c t s .  capital  However, advantage  may  accrue through P l a c e r ' s o p e r a t i n g presence i n Mexico as mining o p p o r t u n i t i e s not otherwise a v a i l a b l e may forthcoming.  be  Taxable income earned i n Mexico from the  p r o j e c t w i l l serve to reduce the c o s t of f u r t h e r e x p l o r a t i o n i n t h a t country  to 38%  i n s t e a d of the f u l l  outlay.  The  of expenditure  (Table  VI)  s i z e of the f i n a n c i a l commitment, by P l a c e r to  the  e n t i r e l y p r o j e c t f i n a n c e d mine i s not such as to ever p l a c e the company i n danger of compulsory l i q u i d a t i o n or receivership.  The  partners  are not f o r e c a s t i n g the need  192 f o r guarantees to l e n d e r s by P l a c e r so P l a c e r ' s  total  commitment o f 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 o f the e q u i t y funds.  There are e x t r a  risks  a t t r i b u t a b l e to a f o r e i g n investment i n the n i n e t y m i l l i o n d o l l a r range but, as d i s c u s s e d i n Chapter t h r e e , these r i s k s are a t an a c c e p t a b l e l e v e l i n 1979.  There  i s a l s o seen to be a c o s t a t t a c h e d to P l a c e r withdrawing support f o r a p r o d u c t i o n d e c i s i o n o r s e l l i n g i n t e r e s t i n Mexican Mining Company S.A.  their  de C.V.  Such a  withdrawal w i l l be seen as a l a c k o f r e s o l v e to make f o r e i g n mining investments and P l a c e r ' s o t h e r f o r e i g n e x p l o r a t i o n ventures w i l l s u f f e r a c c o r d i n g l y .  I t does  not go unnoticed t h a t the l a s t mine developed by P l a c e r o u t s i d e North America was  ten years ago and p r i o r to  t h a t one must look back to the 1930's f o r the p r e v i o u s s u c c e s s f u l f o r e i g n venture. There need be no a i r o f d e s p e r a t i o n f o r P l a c e r t o make a f o r e i g n investment.  The company does have i n t e r e s t i n g  domestic m i n e r a l p r o s p e c t s i n i t s i n v e n t o r y .  I t also  has  an e n t r y i n t o s i l v e r p r o d u c t i o n v i a E q u i t y S i l v e r so has a t t a i n e d 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 p r o d u c t s .  On the o t h e r hand,  p o l i t i c s i n Canada and B r i t i s h Columbia  in particular  have blown c o l d on mining i n the 1970's and, although a degree of s t a b i l i t y has been r e s t o r e d , i t i s obvious t h a t to spread the mining a c t i v i t y t o v a r i o u s n a t i o n s r e p r e sents another form o f 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 t e c t i o n to P l a c e r a g a i n s t the r e t u r n of more demanding government i n Canada. Table XX  shows t h a t the investment d e c i s i o n base  case f o r P l a c e r has  a r e t u r n on investment of 10.5%, h a l f  a p o i n t above the expected case r e s u l t of 10%.  These  r e s u l t s are much worse than the p r o j e c t r e t u r n s owing to the twenty-one percent Table XX  withholding  taxes on  dividends.  a l s o shows r e t u r n s which are improved by  large  tax i n c e n t i v e s but even those r e s u l t s are not  impressive  and  In a d d i t i o n ,  it  t h e i r p r o b a b i l i t y of occurrence i s s m a l l .  i s not P l a c e r ' s p o l i c y to accept s p e c i a l s u b s i d i e s  tax i n c e n t i v e s which convert  uneconomic p r o j e c t s  economic ones at the stroke of a pen.  and  to  Subsidies  and  tax  i n c e n t i v e s can be withdrawn l e a v i n g the i n v e s t o r i n financial trouble.  The  r e t u r n s to P l a c e r are a t l e a s t  above the company's c o s t of c a p i t a l e i g h t percent  or an expected US  value $4 498  i n e a r l y 1979 000  of US  (Table XX).  v a l u e , other  h a l f m i l l i o n d o l l a r s , being  assigned  $5 764  000  However, the inherent  than a nominal  to the  i n t e r e s t i n Mexican Mining Company S.A.  be  recording  are so u n a t t r a c t i v e keeping i n mind r i s k s  i n mining as to prevent any  70%  to  (Table VIII) at 31 December 1980  a f o r e c a s t present  values  forecast  minority  de C.V.  c e r t a i n l e v e l of s i l v e r p r i c e d at an average  at  the  US  $193/kg on a long-term b a s i s . 1979  i s an unusual year f o r s i l v e r metal p r i c e s and  nominal value  for a senior minority  i n t e r e s t i n a poten-  a  194 tial  s i l v e r producer  i n 1981,  when p r i c e s are p r e s e n t l y  more than double the f o r e c a s t long-term p r i c e , i s unrealistic.  O p t i m i s t s might look f a v o u r a b l y upon a l o n g -  term average  of US  $257/kg  (US $8.00/oz) which a f t e r  taxes leaves incremental net cash flow of US k i l o g r a m of s i l v e r produced c a s t p r i c e of US  $193/kg.  $29.12 per  when compared w i t h the  fore-  The cash flow from a US  $257/kg s i l v e r p r i c e under otherwise a l l e q u i t y base case number 1 circumstances p r o v i d e s the P r o d u c t i o n years f o r investment payback Cash flow over the mine l i f e undiscounted US Present v a l u e s - March 1979 - 8% - 12% * - 15% - 20%  following:  100%  34%  4.2  5.2  $284 798  000  70 674  81 747 39 884 20 888  000 000 000  15 611 4 298 ( 1 .044  0  (  6  000 000 000 000)  836  000)  A f u r t h e r p o i n t to a p p r e c i a t e i s t h a t many mining companies may  spend say ten m i l l i o n d o l l a r s on e x p l o r a t i o n  without i d e n t i f y i n g an e c o n o m i c a l l y v i a b l e orebody. Zacatecas p r o p e r t y has been i d e n t i f i e d and to pay a  The few  m i l l i o n f o r i t makes good e x p l o r a t i o n sense even i f f u t u r e cash flows from the a c q u i r e d p r o p e r t y o n l y j u s t the h u r d l e r a t e .  surpass  E x p l o r a t i o n expenses are always sunk  c o s t s when i t s time to conclude the f e a s i b i l i t y study to pay  and  f o r 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 o p t i m i s t w i l l i n g t o i n v e s t on the b a s i s of a US  $257/kg p r i c e w i l l probably reach f o r a twenty percent  195 r e t u r n on investment  to a l l o w f o r the combination  a s s o c i a t e d with the high long-term  silver  of r i s k s  p r i c e and  the  l o c a t i o n of the orebody. I n f l a t i o n a r y e x p e c t a t i o n s are running high i n mid 1979  and i t can be f o r e s e e n t h a t h u r d l e r a t e s w i l l  lowered  i f , as i n the case of s i l v e r ,  inflation mining  i s p e r c e i v e d to be s t r o n g .  i n v e s t o r having prepared  p r i c e of US  be  the hedge a g a i n s t The  cautious  a f e a s i b i l i t y on a  silver  $193/kg (US $6/oz) which i s 70% c e r t a i n of  being e q u a l l e d or b e t t e r e d w i l l have to compete f o r the orebody a g a i n s t the more o p t i m i s t i c viewers of  silver.  I f 15% i s to be the hurdle r a t e of the c a u t i o u s i n v e s t o r , the orebody w i l l not be a c q u i r e d as 1979 have brought out the s i l v e r prevail. choose  Placer f i t s  b u l l s and  market c o n d i t i o n s  the o p t i m i s t s w i l l  the c o n s e r v a t i v e mould and  the combination  will  of a 70% c e r t a i n p r i c e and  15%  hurdle r a t e which s e t s the value of i t s t h i r t y - f o u r cent i n t e r e s t i n Mexican Mining Company S.A.  per-  de C.V.,  on  a cash flow b a s i s , a t zero as the present value i s a n e g a t i v e US  $6 499  000  (Table XX,  case 1).  At the same  time, P l a c e r w i l l a p p r e c i a t e t h a t , to o t h e r s , the o p t i m i s t i c s i l v e r p r i c e w i l l p r o v i d e cash flows d i s c o u n t e d a t 20% of a s i m i l a r negative value  (US $6 836  I t w i l l be r e c a l l e d t h a t the unadjusted l i k e l y value of the m i n o r i t y i n t e r e s t i s US That value i s a t t r i b u t e d to the presence The  000). p r o - r a t a most $3.9  million.  of three  l e n g t h of the mine l i f e and the p o s s i b i l i t y  factors.  of a d d i t i o n s  196 to  ore r e s e r v e s ; i n f l a t i o n a r y e x p e c t a t i o n s and the p o s i -  t i v e n e t e f f e c t i n f l a t i o n w i l l have on n e t cash and the p e r i o d o f investment high s i l v e r p r i c e s .  payback; and, the p r e v a i l i n g  Add to those items the view o f the  m i n e r a l e x p l o r e r who a n t i c i p a t e s b e f o r e - t a x of  flows  say t e n m i l l i o n d o l l a r s  (were i t n o t f o r optimism, i t  would be the twenty-seven m i l l i o n d o l l a r s p r e v i o u s l y quoted  expenditure  (1977 Canadian d o l l a r s )  i n Chapter  hope o f d i s c o v e r i n g an orebody.  