NPV trap

Net present value (NPV) is the universally accepted tool for measuring the value of a mining venture. We spend a lot of effort maximizing the NPV by changing all sorts of parameters. Essentially, NPV just converts future cash flows back into today’s dollars by compounding the discount rate ( think interest rate ) into the future. NPV discounts early cash flow less and later cash flow more. Usually, any cash flows that are more than 15 years away are attributed negligible value in today’s dollars.

Consider two mines, Mine A produces 50kOz of gold for 15 years at a cost of $1000 per Oz. Mine B produces 50kOz of gold for 30 years at $1000 per Oz. These two mines will have practically the same NPV as they are identical for the first 15 years. NPV allocates next to no value to the latter 15 years of mine life of Mine B. The difference between the two mines is that as time goes on, the enterprise value ( measured as NPV) of Mine A will decline year on year until it is completed in year 15. Mine B however will have an enterprise value ( NPV ) that increases over time as the initial capital is fully depreciated.  Mine B could conceivably be worth much more in 15 years than it is worth now so it does not deserve the same valuation as Mine A.

The commonly, the solution would be to increase the production rate in Mine B to bring forward value, however this might require more capital and different approvals and is not always within the means of the company.  The other solution would be to decrease the discount rate once the capital is paid back to value to continuity.  The discount rate is usually high up front because mining is risky and lots can go wrong, however after the project hits steady state, most early problems are usually sorted out there are lots of opportunities for optimisation, meaning that the risk decreases over time.