2.2) without much  Include the p r o s p e c t o f  new o p p o r t u n i t i e s i n Mexico and the zero v a l u e i s seen t o be u n r e a l i s t i c .  The p o s i t i o n o f the m i n o r i t y shareholder  i n Mexican Mining Company S.A. de C.V. i s w e l l p r o t e c t e d through  i t s v o t i n g , d i v i d e n d and commitment veto  rights,  and the n a t i o n a l i z a t i o n with compensation precedents i n Mexico a r e c o m f o r t i n g t o the i n v e s t o r . liability  The shareholder's  i s l i m i t e d owing t o the f o r e c a s t p r o j e c t  ancing o f the mine f r e e o f guarantees  fin-  f o r completion and  performance as f a r as P l a c e r i s concerned,  although t h a t  may not be the case i f P l a c e r i s appointed Operator o f the project.  These p o i n t s demonstrate t h a t the e a s i l y t r a n s -  f e r a b l e m i n o r i t y s h a r e h o l d i n g needs l i t t l e d i s c o u n t  from  i t s p r o - r a t a share o f the value o f the e n t i r e orebody. The o p t i m i s t s US $4 298 000 present value i n March 1979 of  cash flows expressed  counted  i n constant 1979 d o l l a r s  dis-  a t 12%, p l a c e s a value on the n o t i o n a l e x p l o r a t i o n  expenditure o f US $11 134 000 ($6 836 000 p l u s $4 298 000) which i s both before and a f t e r taxes as there i s no deduc-  197 t i o n i n Canada f o r non-Canadian s u c c e s s f u l e x p l o r a t i o n costs.  Here an a r b i t r a r y ten m i l l i o n of n o t i o n a l ex-  p l o r a t i o n i s used which turns the negative present value of US  $6 836  000 a f t e r d i s c o u n t i n g cash flows by 20%  a p o s i t i v e value* of US 7  $3 164  m i l l i o n d o l a r s the same way  into  000 r e g a r d i n g the ten  as sunk c o s t s .  P l a c e r ' s t h i r t y - f o u r percent s h a r e h o l d i n g i n t e r e s t i n Mexican Mining Company S.A. valued i n the range US mid  1979  $3 100  de C.V. 000  with a p r e f e r e n c e f o r US  i s therefore  to US $3 500  $3 900  000 i n  000 as i t i s the  mid p o i n t .  7.8  P l a c e r ' s next s t e p i n Mexico A value of US  $3 500  000  f o r P l a c e r ' s investment  in .  Mexico i s the s a l e v a l u e but there are two o t h e r courses of a c t i o n a v a i l a b l e :  to h o l d the investment  and vote to  delay major expenditure on the p r o p e r t y pending  improved  economic c o n d i t i o n s ; and to h o l d the investment  and  support the development of the orebody i n t o a mine. P l a c e r ' s long-term aim i n Mexico i s to become a c t i v e i n mining and, p r o v i d i n g no f u r t h e r s e r i o u s problems a r i s e between the p a r t n e r s , s a l e of the m i n o r i t y i n t e r e s t i s not foreseen.  R e s u l t s of the f o r e c a s t cash flows to P l a c e r  Development L i m i t e d under base case c o n d i t i o n s 'for i n v e s t ment d e c i s i o n purposes investment  (Table XX,  case number 1) show the  of f u r t h e r resources i n t o the Zacatecas mine  at t h i s time to be unwise.  The  10.5%  r e t u r n on  investment  198 i s inadequate compensation project.  f o r the r i s k s i n v o l v e d i n the  Base case assumptions  are those c o n s i d e r e d  most l i k e l y to occur and u n l e s s and u n t i l they a l t e r f o r the betterment of f o r e c a s t cash flows, the development of the orebody  ought to be d e l a y e d .  P l a c e r ' s next step i s to r e t a i n the m i n o r i t y i n t e r e s t i n Mexican Mining Company S.A. the Zacatecas orebody value.  de C.V.  and vote to h o l d  f o r p e r i o d i c review of i t s economic  199 CHAPTER EIGHT SUMMARY AND CONCLUSIONS  8.1  Summary T h i s study examines the circumstances l e a d i n g t o a v a l u a t i o n o f a Mexican s i l v e r mining investment by the Canadian mining company, P l a c e r Development L i m i t e d . The v a l u a t i o n forms a major p a r t o f the company's d e c i s i o n whether to commit a d d i t i o n a l corporate  resources  j o i n t venture i n the State o f Zacatecas, The  b a s i c p r o j e c t data  feasibility  to the  Mexico.  i s taken from a 1975 P l a c e r  study amended by the w r i t e r i n an attempt t o  allow f o r changes a f f e c t i n g the p r o j e c t d u r i n g the subsequent four y e a r s .  An understanding o f the events and c i r -  cumstances l e a d i n g t o the c u r r e n t s i t u a t i o n where P l a c e r holds a m i n o r i t y 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 tial  essen-  f o r a thorough assessment o f P l a c e r ' s p o s i t i o n . The  need f o r e x p l o r a t i o n e f f o r t to i d e n t i f y v i a b l e orebodies  economically  i s l i n k e d to the s u r v i v a l o f P l a c e r as  a mining company and i t s importance to the company's management i s s t r e s s e d . The c h o i c e o f Mexico as a t a r g e t country  f o r mineral  e x p l o r a t i o n demands a t h i r t y year  h o r i z o n o f s a t i s f a c t o r y investment c o n d i t i o n s i n t h a t country  i f the company Is to achieve  t i o n and mine investment programme. i n the f u t u r e i s impossible  a successful exploraSuch a lengthy  period  t o foresee i n any meaningful  200 d e t a i l and a l l t h a t i s a v a i l a b l e i s an h i s t o r i c a l p e r s p e c t i v e to guide the p o t e n t i a l  mining  investor.  A major i n f l u e n c i n g f a c t o r i n both the value of P l a c e r ' s investment and the d e c i s i o n to develop the prop e r t y i s t h a t of the Mexican ture.  A workable  p a r t n e r s i n the j o i n t  long-term p a r t n e r s h i p i s v i t a l to the  e f f i c i e n t e x p l o i t a t i o n of the orebody of  ven-  and the o b j e c t i v e s  the p a r t n e r s must be s u f f i c i e n t l y i n harmony to allow  a good r e l a t i o n s h i p .  The o b j e c t i v e s of the p a r t n e r s i n  the j o i n t venture have a s t r o n g b e a r i n g on t h e i r methods of  p r o j e c t e v a l u a t i o n and t h i s area i s c o n s i d e r e d i n  d e t a i l , p a r t i c u l a r l y as regards ownership of  the Mexican  1978  f e d e r a l government.  by an agency  I t i s only since  late  t h a t the t h r e e p a r t i e s to the j o i n t venture have  reached agreement on fundamental p o l i c y and a new ment of the  matters of p a r t n e r s h i p  wave of enthusiasm emerged toward  develop-  orebody.  The study concludes with a review of the f o r e c a s t s and a v a l u a t i o n of both the orebody  financial itself  and  t h i r t y - f o u r percent s h a r e h o l d i n g i n the Mexican c o r p o r a t i o n which owns the m i n e r a l r i g h t s to the orebody.  The  v a l u a t i o n i s s u b j e c t to a number of l i m i t a t i o n s i n the data which have been r e f e r r e d to throughout the t e x t of the study. and  The most important are the s i z e of ore r e s e r v e s  the annual r a t e of m i l l i n g the ore, which are both  determined on the b a s i s of 1975  economic c o n d i t i o n s ,  estimates of the c o s t o f mine c o n s t r u c t i o n i n  1979.  and  201 8.2  Conclusions F i n d i n g s i n d i c a t e t h a t the t h i r t y - f o u r percent minori t y s h a r e h o l d i n g 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 s a l e were t o occur, t h a t the mid p o i n t o f US $3 500 000 would be the l i k e l y p r i c e . stream o f income expressed  i n constant d o l l a r s f o r e c a s t  to a r i s e from new investment j u s t i f y the v a l u e . are expected  The  o u t l a y s does not, on i t s own,  Future long-term  silver price  trends  by many i n 1979 t o i n c r e a s e w i t h accompanying  i n c r e a s e s i n the Zacatecas  ore r e s e r v e s .  When combined  w i t h the e f f e c t s o f a n t i c i p a t e d g e n e r a l p r i c e l e v e l t i o n , the investment inflation.  i s regarded  The mining  infla-  as a good hedge a g a i n s t  i n d u s t r y i n 1979 i s b u l l i s h on the  f u t u r e o f s i l v e r and, f o r 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 o f a c t u a l e x p l o r a t i o n e f f o r t even i f i t means lowering customary hurdle r a t e s . Ten m i l l i o n : d o l l a r s i s the assumed sum which allows the m i n o r i t y h o l d i n g t o be v a l u e d a t US $3 500 000. The  second c o n c l u s i o n i s t h a t P l a c e r w i l l continue t o  h o l d the investment  u n t i l circumstances  a l l o w improved  r e t u r n s t o the owners o f the orebody. P l a c e r ' s o b j e c t i v e o f e s t a b l i s h i n g a mining still  i n evidence  presence  long-term  i n Mexico i s  and continued e f f o r t s to achieve b e t t e r  economic terms, f o r example i n smelter charges of mine l i f e , w i l l ,  and l e n g t h  i n the f o r e s e e a b l e f u t u r e , l e a d t o the  s u c c e s s f u l development o f the orebody.  202 8.3  Concluding comments The study has shown the p r o j e c t to be very s e n s i t i v e to the p r i c e of s i l v e r ; a f a c t o r w e l l understood i n the mining i n d u s t r y .  The c u r r e n t extremely h i g h s i l v e r  prices  are regarded as a s h o r t term phenomenon not a n t i c i p a t e d to l a s t the two years o f mine c o n s t r u c t i o n .  I t i s the  long-term s i l v e r p r i c e t r e n d t h a t i s of g r e a t e s t i n t e r e s t to the p o t e n t i a l i n v e s t o r i n the Mexican mine although the c u r r e n t market p r i c e p l a y s a s i g n i f i c a n t r o l e i n e s t a b l i s h i n g the l a r g e l y s u b j e c t i v e v a l u e of the m i n o r i t y investment i n the c o r p o r a t e v e h i c l e f o r the An obvious way  to improve  orebody.  cash flow r e s u l t s i s to  speed up the r a t e of p r o d u c t i o n and no doubt t h i s avenue is s t i l l  b e i n g examined by the j o i n t venture p a r t n e r s .  203 BIBLIOGRAPHY 1.  R.N. Anthony, "Accounting f o r the c o s t o f i n t e r e s t " Lexington Books, Mass., U.S.A., 1975, Pages 18, 69 and 76.  2.  W.F. A t k i n s , " F a i r Market Value o f a Mining P r o p e r t y " , CIM B u l l e t i n , September 1977, pp. 113-115.  3.  G.O. 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D r e c h s l e r , " E v a l u a t i o n o f New Mining Ventures: Average Cost versus Net Present Value", CIM B u l l e t i n , January 1978, pp. 53-58.  54.  " S i l v e r Mining a t Las T o r r e s " , Mining Magazine, February 1979, pp. 110-123.  55.  " S i l v e r " , Annual Review and Outlook, J . Aron Commodities C o r p o r a t i o n , P r e c i o u s Metals Research Department, New York, January 1979, pp. 30-46.  5.6.  D.N. Smith, L.T. Wells, J r . , N e g o t i a t i n g T h i r d World M i n e r a l Agreements, B a l l i n g e r P u b l i s h i n g , Mass. U.S.A., 1975, pp. 82-98.  57.  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 S t a t e s Of the World f o r the Year, London, MacMillan, 1978/79, page 842.  Northern  207 58.  H.K. T a y l o r , "General Background Theory of C u t o f f Grades", T r a n s a c t i o n s of the I n s t i t u t i o n of Mining and M e t a l l u r g y , Volume 81, 1972, P a r t A, pp. 160-179.  59.  H.K. 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Wynant, " P r o j e c t F i n a n c i n g f o r E x t r a c t i v e Ventures", Management Accounting, October 1978.  2nd e d i t i o n , Washing-  Statistics,  208 APPENDIX 1 P l a c e r Development L i m i t e d Assumptions made i n Pro-Forma Balance Sheets as a t 31 December 1980 (See Table I I I ) 1979 Present o p e r a t i o n s (Cdn $) Net earnings Non-cash charges, net Non-cash g a i n on exchange of Mattagami shares f o r Noranda shares Dividends C a p i t a l expenditure E q u i t y S i l v e r Mines Limited(Cdn Estimated c o s t s C o n s t r u c t i o n (cumulative) Working c a p i t a l (net) Net earnings (est.) Non cash charges, n e t (est.)  Forecasts  1980  Notes 1 $45 000 000 2 10 000 000  $51 000 000 15 300 000  38 600 000 12 000 000 20 000 000  12 000 000 20 000 000  3  $)4  5  Mexican Mining Company S.A. de C.V. (Base case) cumulative Estimated c o s t s 7 Construction Working c a p i t a l (net) Net earnings 8 8 Non cash charges , net P l a c e r share o f investment i n Mexican Mine S.A. de C.V. 9  000 000 000 000  000 000 000 000  US39 500 500 US  000 US80 000 000 US 2 500  000 000  US10 200  000 US10 200  000  US10 200  000 US10 200  000  40 000 000  -  -  80 15 4 12  -  Notes 1 F o r e c a s t by A l f r e d Bunting & Co. L i m i t e d P.J. Mars, Monthly Metals and Mining Review, Toronto, March 1979. 2 1  Based on 1978 c o n s o l i d a t e d statement o f changes i n f i n a n c i a l p o s i t i o n i n Annual Report o f P l a c e r Development Limited D e p r e c i a t i o n and d e p l e t i o n E q u i t y i n excess o f d i v i d e n d s from a s s o c i a t e d companies Other items Cdn  1979 14 500 000  1980 15 000 000  (7 500 000) 3 000 000  (2 700 000) 3 000 000  $10 000 000  15 300 000  209 Notes 3 Omitted by Buntings (see note 1 above), per P l a c e r q u a r t e r 1979 r e p o r t t o s h a r e h o l d e r s .  first  4  New mine c o n s t r u c t i o n near Houston, B.C. announced March 19 79.  5  Receivables and i n v e n t o r y , $18 000 000 l e s s payable $3 000 000.  6  No new b u s i n e s s , and no a s s e t s d i s t r i b u t i o n , o f Craigmont Mines L t d . i s assumed.  7  Assumes c o n s t r u c t i o n begins 31 December 1980.  8  Assumes p r o d u c t i o n begins  9  34% o f c o s t o f a s s e t s l e s s loans o f Mexican Mining Co. S.A. de C.V.  accounts  f a l l . 1979 and ends  1 January 1981.  APPENDIX 2 M e t r i c Symbols and Imperial  Metric  Symbol  Imperial  Equivalents  Equivalent  Tonne  t  1 t approximates 1.1 tons  Kilogramme  k  1 kg approximates 2.2 l b s . 1 kg approximates 32.15 t r o y  Grams per tonne  g/t  100 g / t approximates 2.9 t r o y oz/ton  Metre  m  1 m approximates 3.25 f e e t  APPENDIX 3 Mexican Mining Company S.A. de C.V. Investment D e c i s i o n Case Cash Flow Results Case Production Return on Net Present Values.discounted a t Number Years to Investment (US $000) 15% Payback A f t e r Tax i01 20% 1 BASE 5.2 15.2% 196 726 577 (14 424) 2 - 10 year l i f e 5.2 64 291 11.2% (10 571) (19 855) 3 - minus 10% o f metal p r i c e s 6.4 12.2% 147 817 (22 340) (10 585) 4 - minus 20% o f s i l v e r p r i c e 6.6 11.8% 143 716 (23 278) (11 857) 5 - p l u s 10% c o n s t r u c t i o n c o s t s 5.7 192 676 14.0% (19 173) ( 4 200) 6 - p l u s 10% o p e r a t i n g c o s t s 5.7 13.9% 177 275 (17 825) ( 4 144) 7 - accelerated tax d e p r e c i a t i o n 20% 4.0 16.9% 200 175 6 846 ( 8 587) 8 - accelerated tax d e p r e c i a t i o n 33 1/3% 4.0 17.0% 200 226 .7 183 ( 8 286) 9 - a c c e l e r a t e d tax d e p r e c i a t i o n 100% f o r p r e - p r o d u c t i o n c a p i t a l 4.0 16.8% 199 333 6 645 ( 8 687) 10 a c c e l e r a t e d tax d e p r e c i a t i o n 100% f o r p r e - p r o d u c t i o n c a p i t a l and 20% a f t e r 4.0 16.9% 200 175 6 999 ( 8 427) 11 - 50% taxes r e m i s s i o n f o r 3 years 4.6 16.4% 205 857 5 535 (10 302) 12 50% taxes r e m i s s i o n f o r 3 years and 20% a c c e l e r a t e d t a x depreciation 4.0 17.0% 201 145 7 339 ( 8 185) 13 10 year l i f e , 5 0 % taxes remiss i o n f o r 3 years and 20% accelerated tax depreciation 4.0 13.6% 71 246 (13 501) ( 3 578) 14 no p r o d u c t i o n t a x f o r 5 years and 20% a c c e l e r a t e d tax depreciation 3.6 18.6% 210 297 12 469 ( 3 845) 15 no p r o d u c t i o n t a x and income tax f o r 5 years 3.3 22.7% 251 904 27 723 7 569 16 no p r o d u c t i o n t a x and income tax f o r 5 years and $10 m i l l i o n cons t r u c t i o n cost reduction/subsidy3.0 26.5% 259 844 35 870 15 590 17 minus 10% o f metal p r i c e s , 5 0 % taxes r e m i s s i o n f o r 3 years and 20% a c c e l e r a t e d t a x d e p r e c i a t i o n s . 4 13.0% 146 661 040) (18 824) EXPECTED (see Appendix 11) 5.1 14.9% 176 537 305) (14 2 94) i —  7  APPENDIX 4 Mexican Mining Company S.A, de C.V. F i n a n c i n g D e c i s i o n Case Cash Flow Results Production Return on Net Present Values discounted a t Case Years to Investment (US $000) Number ayback A f t e r Tax 0% 15% 20% 101 BASE 6.5 17.2% 180 927 6 060 ( 5 592) 102 10 year l i f e 6.5 12.1% 48 491 ( 5 088) (11 023) 103 minus 10% o f metal p r i c e s 7.8 13.4% 130 457 ( 4 279) (12 470) 104 minus 20% of s i l v e r p r i c e 8.1 12.9% 126 028 ( 5 416) (13 239) 105 p l u s 10% c o n s t r u c t i o n c o s t s 7.1 16.1% 173 357 2 977 ( 7 921) 106 p l u s 10% o p e r a t i n g c o s t s 7.0 15.6% 160 771 1 741 ( 8 486) 107 a c c e l e r a t e d tax d e p r e c i a t i o n - 2 0 % 5.7 18.2% 180 601 8 327 ( 3 505) 5.5 18.5% 182 348 9 262 ( 2 779) 109 a c c e l e r a t e d tax d e p r e c i a t i o n - 1 0 0 % for pre-production c a p i t a l 5.2 18.9% 184 787 10 197 ( 2 029) 110 a c c e l e r a t e d tax d e p r e c i a t i o n - 1 0 0 % f o r p r e - p r o d u c t i o n c a p i t a l and 20% a c c e l e r a t e d tax d e p r e c i a t i o n after 5.1 19.1% 185 629 10 552 ( 1 769) 111 50% taxes r e m i s s i o n f o r 3 years 6.1 18.1% 186 900 8 403 ( 3 829) 112 50% taxes r e m i s s i o n f o r 3 years and 20% a c c e l e r a t e d tax d e p r e c i a t i o n 5.7 18.2% 180 601 8 327 ( 3 505) 113 10 year l i f e , 5 0 % taxes r e m i s s i o n f o r 3 years and 20% a c c e l e r a t e d tax d e p r e c i a t i o n 5.7 13.5% 50 702 ( 2 591) ( 8 822) 114 no p r o d u c t i o n tax f o r 5 years and 20% a c c e l e r a t e d tax d e p r e c i a t i o n 4.4 21.1% 196 543 15 441 2 065 115 no p r o d u c t i o n tax and income tax f o r 5 years 3.9 25.7% 231 601 27 564 10 985 116 no p r o d u c t i o n tax and income tax f o r 5 years and $10 m i l l i o n cons t r u c t i o n cost reduction/subsidy 3.5 28.9% 244 437 34 426 16 628 117 minus 10% of metal p r i c e s , 5 0 % taxes r e m i s s i o n f o r 3 years and 20% a c c e l e r a t e d tax d e p r e c i a t i o n 8.0 13.1% 124 825 ( 4 712) (12 563) 118 Canadian Investor US $8.5 m i l l i o n 6.5 17.2% 180 927 6 060 ( 5 592) to  APPENDIX 4 (Cont'd) Mexican Mining Company S.A. de C.V. F i n a n c i n g D e c i s i o n Case Cash Flow R e s u l t s P r o d u c t i o n Return on Net Present Values d i s c o u n t e d a t (US $000) Years to Investment Case 20% 15% Payback A f t e r Tax Number 119 Canadian I n v e s t o r US $8.5 m i l l i o n , 50% taxes r e m i s s i o n f o r 3 years and 20% a c c e l e r a t e d tax depre829) 8 403 186 900 18 1 ciation 043) 5 457 179 358 17 .6 120 i n t e r e s t 14% 121 Mexican investment tax c r e d i t ( 4 258) 7 844 185 563 17.8% 6.2 f o r 2 years EXPECTED (see Appendix  12)  6.5  16.7  163 338  4 570  ( 6 173)  APPENDIX 5 Mexican Mining Company S.A. de C.V. Investment D e c i s i o n Base Case Cash Flow' Results and Case Production %Return on Net Present Investment Number Years to Payback A f t e r Tax 0% 1 BASE case r e s u l t s (Appendix 13) 5.2 15.2 196 726 SENSITIVITIES b e t t e r (worse) 2 10 year base (4.0) (132 435) 0 3 minus 10% of metal p r i c e s (0.8) (3.0) ( 48 909) 4 minus 20% of s i l v e r p r i c e (1.4) (3.4) ( 53 010) 5 p l u s 10% c o n s t r u c t i o n c o s t s (0.5) (1.2) ( 4 050) 6 p l u s 10% o p e r a t i n g c o s t s (0.5) (1.3) ( 19 451) 7 a c c e l e r a t e d tax d e p r e c i a t i o n - 2 0 % 1.2 1.7 3 449 8 a c c e l e r a t e d tax depreciation-33-1/3% 1.2 1.8 3 500 1.2 2 607 9 100% f o r p r e - p r o d u c t i o n capital 1.6 10 a c c e l e r a t e d tax d e p r e c i a t i o n 100% f o r p r e - p r o d u c t i o n capital 1.2 1.7 and 20% a c c e l e r a t e d a f t e r 3 449 1.2 11 0.6 9 131 50% taxes r e m i s s i o n f o r 3 years 12 50% taxes r e m i s s i o n f o r 3 years and 20% a c c e l e r a t e d tax depre1.2 1.8 4 419 ciation 13 10 year l i f e , 50% taxes r e m i s s i o n and 20% a c c e l e r a t e d tax depre1.2 ciation (1.6) (125 480) 14 no p r o d u c t i o n tax f o r 5 years and 20% a c c e l e r a t e d tax d e p r e c i a t i o n 1.6 3.4 13 571 15 no p r o d u c t i o n tax and income tax 1.9 7.5 f o r 5 years 55 178 16 no p r o d u c t i o n tax and:'Income tax f o r 5 years and $10 m i l l i o n con2.2 s t r u c t i o n cost reduction/subsidy 11.3 63 118 17 minus 10% of metal p r i c e s , 5 0 % taxes r e m i s s i o n f o r 3 years and 20% (0.2) (2.2) a c c e l e r a t e d tax d e p r e c i a t i o n ( 50 065)  Sensitivities Values discounted at (US $000) 15% 20% 577 (14 424) (11 (.11 (12 ( 4 ( 4 6 6 6  148) 162) 434) 777) 721) 269 606 068  ( ( ( ( (  5 7 8 4 3 5 6 5  431) 916) 854) 749) 401) 837 138 737  6 422 4 958  5 997 4 122  6 762  6 239  ( 4 155)  923  11 892  10 579  27 146  21 993  35 293  30 014  ( 7 617)  ( 4 400)  APPENDIX 6 Mexican Mining Company S.A. de C.V. Financing. D e c i s i o n Base Case Cash Flow Results and Production ',%Return on Net Present Case Years to Investment Number Payback A f t e r • Tax 0% 101 BASE case r e s u l t s (Appendix 14) 6. 5 17. 2 180 927 SENSITIVITIES b e t t e r (worse) [ 102 10 year base (132 436) (5. 1) 103 minus 10% o f metal p r i c e s (3. 8) ( 50 470) (1. .3) 104 minus 20% o f s i l v e r p r i c e (4. 3) ( 54 899) (1. 6) 105 p l u s 10% c o n s t r u c t i o n c o s t s (0. 6) ( 7 570) (1. 1) 106 p l u s 10% o p e r a t i n g c o s t s (0. 5) ( 20 156) (1. 6) 107 a c c e l e r a t e d t a x d e p r e c i a t i o n - 2 0 % 0. 8 1. 0 326) ( 108 a c c e l e r a t e d t a x d e p r e c i a t i o n 33-1/3% 1. 0 1. 3 1 421 109 a c c e l e r a t e d t a x d e p r e c i a t i o n 100% f o r p r e - p r o d u c t i o n capital 1. 3 1. 7 3 860 110 a c c e l e r a t e d t a x d e p r e c i a t i o n 100% f o r p r e - p r o d u c t i o n capital and 20% a c c e l e r a t e d t a x depreciation after 1.9 1.4 4 702 111 50% taxes r e m i s s i o n f o r 3 years 0.4 0. 9 5 973 112 50% taxes r e m i s s i o n f o r 3 years and 20% a c c e l e r a t e d t a x depreciation 0. 8 1. 0 326) ( 113 10 year l i f e , 5 0 % taxes r e m i s s i o n f o r 3 years and 20% a c c e l e r a t e d tax d e p r e c i a t i o n 0. 8 (3. 7) (130 225) 114 no p r o d u c t i o n tax f o r 5 years and 2. 1 20% a c c e l e r a t e d t a x d e p r e c i a t i o n 3.9 15 616 115 no p r o d u c t i o n tax and income t a x f o r 5 years 2. 6 8. 5 50 674 116 no p r o d u c t i o n tax and income t a x f o r 5 years and $10 m i l l i o n construction cost reduction/subsidy 3.0 11. 7 63 510 T  Sensitivities Values discounted a t (US $000) 15% 2C )% 6 060 ( 5 592) (11 (10 (11 ( 3 ( 4 2  148) 339) 476) 083) 319) 267  ( ( ( ( (  5 6 7 2 2 2  431) 878) 647) 329) 894) 087  3 202  2 813  4 137  3 563  4 492 2 343  3 823 1 763  2 267  2 087  ( 8 651) 9 381  ( 3 230) 7 657  21 504  16 577  28 366  22 220  APPENDIX 6 (Cont'd) Mexican Mining Company S.A. de C.V. F i n a n c i n g D e c i s i o n 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 Production %Return on Net Present Values d i s c o u n t e d a t (US $000) Years to Investment Case 20 Payback 0% 15% A f t e r Tax Number 117 minus 10% o f metal p r i c e s , 50% taxes r e m i s s i o n f o r 3 years and 20% a c c e l e r a t e d t a x depre56 102) (10 772) 6 971) (4.1) (1.5) ciation 118 Canadian I n v e s t o r US $8.5 m i l l i o n 0 0 0 0 0 119 Canadian I n v e s t o r US $8.5 m i l l i o n , 50% taxes r e m i s s i o n f o r 3 years and 20% a c c e l e r a t e d tax depre5 973 1 763 0 9 2 343 0, 4 ciation 1 569) 451) (0 2) 603) (0, 1) 120 i n t e r e s t 14% 121 Mexican investment tax c r e d i t 1 334 0.6 4 6 36 1 784 0.3 f o r 2 years !  APPENDIX 7 P l a c e r Development L i m i t e d Investment D e c i s i o n Case Cash Flow Results t o Shareholder i n Mexican P r o j e c t Production Return on Net Present Values discounted a t Case Years t o Investment (US $000) Number Payback A f t e r Tax 0% 20% 8% 15% 1 BASE 47 018 5 764 6. 9 10. 5% (6 499) (10 684) 2 10 year l i f e 5. 7% 11 446 6. 9 (3 146) (9 494) (12 143) 8. 2% 357 3 minus 10% o f metal p r i c e s 8. 2 33 881 (9 497) (12 811) 7. 9% 32 780 4 minus 20% o f s i l v e r p r i c e 8. 4 (9 839) (13 063) ( 202) 9. 6% 45 448 5 p l u s 10% c o n s t r u c t i o n c o s t s 7. 4 3 991 (12 513) (.8 324) 41 694 6 p l u s 10% o p e r a t i n g c o s t s 7. 4 9. 5% 3 440 (7 856) (11 684) 11. 5% 47 945 7 a c c e l e r a t e d t a x d e p r e c i a t i o n - 2 0 % 5. 9 7 451 (4 816) ( 9 117) 8 accelerated tax d e p r e c i a t i o n 5. 9 11. 5% 47 958 7 546 33 1/3% (4 725) ( 9 036) 9 a c c e l e r a t e d tax d e p r e c i a t i o n - 1 0 0 % 11. 5% f o r pre-production c a p i t a l 6. 0 47 719 7 335 (4 870) ( 9 143) 10 a c c e l e r a t e d tax d e p r e c i a t i o n - 1 0 0 % f o r p r e - p r o d u c t i o n 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 r e m i s s i o n f o r 3 years 6. 3 11. 4% 49 471 7 515 (5 168) ( 9 577) 12 50% taxes r e m i s s i o n f o r 3 years and 20% a c c e l e r a t e d t a x depreciation 5. 8 48 205 7 6 30(4 683) ( 9 009) 11. 6% 13 10 year l i f e , 5 0 % taxes r e m i s s i o n f o r 3 years and 20% a c c e l e r a t e d tax d e p r e c i a t i o n 5. 8 7. 2% 13 314 (7 615) (10 437) (1 102) 14 no p r o d u c t i o n t a x f o r 5 years and 12. 5% accelerated tax d e p r e c i a t i o n 4. 9 50 663 9 407 (3 305) ( 7 843) 15 no p r o d u c t i o n tax and income tax 15. 6% 3. 9 61 839 792 f o r 5 years 15 759 ( 4 777) 16 no p r o d u c t i o n t a x and income tax f o r 5 years and $10 m i l l i o n cons t r u c t i o n c o s t r e d u c t i o n / s u b s i d y 3. 6 17. 9% 64 686 18 634 3 616 ( 2 009) 17 minus 10% o f metal p r i c e s , 5 0 % taxes r e m i s s i o n f o r 3 years and 1 117 20% a c c e l e r a t e d t a x d e p r e c i a t i o n 8. 0 8. 6% 33 571 (8 545) (11 866) EXPECTED  (see Appendix 11)  6 .8  10. 0%  41 583  4 498  (6 751)  (10 665)  APPENDIX 8 P l a c e r Development L i m i t e d F i n a n c i n g D e c i s i o n Case Cash Flow Results to Shareholder i n Mexican P r o j e c t Production Return on Net Present Values discounted a t Investment (US $000) Case Years to A f t e r Tax 8% 15% 20% Number Payback 0% 47 788 10 427 234; 6 .7 15. 3% (2 959) 101 BASE 12 216 1 517 102 10 year l i f e 6 .7 10. 0% (2 760) (4 417) 4 628 8 .3 11. 5% 33 537 (2 842) (5 036) 103 minus 10% o f metal p r i c e s 11. 4% 4 452 (5 076) 104 minus 20% o f s i l v e r p r i c e 8 .3 33 042 (2 915) 14. 3% 45 755 9 180 (3 584) 7 .3 105 p l u s 10% c o n s t r u c t i o n c o s t s ( 594) 42 374 7 .2 13. 9% 8 222 (3 736) 106 plus 10% o p e r a t i n g c o s t s ( 926) 16. 1% 47 700 11 053 920 (2 321) 107 a c c e l e r a t e d tax d e p r e c i a t i o n - 2 0 % 6 .0 108 a c c e l e r a t e d tax d e p r e c i a t i o n 16. 4% 48 170 11 407 1 171 (2 126) 5 .8 33-1/3% 109 a c c e l e r a t e d tax d e p r e c i a t i o n 16. 8% 48 825 11 768 1 422 100% f o r p r e - p r o d u c t i o n c a p i t a l 5 .5 (1 925) 110 a c c e l e r a t e d tax d e p r e c i a t i o n 100% f o r p r e - p r o d u c t i o n c a p i t a l and 20% a c c e l e r a t e d tax depreciation after 5 .5 16. 9% 49 051 11 915 1 518 (1 855) 111 50% taxes r e m i s s i o n f o r 3 years 6 .3 16. 1% 49 392 11 448 940 (2 408) 112 50% taxes r e m i s s i o n f o r 3 years and 20% a c c e l e r a t e d tax depreciation 6 .0 16. 1% 47 700 11 053 (2 321) 920 113 10 year l i f e , 50% taxes r e m i s s i o n for 3 years and 20% a c c e l e r a t e d 12 810 2 321 tax d e p r e c i a t i o n 6 .0 11. 2% (3 749) (2 012) 114 no p r o d u c t i o n tax f o r 5 years and 20% a c c e l e r a t e d tax de4 .6 18. 7% 51 982 13 865 2 919 preciation ( 733) 115 no p r o d u c t i o n tax and income 4 .0 22. 7% 61 399 19 033 1 648 tax f o r 5 years 6 161 116 no p r o d u c t i o n tax and income tax f o r 5 years and $10 m i l l i o n construction cost reduction/ 3 .4 29. 0% subsidy 66 547 23 089 4 637 9 530  APPENDIX 8 (Cont'd) P l a c e r Development L i m i t e d F i n a n c i n g D e c i s i o n Case Cash Flow Results t o Shareholder i n Mexican P r o j e c t Production Return on Net Present Values d i s c o u n t e d a t (US $000) Years to Investment Case 20% Payback A f t e r Tax 0% 8% 15% Number 117 minus 10% o f metal p r i c e s , 5 0 % taxes r e m i s s i o n f o r 3 years and 20% a c c e l e r a t e d t a x de32 719 4 641 (4 831) 11.5% (2 659) 8.3 preciation 118 Canadian I n v e s t o r US $8.5 (1 498) 49 488 12 022 1 747 6.3 17.3% million 119 Canadian I n v e s t o r US $8.5 m i l l i o n , 50% taxes r e m i s s i o n f o r 3 years and 20% a c c e l e r a t e d tax de51 092 13 043 2 454 ( 948) 5.8 18 .3% preciation 72 6.8 15.1% 47 367 10 178 (3 080) 120 i n t e r e s t 14% 121 Mexican investment tax c r e d i t (2 641) 6.5 15.7% 48 739 11 026 644 f o r 2 years EXPECTED  (see Appendix 12)  6.7  15.0  43 147  9 296  (  13)  (2 956)  I—  vo  APPENDIX 9 P l a c e r Development L i m i t e d Investment D e c i s i o n Base Case Cash Flow Results to Shareholder i n Mexican P r o j e c t and S e n s i t i v i t i e s Production %Return on Net Present Values discounted a t Investment (US $000) Case Years to 15% 20% A f t e r Tax 0% 8% Number Payback 5 764 (6 499) (10 684) 10. 5 47 018 6.9 1 BASE case r e s u l t s (Appendix 15) SENSITIVITIES b e t t e r (worse) (2 995) (4. 8) (35 572) (8 910) 2 10 year base ( 1 459) 0 (2 998) (2. 3) (13 137) (5 407) (1.3) 3 minus 10% metal p r i c e s ( 2 127) (3 340) (2. 6) (14 238) (5 966) 4 minus 20% o f s i l v e r p r i c e (1.5) ( 2 379) 825) (0.5) (0. 9) 570) 773) 5 plus 10% c o n s t r u c t i o n c o s t s ( 1 (1 ( 1 829) (1 324) 324) (2 357) (0.5) 0) ( 5 6 p l u s 10% o p e r a t i n g c o s t s ( 1 000) (1 (1. 927 1 687 1 683 1 567 1. 0 7 a c c e l e r a t e d t a x d e p r e c i a t i o n - 2 0 % 1.0 8 a c c e l e r a t e d tax d e p r e c i a t i o n 1 782 1 774 1 648 940 1.0 1. 0 33-1/3% 1 541 1 571 1 629 1.0 701 0.9 capital 9 100% f o r p r e - p r o d u c t i o n 10 a c c e l e r a t e d t a x d e p r e c i a t i o n 100% f o r p r e - p r o d u c t i o n capital and 20% a c c e l e r a t e d a f t e r 1.0 1. 0 927 1 718 1 725 1 610 2 453 1 107 1 751 1 331 0.6 0. 9 11 50% taxes r e m i s s i o n f o r 3 years 12 50% taxes r e m i s s i o n f o r 3 years and 20% a c c e l e r a t e d tax depre1 187 1 866 1 816 1 675 1. 1 ciation 1.1 10 year l i f e , 5 0 % taxes r e m i s s i o n 13 and 20% a c c e l e r a t e d tax depre247 (3. 3) (33 704) (6 866) ciation 1.1 (1 116) 14 no p r o d u c t i o n t a x f o r 5 years and 2. 0 3 645 3 643 3 194 2 841 20% a c c e l e r a t e d tax d e p r e c i a t i o n 2.0 15 no p r o d u c t i o n t a x and income tax 5. 1 14 821 7 291 5 907 9 995 3.0 f o r 5 years 16 no p r o d u c t i o n t a x and income tax f o r 5 years and $10 m i l l i o n con8 675 7. 4 17 668 12 870 10 115 s t r u c t i o n c o s t r e d u c t i o n / s u b s i d y 3.3 17 minus 10% o f metal p r i c e s , 5 0 % taxes r e m i s s i o n f o r 3 years and 20% a c c e l e r a t e d t a x d e p r e c i a t i o n ( 1 . 1 ) (13 447) ( 4: 647) (2 046) ( 1 182) (1. 9)  APPENDIX 10 P l a c e r Development L i m i t e d F i n a n c i n g D e c i s i o n Base Case Cash Flow Results to Shareholder i n Me x i c a n P r o j e c t and S e n s i t i v i t i es %Return on Net Present Value s discounted a t Production Investment (US $0 00) Years to Case 15'20% 8% A f t e r Tax 0% Payback Number (2 959) 234 47 788 10 427 15.3 6.7 101 BASE case r e s u l t s (Appendix 16) SENSITIVITIES b e t t e r (worse) (1 458) (2 994) (35 572) (8 910) (5. 3) 102 10 year base 0 (2 077) (3 076) (14 251) (5 799) (3. 8) 103 minus 10% of metal p r i c e s (1.6) (3 149) (2 117) (14 746) (5 975) (3, 9) 104 minus 20% of s i l v e r p r i c e (1.6) ( 828) ( 625) ( 2 033) (1 247) (1. 0) 105 plus 10% c o n s t r u c t i o n c o s t s (0.6) (1 160) ( 777) (1.4) ( 5 414) (2 205) 106 p l u s 10% o p e r a t i n g c o s t s (0.5) 686 638 88) 626 0.8 ( 107 a c c e l e r a t e d tax d e p r e c i a t i o n - 2 0 % 0.7 108 a c c e l e r a t e d tax d e p r e c i a t i o n 833 936 382 980 1.1 0.9 33-1/3% 109 a c c e l e r a t e d tax d e p r e c i a t i o n 1 034 1 188 1 341 1 037 1.5 100% f o r p r e - p r o d u c t i o n c a p i t a l 1.2 110 a c c e l e r a t e d tax d e p r e c i a t i o n 100% f o r p r e - p r o d u c t i o n c a p i t a l and 20% a c c e l e r a t e d tax depre1 104 1 284 1 488 1 263 1.6 1.2 ciation after 551 1 021 706 1 604 0.8 0.4 111 50% taxes r e m i s s i o n f o r 3 y e a r s 112 50% taxes r e m i s s i o n f o r 3 y e a r s and 20% a c c e l e r a t e d tax depre638 686 626 88) 0.8 0.7 ( ciation 113 10 year l i f e , 5 0 % taxes r e m i s s i o n f o r 3 years and 20% a c c e l e r a t e d (34 978) (8 106) (2 246) (4.1) 0.7 ( 790) tax d e p r e c i a t i o n 114 no p r o d u c t i o n tax f o r 5 years and 2 226 2 685 3.2 4 194 3 438 20% a c c e l e r a t e d tax d e p r e c i a t i o n 2.1 115 no p r o d u c t i o n tax and income tax 4 607 7.4 8 606 5 927 13 611 2.7 f o r 5 years 116 no p r o d u c t i o n tax and income tax f o r 5 years and $10 m i l l i o n con7 596 12 662 9 296 18 759 13.7 s t r u c t i o n c o s t r e d u c t i o n / s u b s i d y 3.3  APPENDIX 10 (Cont'd) P l a c e r Development L i m i t e d F i n a n c i n g D e c i s i o n Base Case Cash Flow R e s u l t s to Shareholder i n Mexican P r o j e c t and S e n s i t i v i t i e s Production %Return on Net Present Values d i s c o u n t e d a t (US $000) Case Years to Investment 151 Number Payback 20? A f t e r Tax 117 minus 10% o f metal p r i c e s , 5 0 % taxes r e m i s s i o n f o r 3 years and 20% a c c e l e r a t e d t a x (.3.8) (15 069) (.5 786) (2 893) (1 872) (1.6) depreciation 118 Canadian I n v e s t o r US $8.5 0.4 2.0 1 700 1 595 1 461 1 513 million 119 Canadian I n v e s t o r US $8.5 m i l l i o n , 5 0 % taxes r e m i s s i o n f o r 3 years and 20% acce304 0, 9 616 220 011 lerated tax d e p r e c i a t i o n 3. 0 421) 162) 249) 121) 120 i n t e r e s t 14% (.0.1) CO 2) 121 Mexican investment tax c r e d i t 0.2 0.4 951 599 410 318 f o r 2 years  to  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 de C V I N V E S T M E N T DECISION C A S E S : PROBABILITY OF OCCURRENCE C w r r e M M M I C M tax law with/without c o n e * t i i o r a  20  (0.8) b b t « opar./cont'r. coir .  bait  Probability of o c c u r o n c r>  vr.  (0.81  .2 24  10,r.  1-2)  • 036  optr. c o i t / 1 1 0 * / . cor.it.  .035 .035  \\  20%  (.3)  •04 2  33'*%  (.41  •056  12)  •028  100 %  \ •  100% • 2 0 %  (.11  .014  I.JI /•VII.  tan dopr. (-5)  20 m .  III  10 r n .  (-2)  ( . 1 1 * 2 0 % roi dopr.  .  ii  •033  12  •021  13  • 007  U  .112  IS  .017  $10 m i l l i o n l u b i l d y  othorwiio  bcia  3 r r . 3 0 % tw* r o i ' l l l o n o n d 2 0 % t o i  orttorwlii boio  d»pr.  .011  ML  3  •160  _L2L  17  •040  .100 1.000  N o l o 1 • r o b o b i l i r i o t for . a c h ovont (iriown m b r o t k o M ) oro a l d o t a r a t o . d  b f ttio o»rbo»  to  to  U)  APPENDIX  C o l t Numbtr 1 A p p t n j i K A.)  12.  Probability, of OCCUrrtn'ct 0.1613  MEXICAN MINING COMPANY SA da CV FINANCING DECISION C A S E S :•  0.0403  PROBABILITY OF OCCURRENCE  0.025 2 (.5) belt to«ti  0.0252 0.0630  occol. r o i dtpr.  Ml  invtit crtdit 20%  1.3)  '00%<.2> I00%*20%|.l | L  3yr.50%te>  rtmiuion  (••>  121  0.0126  107  0.0378  I0«  0.0371  ,09 110  I.S)  /•70V. t o i d t o r . ( J )  112  I0rrt.(.2)  0.1001  12)  115  aoisi  116  0.0101  103  0.1440  117  0.0360  104  ao»oo  1-7) 111  0.0700  \  orhtrwlM b o l t 3yr. 5 0 % r o » f t m i n i o n ond 2 0 % t o » dtpr. othorwiio  boM  othtrwiu  bolt  3yr. 5 0 % t o i r t m l n l o n ond 2 0 % t o « d t p r .  N o t * : P r o b o b l l l t l t i for t « h t y t n l (ihown In b reckon ) a r « o i do lor min t d by tho  author.  0.02 5 2  0.0063  |.»> » 2 0 % Ion d t p r .  5 y r i . no inc. l o a  0.0126 0.0315  20yr».(.8)  .21 5yr. no Prodn.Toa  0.0252  (.21  JUL  II*  0.0300 1. 0 0 0 0  to to  M E X I C A N M I N I N G CO. SA DE CV 1 9 7 9 U N I T E D S T A T E S CONSTANT DOLLARS I  (S000  APPENDIX 13  MARCH 1 9 7 9 - C A S E ! E Q U I T Y - B A S E - 2 0 YEARS PRODUCT P R I C E S : R A S E AG US$ 193/KG (US 16.00/OZ) ZN US* 882/T PR USS 750/T CD U S $ 4.05/KG C A P I T A L COST WAREHOUSE INVENTORY I N I T I A L O P E R A T I N G COSTS - 3 MONTHS MAXIMUM  INVESTMENT  75 105 000 2 500 000 >T 5 0 5 0 0 0  - PROJECT  US $  82 110 000  P R O J E C T CASH FLOW PRODUCTION  YEAH  -2  1  -1  2  3  4  5  6  7  8  9  SALES  'Il  532  19 307  56 4 45  50 043  46 716  49 704  40 626  50 675  53 370  SALES RECEIPTS OPERATING COSTS EXPLORATION EXPENSES WAREHOUSE INVENTORY STATE PROPERTY TAX OPERATING CASH PROFIT  31 149 10 0 1 9  40 916 21 058  50 163 20 904  52 696 21 000  -2 0 0 0  12  57 644 10 614 51 100 350 30 529  49 017 20 1 9 4  350 30 9 3 6  -3 5 0  -3 5 0  -3 5 0  -500  54 6 0 1 18 550 479 200 350 3 5 102  49 548 18 262  400 350 380  17 423 18 322 230 300 350 28 214  20 473  27 508  28 029  350 31 266  INTEREST EXPENSE CASH EARNINGS BEFORE TAXES  -500  -2 0 0 0  12 3 8 0  28 214  3 5 102  38 529  30 9 3 6  28 473  27 500  28 029  31 2 6 6  3 379 175 33  3 979 7 786 1 403  4 504 10 3 0 0 1 962  11 0 0 1 2 095  4 634  3 748 7 290 1 389  3 979 7 4 74 1 424  3 801 6 509 1 240  4 029 7 283 1 307  4 230 9 721 1 052  000  8 792  14 9 6 5  10 336  . 20 790  IB 509  15 5 9 6  15 078  129  15 456  38 175 700  31 6 5 0 1 272  ,015  750  650  1 110  1 955  3 680  2 235  1 110  1 250  -7 5 0  -6 5 0  _  _  _  _  35 930  1 333 2 170  _  39 175  1 110  1 955  3 680  2 235  1 110  1 250  6 614  14 2 1 5  17 6 0 6  19 600  16 5 5 4  11 9 1 6  13 643  15 019  14 2 0 6  -37 930 -77 605  6 614 70 9 9 1  1M 2 1 5 -56 776  17 6 0 6 - 3 9 090  19 6 8 0 - 1 9 401  16 554 -2 0 4 8  11 9 1 6 9 069  22 7 1 1  13 643  15 019 37 731  14 2 0 6 51 9 3 6  272 972  3 930 5 910  13 599 19 500  17 1 1 5 36 624  i n onn 54 7 0 4  12 7 7 7 67 401  13 227 00 700  11 9 0 0 92 600  13 049 105 7 3 7  1 6 161 121 8 9 8  500  2  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  -500  -39 6 7 5 -39 6 7 5  -2  -  000  --  -  -  -  16  --  -  LOAN BALANCE REMAINING TOTAL TAXES AND DUTY CUMULATIVE TOTAL TAXES « DUTY PRESENT VALUE  700 7U0  MAR.1979- H PC I -15 per -20 PCT  4 5 1)90 577 -14 4 2 4  INTERNAL RATE OF RETURN (PCT.) YEARS TO PAYbACK (PRODN YRS)  15.2 5.2  1 1  APPFMDTX U000  MARCH 1 9 7 9 - CASE'• E Q U I T Y PRODUCT P R I C E S : R A S E AG USJ> 1 9 3 / K G ( U S 1 6 . 0 0 / 0 Z ) Pn USt 7 5 0 / T  - B A S E - 2Q ZN CD  USt USS  YEARS B82/T 4.85/KG  C A P I T A L COST WAREHOUSE I N V E N T O R Y I N I T I A L O P E R A T I N G C O S T S - 3 MONTHS MAXIMUM  13  M E X I C A N M I N I N G CO. SA OE CV 1^79 U N I T E D S T A T E S CONSTANT D O L L A R S )  INVESTMENT  75 105 000 2 500 000 4 505 000  - 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 OPERATING COSTS EXPLORATION EXPENSES WAREHOUSE INVENTORY STATE PROPERTY TAX OPERATING CASH PROFIT  51 263 20 057  45 430 20 645  43 682 20 798  45 472 20 071  44 544 20 153  47 227 10 430  53 430 18 054  49 B94 17 843  45 010 17 609  -350  -350  44 751 17 970 705  31 701  26 979  350 25 726  72 21 1 -3  INTEREST EXPENSE CASH EARNINGS BEFORE TAXES  -350  30 056  -  -350  24 235  -  -350  22 534  -  -  25 051  -  -  24 041  -  -350  20 447  -  -  -350  35 026  -  -350 -  -350 -  -  -  223 217 089 500 350 53 067  -  30 056  24 235  22 534  25 051  24 041  28 447  35 026  31 701  26 979  25 726  53 067  4 007 9 62b 1 033  3 499 6 800 1 310  3 406 6 849 1 305  3 680 8 028 1 529  3 537 7 211 1 374  3 060 9 590 1 827  4 370 12 541 2 309  3 844 10 027 1 910  3 510 0 493 1 618  3 623 8 51 1 1 621  4 889 13 330 2 539  14 590  12 546  10 094  11 014  11 919  13 170  15 726  15 919  13 358  11 971  32 309  2 235  4 010  2 020  2 165  935  2 100  1 680  1 330  195  -  4 010  -  2 020  2 165  935  1 825  2 100  1 600  1 330  -195  130  2 235  --  1 825  — -  CASH FLOW BEFORE LOAN PAYMENT LOAN PAYMLNT-100 PCT CASH FLOW  12 355  8 536  0 074  9 649  10 904  11 345  13 626  14 239  12 028  11 776  32 179  PROJECT NET CASH FLOW -100PC1 PROJECT CUM NET CASH FLOW  12 355 64 291  PRODUCTION TAXES INCOME TAXES EMPLOYEE SHARING TAX CASH EARNINGS AFTER TAX CAPT ITAL EXPENDITURES - ACQUISITIONS - TAX AND DUTY ADDED - PREI'ROUUCTION INTEREST TOTAL CAPITAL EXPENDITURES  LOAN BALANCE REMAINING TO 1AL TAXES AND DUTY CUMULATIVE TOTAL TAXES « DUTY  -  -  15 016 137 713  -  -  0 536 72 827  12 039 149 753  -  0 074 00 900  11 990 161 743  -  9 649 90 549  13 507 175 33(1  -  10 904 101 534  12 471 107 (101  -  11 34 5 112 079  15 627 203 428  -  -  13 626 126 505  19 650 223 078  -  —  14 239 140 744  16 131 239 209  -  ~  12 028 152 772  13 971 253 180  11 776 164 540  14 105 267 285  130  ***  32 179 196 726  21 108 280 393  APPENDIX  (S000  13  M E X I C A N M I M I N G CO. SA OE CV 1 9 7 9 U N I T E D S T A T E S CONSTANT D O L L A R S )  MARCH 1 9 7 9 - C A S E ! E O U l ft - UASF. - 2 0 Y E A R S PRODUCT P R I C E S : B A S E AG U S * 1 9 3 / K G ( U S Sb.OO/OZ) 2M US1 802/T PU US'J. 7 5 0 / T CP U S J <».85/KG C A P I T A L COST WAREHOUSE I N V E N T O R Y I N I T I A L O P E R A T I N G C O S T S - 3 MONTHS MAXIMUM  INVESTMENT  - PROJECT  PROJECT CASH PRODUCTION  75 105 000 2 500 000 14 5 0 5 0 0 0 US $  82 110 000  FLOW  YEAR  TOTALS SALES  984  SALES RECEIPTS OPERATING COSTS EXPLORATION EXPENSES WAREHOUSE I N V E N T O R Y S T A T E P R O P E R T Y TAX OPERATING CASH P R O F I T  98<4 1 6 B 389 010 2 562 7 000 585 596  IhlEREST EXPENSE CASH EARNINGS UEFORE  TAXES  C APT H A L  AFTER  585 596 78 676 168 626 32 119  PRODUCTION TAXES INCOME T A X E S E M P L O Y E E S H A R I N G TAX CASH EARNINGS  168  TAX  306 17q  EXPENDITURES  - ACQUISITIONS - TAX AND DUTY ADDED - PRLPRUUUCTION INTEREST TOTAL C A P I T A L E X P E N D I T U R E S  106 1 1 109  143 972 333 <i'.H  CASH F L O U BEFORE LOAN PAYMENT L O A N P A Y M E N I - 1 0 0 P C I C A S H FLOW  27<* 3 3 1  P R O J E C T NET P R O J E C T CUM  196 726  LOAN  BALANCE  C A S H FLOW -J00PCT NET C A S H FLOW REMAINING  T O T A L T A X E S AND DUTY C U M U L A T I V E T O T A L T A X E S S DUTY  288  393  to to  M E X I C A N M I N I N G CO. SA DE CV (SOOO 1 9 7 9 U N I T E D S T A T E S CONSTANT D O L L A R S ! MARCH 1 9 7 9 - C A S E : L O A N PROOUCT PRICES." B A S E AG U S S 1 9 3 / K G ( U S *6.OO/OZ) PH USS 750/T C A P I T A L COST PREPRODUCTION INTEREST WAREHOUSE INVENTORY I N I T I A L OPERATING COSTS MAXIMUM  INVESTMENT  -  BASE - 2 0  APPENDIX  14  YEARS  USJ 882/T USS 4.85/KG  ZN  CO  75 4 2 4  3 MONTHS  PROJECT  US S  105 975 500 505  000 000 000 000  8 7 085 000  P R O J E C T C A S H FLOW PRODUCTION  YEAR  2  1  3  1  5  6  7  8  9  SALES  11 532  19 387  56 115  58 013  16 716  19 781  18 626  50 675  53 370  SALES RECEIPTS OPERATING COSTS EXPLORATION EXPENSES WAHEHOUSE INVENTORY S T A T E P R O P E R T Y TAX OPERATING CASH PROFIT  31 1<»9 18 019  51 681 i n 550 179 200 350 35 102  57 611 18 611 51 100 350 38 529  19 518 18 262  19 017 " 18 916 20 191 21 058  50 163 20 984  52 696 21 080  <|00 350 12 380  17 123 18 322 238 300 350 28 211  -350  30 936  28 173  -350  27 508  6 835 5 5<»5  6 661 21 550  1 832 30 270  2 817 35 682  172 30 161  28 173  3 979 2 292 137  1 501 8 270 1 575  1 631 • 9 805 1 868  718 7 092 1 351  INTEREST EXPENSE CASH EARNINGS BEFORE  500  TAXES  2  000  -500  -2  000  -500  -2  000  3  PRODUCTION TAXES INCOME T A X E S E M P L O Y E E S H A R I N G TAX CASH EARNINGS  AFTER  379  -  — TAX  CAPTITAL EXPENDITURES - ACQUISITIONS - TAX AND DUTY AOOED - PREPRODUCTION INTEREST TOTAL C A P I T A L E X P E N D I T U R E S C A S H FLOW B E F O R E LOAN PAYMENT—100  -  —  3  --350  _ _  _  350 28 829  350 31 266  27 50B  ?8 829  31 266  3 979 7 171 1 124  3 881 6 509 1 210  4 02" 7 283 1 387  4 238 9 721 1 852  _  -500  -2  000  2 166  11 812  15 920  19 375  18 273  15 596  15 878  16 129  15 456  3 8 <»75 700 325 39 500  31 1 4 tO  658  8<»5  750  650  1 110  1 955  3 680  2 235  1 110  1 250  650 580  -815  -750  -650  _  1 110  1 333 3 288  272  3  680  _  _  2 235  1 110  1 250  LOAN P A Y M E N T PCT C A S H FLOW  -10 000  - 4 2 580  1 321 1 321  11 092 11 092  15 270 15 270  18 265 lfl 265  11 985 3 632  11 916  13  613  15 019  14 206  P R O J E C T NET C A S H FLOW -100PCT P R O J E C T CUM NET C A S H FLOW  -30 000 -30 000  -30 0 0 0  -000  -000  -000  -000  11 352 -18 618  11 916 -6 731  13 643 6 911  15 019 21 931  14 206 36 136  10 000  52 5flO  51 259  37 167  21 897  3 632  -  -  -  700 700  1 272 1 972  3 729 5 701  7 05B 12 759  11 700 27 158  16 657 11 115  12 511 56 657  13 227 69 883  11 980 81 863  LOAN BALANCE  REMAINING  TOTAL T A X E S AUG OUTY C U M U L A T I V E TOTAL T A X E S 8 OUTY  MAR.1979- 8 PCT -15 P C T PCT  13 367 6 060 -5 592  INTERNAL HATE OF RETURN (PCT.) YEARS TO PAYBACK (PRoON YRS)  17.2 6.5  PRESENT  VALUE  -20  •30  -30  -30  -30  -  -  -  13 049 94 912  -  16 161 111 073  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 PREPRODUCTION INTEREST WAREHOUSE INVENTORY INITIAL OPERATING COSTS - 3 MONTHS  75 4 2 4  MAXIMUM INVESTMENT - PROJECT  US $  105 975 500 505  000 000 000 000  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 OPERATING COSTS EXPLORATION EXPENSES WAREHOUSE INVENTORY STATE PROPERTY TAX OPERATING CASH PROFIT  51 263 20 857  45 430 20 845  43 682 20 790  45 472 20 071  44 544 20 153  47 227 18 430  53 430 18 054  49 894 17 043  45 b i n 17 689  44 751 17 970 705  72 21 1 -3  INTEREST EXPENSE CASH EARNINGS BEFORE TAXES  -  350 30 056 _  -  -  350 24 235  -  -  350 22 534 _  -  350 25 051  -  -  350 24 041 _  -  -  350 20 447  -  -  -  350 35 026  350 31 701  _  -  -350  -  26 979  350 25 726 _  _ •  223 217 009 500 350 53 067 —  30 056  24 235  22 534  25 051  24 041  20 447  35 026  31 701  26 979  25 726  53 067  4 007 9 625 1 833  3 499 6 880 1 310  3 486 6 049 1 305  3 680 8 020 1 529  3 537 7 211 1 374  3 860 9 590 1 027  4 370 12 541 2 389  3 844 10 027 1 910  3 510 8 493 1 618  3 623 0 511 1 621  4 889 13 330 2 539  14 590  12 546  10 094  11 814  11 919  13 170  15 726  15 919  13 358  11 971  32 309  2 235  4 010  2 020  2 165  935  1 825  2 100  1 680  1 330  2 235  4 010  2 820  -  2 165  CASH FLOW BEFORE LOAN PAYMENT LOAN PAYMENT-100 PCT CASH FLOW  12 355  0 536  0 074  PROJECT NET CASH FLOW -100PCT PROJECT CUM NET CASH FLOW  12 355 40 491  a 036 57 027  8 074 65 100  -  _  PRODUCTION TAXES INCOME TAXES EMPLOYEE SHARING TAX CASH EARNINGS AFTER TAX CAPTITAL EXPENDITURES' - ACQUISITIONS - TAX AND DUTY ADDED - PREPRODUCTION INTEREST TOTAL CAPITAL EXPENDITURES  LOAN BALANCE REMAINING TOTAL TAXES AND DUTY CUMULATIVE TOTAL TAXES 8 DUTY  -  -  15 016 126 BH9  -  -  12 039 138 920  -  -  11 990 150 910  -  -  -  -  -  -  195  -  130  -  935  1 825  -  2 100  1 680  1 330  -195  9 649  10 904  11 345  13 626  14 239  12 028  11 776  32 179  9 649 '74 749  )0 904 85 734  11 345 97 079  13 626 110 705  14 239 124 944  12 028 136 972  11 776 140 748  32 179 100 927  -  13 507 164 505  -  _  12 471 176 977  -  _  15 627 192 603  -  -• 19 650 212 253  -  _  16 131 220 305  -  _  13 971 242 356  -  14 105 256 460  130  -  21 108 277 569  APPENDIX 14 M E X I C A N M I N I N G CO. SA DE CV (lOOl) 1 9 7 9 U N I T E D S T A T E S C O N S T A N T D O L L A R S ) MARCH 1 9 7 9 - C A S E I L O A N PRODUCT P R I C E S : U A S E AG USl 193/KG ( U S 1 6 . 0 0 / 0 2 ) PO USl 750/T  - BASE - 20 2N CD  YEARS  USJ. B B 2 / T USl 4.B5/KG  C A P I T A L COST PREPRODUCTION INTEREST WAREHOUSE I N V E N T O R Y INITIAL  O P E R A T I N G C O S T S - 3 MONTHS  MAXIMUM  INVESTMENT  -  PROJECT  75 105 4 975 2 500 4 505 US 1  000 000 000 000  87 005 000  P R O J E C T C A S H FLOW PRODUCTION  YEAR TOTALS  SALES  98'l 168  SALES RECEIPTS OPERATING COSTS EXPLORATION EXPENSES WAREHOUSE I N V E N T O R Y S T A T E P R O P E R T Y TAX OPERATING CASH P R O F I T  984 166 389 010 2 562  INTEREST EXPENSE CASH EARNINGS UEFORE  7 000 585 59b TAXES  PRODUCTION TAXES INCOME T A X E S E M P L O Y E E S H A R I N G TAX CASH EARNINGS  AFTER  TAX  CAPT1TAL EXPENDITURES - ACQUISITIONS - TAX AND DUTY A D D E D - PREPRODUCTION INTEREST TOTAL C A P I T A L E X P E N D I T U R E S C A S H FLOW B E F O R E LOAN PAYMENT-100 P R O J E C T NET P R O J E C T CUM LOAN  BALANCE  LOAN PAYMENT P C T C A S H FLOW  C A S H FLOW -100PCT NET C A S H FLOW  21 650 563 946 78 159 30  676 533 387  295  350  106 1 6 114  143 972 308 423  263 507  180  927  277  569  REMAINING  TOTAL T A X E S AND DUTY C U M U L A T I V E T O T A L T A X E S & DUTY  to  CO  APPENDIX 15 MEXICAN MINING CO. SA DE CV (SOOO 1979 UNITED STATES CONSTANT DOLLARS I MARCH 1979 - CASE! EQUITY - BASE - 20 YEARS PRODUCT PRICES! BASE AG USS 193/KG (US $6.00/02) ZN 05$ 002/T PB USS 750/T CD USS 4.85/KG CAPITAL COST WAREHOUSE INVENTORY  75 105 000 2 500 000 4 505 000  INITIAL OPERATING COSTS - 3 MONTHS  US S  MAXIMUM INVESTMENT - PROJECT  02 110 000  CANADIAN CASH FLOW PRODUCTION YEAR  -1  1  2  3  PROJECT CASH fLOW TO CANADIAN EXPLORATION COSTS RECOVERED MEXICAN WITHHOLDING TAX  2 249 1 333 472  4 833  6 013  6 694  5 628  4 052  4 639  5 107  4 830  1 015  1 263  1 406  1 182  851  974  1 072  1 014  NET DISTRIBUTION TO CANADA  3 110  3 818  4 751  5 288  4 446  3 20i  3 664  4 034  3 816  3 110  3 818  4 751  5 288  4 446  3 201  3 664  4 034  3 816  -24 890  -21 072  -16 322  -11 034  -6 587  -3 386  270  4 312  8 128  PROJECT FUNDS INVESTED 1NTEKEST-1NV FUNDS-AFTER TAX  28 000  NET CASH FLOW TO CANADIAN  -28 000  CUM MET CASH FLOW TO CANADIAN  -20 000  PRESENT VALUE  MAR.1979- 8 PCT -15 PCT -20 PCT  5 764 -6 499 -10 684  INTERNAL RATE OF RETURN (PCT.)  10.5  PV PER INVESTMENT DOLLAR YEARS TO PAYBACK (PRODN YRS)  .21 6.9  -28 000  APPENDIX 15  M E X I C A N M I N I N G CO. S A DE CV 1 9 7 9 U N I T E D S T A T E S CONSTANT O O L L A R S )  ($000  MARCH 1 9 7 9 - C A S E : E Q U I T Y PRODUCT P R I C E S ! R A S E AG US$ 193/KG (US S6.00/OZ) PR US$ 750/T C A P I T A L COST WAREHOUSE I N V E N T O R Y I N I T I A L OPERATING COSTS MAXIMUM  INVESTMENT  3  BASE - 2 0 ZN CD  YEARS  USS B82/T USS 4.85/KG 75 105 000 2 500 000 4 505 000  MONTHS US S  - PROJECT  82 110 000  C A N A D I A N C A S H FLOW PRODUCTION  10  YEAR  CUM NET C A S H fLOW  16  17  19  18  3 735  3 857  4 633  4 841  4 090  4  882  609  576  609  784  810  973  1 017  859  318  2 293  2 169  2 592  2 950  3 047  3 660  3 825  3 231  3  3 318  2 293  2 169  2 592  2 950  3 047  3 660  3 825  13 739  15 908  18 499  21 450  24 497  28 157  31 9 8 2  20  004  10 941  841  2 298  163  8 643  3 231  3 163  8 643  35 212  38 375  47 018  TAX  CANADIAN TO  15  3 281  3  NET C A S H FLOW TO  14  2 745  NET D I S T R I B U T I O N  PROJECT FUNDS I N V E S T E D IN1EREST-INV FUNDS-AFTER  13  2 902  4  CANAUA  12  201  P R O J E C T C A S H FLOW TO C A N A D I A N E X P L O R A T I O N COSTS RECOVERED M E X I C A N W I T H H O L D I N G TAX TO  11  CANADIAN  11  446  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 WAREHOUSE INVENTORY INITIAL OPERATING COSTS - 3 MONTHS MAXIMUM INVESTMENT - PROJECT CANADIAN CASH FLOW PRODUCTION YEAR  TOTALS  PROJECT CASH FLOW TO CANADIAN EXPLORATION COSTS RECOVERED MEXICAN WITHHOLDING TAX  93 273 1 333 19 587  NET DISTRIBUTION TO CANADA  75 018  PkOJECT FUNDS INVESTED INTEREST-1NV FUNDS-AFTER TAX  2B 000  NET CASH FLOW TO CANADIAN  47 018  CUM NET CASH FLOW TO CANADIAN  BBRKPT PRINT*  75 105 000 2 500 000 1 505 000 US S  82 110 000  APPENDIX  16  M E X I C A N M I N I N G CO. SA DE CV UOOf! 1 9 7 9 U N I T E D S T A T E S CONSTANT D O L L A R S > MARCH 1 9 7 9 - C A S E : L O A N PRODUCT P R I C E S : B A S E A6 U S $ 193/K.G ( U S $ 6 . 0 0 / 0 2 ) PB US$ 750/T C A P I T A L COST PREPRODUCTION INTEREST WAREHOUSE I N V E N T O R Y I N I T I A L O P E R A T I N G COSTS MAXIMUM  - BASE - 2 0 YEARS ZN CO  US$ 882/T U S $ <«.B5/KG 75 4 2 1  3 MONTHS  INVESTMENT - PROJECT  US $  105 975 500 505  000 000 000 000  87 085 000  C A N A D I A N C A S H FLOW PRODUCTION  YEAR  -2  -1  1  2  3  P R O J E C T C A S H FLOW TO C A N A D I A N EXPLORATION COSTS RECOVERED M E X I C A N W I T H H O L D I N G TAX  3 860 1 333 811  4  NET  4  DISTRIBUTION  TO  CANADA  PROJECT FUNDS INVESTED INTEREST-INV FUNDS-AFTER NET  C A S H FLOW TO  CUM  N E T C A S H FLOW TO  PRESENT  VALUE  851  974  382  3 201  4 382 -5 8 1 8  5  107  4 830  1 072  1 014  3 664  4  034  3 816  3 201  3 664  4 034  3 816  -2 6 1 7  1 047  5 082  8 897  TAX -10 2 0 0  CANADIAN  M A R . 1 9 7 9 - 8 PCT - 1 5 PCT - 2 0 PCT  PV P E R I N V E S T M E N T Y E A R S TO P A Y B A C K  4 639  10 2 0 0  CANADIAN  I N T E R N A L R A T E OF R E T U R N  052  (PCT.)  DOLLAR (PROON  YRS)  -10 2 0 0  10 427 234 -2 9 5 9 15.3 1.02 6.7  -10 200  -10 200  - 1 0 200  -10 200  -10 200  APPENDIX  16  M E X I C A N M I N I N G CO. SA DE CV (1,000 1 9 7 9 U N I T E D S T A T E S C O N S T A N T D O L L A R S ! MARCH 1 9 7 9 - C A S E : L O A N PRODUCT P R I C E S : RASE AG ItSS 1 9 3 / K G ( U S S 6 . 0 0 / 0 Z ) PO USt 7 5 0 / T  - RASE - 2 0 ZN CD  YEARS  USS 802/T U S S '4.85/KG  C A P I T A L COST PREPRODUCTION INTEREST WAREHOUSE I N V E N T O R Y I N I T I A L O P E R A T I N G C O S T S - 3 MONTHS MAXIMUM  INVESTMENT  - PROJECT  US $  CANADIAN PRODUCTION  YEAR  10  P R O J E C T C A S H FLOW TO C A N A D I A N E X P L O R A T I O N COSTS RECOVERED MEXICAN WITHHOLDING TAX  4  NET D I S T R I B U T I O N  3  TO  CANADA  PROJECT FUNDS INVESTED INTEKEST-IMV FUNDS-AFTER NET  C A S H FLOW TO  CUM  NET  C A S H FLOW TO C A N A D I A N  11  2  3  310  902  -  12  2  609  802  TAX  CANADIAN  201  -  2  293  75 4 2 4  2  745  -5 7 6  169  3 281  -6 8 9  592  3  735  _  2  950  _  _  _  -  -  -  -  -  12 2 1 6  293  14 5 0 8  2  169  16 677  2  592  19 269  15  3  784  _  2  07 085 000  14  _  318  000 000 000 000  C A S H FLOW  13  2  105 975 500 505  2  950  22 2 1 9  857 _  4  810 3  047  3  3  047  25 266  17  16  3  633  4  973  1 017  660  3  -  • -  .  660  28 926  3  041  825  18  4  090  19  4  859 3 231  3  025  3 231 35 902  10 9 4 1  841  2  298  163  0  643  -  -  32 751  004  20  3  -  163  8  643  39 145  47  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 PREPRODUCTION INTEREST WAREHOUSE INVENTORY INITIAL OPERATING COSTS - 3 MONTHS MAXIMUM INVESTMENT - PROJECT CANADIAN CASH FLOW PRODUCTION YEAR  TOTALS  PROJECT CASH FLOW TO CANADIAN EXPLORATION COSTS RECOVERED MEXICAN WITHHOLDING TAX  71 715 1 333 15 060  NET DISTRIBUTION TO CANADA  57 908  PROJECT FUNDS INVESTED INTEREST-1NV FUNDS-AFTER TAX  10 200  NET CASH FLOW TO CANAOIAN  47 788  CUM NET CASH FLOW TO CANADIAN  BBRKPT PRINTS  75 1 2 <4 US S  105 975 500 505  000 000 000 000  87 085 000  237 APPENDIX 17 S o c i a l B e n e f i t s and Costs - F o r e i g n Currency Inflow and Outflow (Expressed i n thousands of 1979 constant United S t a t e s d o l l a r s ) 1.  F o r e i g n exchange earnings (a)  Assume a l l l e a d and s i l v e r i n l e a d c o n c e n t r a t e exported by the Mexican smelter. Note t h a t smelter charge income remains: i n Mexico. However some o f smelters marginal c o s t s w i l l r e l a t e to imported m a t e r i a l s used i n I t s processing. Smelters marginal c o s t s r e p r e s e n t an estimated 75% o f smelter charges as f o l l o w s : Labour M a t e r i a l s - domestic - imported Profit tax  content - b e f o r e  Smelter charge  25% 35% 15% 75% 25% 100%  Lead c o n c e n t r a t e net smelter r e t u r n (.NSR) add back smelter and r e f i n i n g charges l e s s 15% o f l e a d c o n c e n t r a t e smelter charge f o r c o s t o f imported m a t e r i a l s (b)  Zinc c o n c e n t r a t e exported - NSR value  (c)  P l a c e r ' s investment Appendix 16  (d)  797 396 147 601 944 997  17 12 3  927 874 186 77 3 1 114 647  as shareholder 10 200  Non shareholder l o a n funds Invested Appendix 14 T o t a l Inflow  57 085 US $1 181 932  238 APPENDIX 17  (Cont'd)  S o c i a l B e n e f i t s and Costs - F o r e i g n Currency Inflow and Outflow (Expressed i n thousands of 1979. constant U n i t e d S t a t e s d o l l a r s ) 2.  F o r e i g n exchange c o s t s (a) C a p i t a l c o s t s (i) I n i t i a l c o n s t r u c t i o n years - M a t e r i a l imported d i r e c t Domestic S u p p l i e r s imp o r t e d m a t e r i a l content 32% of US $11 733 - Equipment, i n c l u d i n g domestic s u p p l i e r s imported content,estimate 70% of US $25 155 - Warehouse i n v e n t o r y - Indirect costs 50% i n c l u d i n g f o r e i g n c o n t r a c t o r s p r o f i t and f o r e i g n personnel remittanced (ii)  P r o d u c t i o n years - Estimated a t 40  20% 12%  3  755  17 1  608 500  6 28  000 863  13  204  42  067  (b) Operating c o s t s 21% of $389 010  81  692  (c) I n t e r e s t expense, i n c l u d i n g p r e p r o d u c t i o n i n t e r e s t of $4 975  26  625  (d) Loan funds r e p a i d , other than Canadian shareholder  57  085  68  188  $275  657  US $906  275  s  of  US  $33  010  Domestic F o r e i g n T o t a l Transportation 7% 5% 12% Materials 34% 16% 50% Labour 38% 0% 38% 21% 100*  (e) D i s t r i b u t i o n s to Canadian I n v e s t o r - P l a c e r - Preproduction corporate costs recouped 1 - Dividends l e s s w i t h h o l d i n g taxes 56 - Return of i n i t i a l investment (see note below) 10 Total Note:  I.  Net  Outflow  333 655 200 US  The c a p i t a l i s assumed to be a v a i l a b l e out of proceeds of d i s p o s i t i o n of mine a s s e t s at the end of the mine l i f e which may i n clude new p o t e n t i a l mine prospects l o c a t e d through e x p l o r a t i o n . f o r e i g n currency i n f l o w  239 APPENDIX 18 Hurdle Rate  The  hurdle  r a t e i s a s p e c i f i e d percentage d i s c o u n t  rate  used by an investment d e c i s i o n maker as a p r o f i t a b i l i t y d e c i s i o n t o o l to screen projects.  out f i n a n c i a l l y u n a t t r a c t i v e investment  In order to pass the p r o f i t a b i l i t y t e s t , the  f i n a n c i a l i n t e r n a l r a t e o f r e t u r n f o r e c a s t to be  generated  from a proposed investment, which i s assumed to be an a l l e q u i t y b a s i s , has  to exceed the hurdle  funded  percentage r a t e  of r e t u r n o r , a l t e r n a t i v e l y , the p r o j e c t ' s stream of cash to provide hurdle  a p o s i t i v e net present  on  value when discounted  has  at  the  rate. The  hurdle  r a t e i s s e t by an investment d e c i s i o n maker  at such a number which, i n h i s o p i n i o n , w i l l p r o v i d e  future  cash flows from the investment s u f f i c i e n t to recover  both the  opportunity  c o s t of making the investment, and  surate w i t h the r i s k o f l o s i n g the value time the investment i s to be made. complication  a reward commen-  i n v e s t e d assumed a t  In the mining i n d u s t r y , a  a r i s e s i n s e t t i n g a hurdle  rate.  ments must c a r r y a share of the c o s t of a  Most mine i n v e s t -  project-unrelated  f u t u r e e x p l o r a t i o n programme undertaken to i d e n t i f y new The mining investment d e c i s i o n maker knows t h a t t i o n expenditure i s d i s c r e t i o n a r y and  t h a t any  a p r o j e c t towards the recoupment of general diture i s valuable.  The  the  mines. explora-  c o n t r i b u t i o n by  e x p l o r a t i o n expen-  a l l o c a t i o n to a proposed mine of a  f i x e d amount or p o r t i o n of a general  e x p l o r a t i o n budget, without  240 APPENDIX 18  regard  (cont'd)  to t h a t mine's s i z e and  l o c a t i o n , ore grade and  duct i n v o l v e d , c o u l d l e a d to unreasonably high o r low assigned  to the p r o j e c t -  can be captured  f a c t o r s of mine s i z e and  revenue amounts.  product can be captured  by s e t t i n g a s i d e  Accordingly,  an  f o r "x"  i n the d i s c o u n t  be  appropriately achieved  value of the f o r e c a s t cash  r a t e used to  obtain  flow.  percentage amount to be Incorporated  r a t e f o r e x p l o r a t i o n i s assessed by c o n s i d e r i n g  i n the  hurdle  the d o l l a r va-  r e l a t i v e s i z e . o f f o r e c a s t e x p l o r a t i o n programmes,  degree o f success achieved  i n the p a s t and  f u t u r e i n l o c a t i n g v i a b l e mines, and such f u t u r e mines, a l l as p e r c e i v e d The  The  "x" percentage p o i n t s of the i n t e r n a l r a t e of  r e t u r n , or a l l o w i n g  lue and  location  i n sales  s i z e d c o n t r i b u t i o n t o f u t u r e e x p l o r a t i o n c o s t s can be  The  charges  A l l four f a c t o r s mentioned can t h e r e f o r e  i n the net cash flows.  a net present  pro-  i n the magnitude of c a p i t a l expenditures.  f a c t o r s o f ore grade and  captured  The  the  the  f o r e c a s t f o r the  the a n t i c i p a t e d s i z e of by the d e c i s i o n maker.  author b e l i e v e s the mining investment d e c i s i o n maker has  draw on past experience to e s t a b l i s h an e x p l o r a t i o n f a c t o r w i t h i n the hurdle a likely  value.  r a t e and  suggests f i v e percentage p o i n t s  as  to  

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