Question 1 of 4: Mine Life-Cycle Stages & Snowy River Project DCF Analysis

Question 1: Mine Life-Cycle Stages & Snowy River Project DCF Analysis (30 marks)

Question text not reproduced: the examination questions are © Engineers and Geoscientists BC. Open the official past paper (linked at the top of this page) to read the question, then follow the worked solution below.

a) The five stages in the life of a mine

A mining project runs through five broad stages between initial discovery and final walk-away. 1 — Exploration. Regional prospecting followed by progressively more targeted geological mapping, geochemical sampling, geophysical surveys and diamond drilling, aimed at discovering and then delineating a mineralized zone well enough to estimate a resource. 2 — Evaluation and Development. The resource is converted to a mineable reserve through pre-feasibility and feasibility studies (geotechnical, metallurgical, environmental and economic work); the mine and mill are engineered in detail, permits are obtained (Snowy River's own timeline shows this stage running from discovery in 2001 through regulatory approval in 2012), and project financing is arranged. 3 — Construction. The bulk of the capital program is spent building the mine access, pit, processing plant, tailings facility, power and water infrastructure, and completing pre-production stripping/development — Snowy River's 2015–2018 build (stripping, power lines, tailings corridor, crusher/conveyor, mill commissioning) is a textbook example of this stage. 4 — Operation (Production). Ore is extracted, processed and sold on a sustained basis; this is the only stage that generates revenue and is where the capital invested in stages 1–3 is recovered and, if the project is economic, turned into profit. 5 — Closure and Reclamation. Once reserves are exhausted, infrastructure is decommissioned, the pit/waste-dump/tailings landforms are re-graded and re-vegetated, water treatment and long-term monitoring commitments are established, and the site is eventually relinquished to a stable, walk-away condition.

b) Typical cash flows through the five stages

Each stage has a characteristic cash-flow signature. Exploration is a small, sustained cash outflow spread over the years it takes to find and delineate a deposit — most exploration projects never reach a discovery, so this spend is high-risk with no assurance of return. Evaluation/Development is a larger outflow: feasibility studies, detailed engineering and permitting are expensive but still produce no revenue. Construction is the single largest cash outflow, concentrated into a short, capital-intensive window as the mine and mill are built — Snowy River spent roughly 295 million CAD by December 2017 alone, with a further 220 million CAD still to go before first revenue. Operation is the only stage with net cash inflow — revenue less operating cost, sustained for the whole production life — and must be large enough, for long enough, to repay the preceding three stages of outflow and still return a profit. Closure is a final outflow (decommissioning and reclamation cost) with no offsetting revenue. The resulting cash-flow diagram is a deep, widening valley (exploration → development → construction) followed by a sustained plateau of positive cash flow during production, ending in a small terminal dip at closure.

c) Discounted Cash Flow Analysis — Snowy River Project

Given. Values interpreted from the press release, with the assumptions stated in the callout below.

Find. (i) the gross and net value of the ore per tonne, for both production periods; (ii) NPV, PVR and before-tax payback period at i = 10%; (iii) a recommendation on whether the project should proceed.

Approach. Discard the sunk $295 M as irrelevant to a forward-looking investment decision; build the annual before-tax cash-flow timeline from the remaining $220 M capital outlay and the two-tier production revenue/cost stream; discount each block of years at 10% using the Appendix A cumulative present-value factors for NPV and PVR; track the undiscounted cumulative cash flow for the simple payback period.

1. Annual tonnage and operating cost. At full design rate, $$\dot{T} = 20{,}000\times 365 = 7{,}300{,}000\ \text{t/yr}, \qquad C_{op} = \dot{T}\times 90 = \$657.0\ \text{M/yr (both periods)}$$
2. Gross and net value of ore per tonne — years 1–9 (485,000 oz/yr). Annual revenue $R_1 = 485{,}000\times 1600 = \$776.0$ M/yr, so $$\boxed{v_{gross,1} = \frac{776.0\times10^{6}}{7.3\times10^{6}} = \$106.30/\text{t}, \qquad v_{net,1}=106.30-90.00=\$16.30/\text{t}}$$
3. Gross and net value of ore per tonne — years 10–17 (180,000 oz/yr). Annual revenue $R_2 = 180{,}000\times 1600=\$288.0$ M/yr, so $$\boxed{v_{gross,2} = \frac{288.0\times10^{6}}{7.3\times10^{6}} = \$39.45/\text{t}, \qquad v_{net,2}=39.45-90.00=-\$50.55/\text{t}}$$ — at constant full-capacity opex, the lower-grade tail years lose money on every tonne milled, a result worth flagging before the NPV even appears.
4. Annual net cash flow, before tax. $$CF_1 = R_1-C_{op}=776.0-657.0=+\$119.0\ \text{M/yr (yrs 1\textendash 9)}$$ $$CF_2 = R_2-C_{op}=288.0-657.0=-\$369.0\ \text{M/yr (yrs 10\textendash 17)}$$
5. Net Present Value at i = 10%. Using Appendix A's cumulative present-value factors, $CPVF(9,10\%)=5.7590$ and $CPVF(17,10\%)=8.0216$, so the block of years 10–17 discounts as $CPVF(17)-CPVF(9)=2.2626$; the reclamation outlay of 35 M/yr in years 18 and 19 discounts with the single-payment factors $PVF(18,10\%)=0.1799$ and $PVF(19,10\%)=0.1635$: $$NPV = -K + CF_1\,CPVF(9) + CF_2\,[CPVF(17)-CPVF(9)] - 35\,[PVF(18)+PVF(19)]$$ $$NPV = -220.0 + 119.0(5.7590) + (-369.0)(2.2626) - 35(0.3434)$$ $$NPV = -220.0 + 685.3 - 834.9 - 12.0$$ $$\boxed{NPV \approx -\$381.6\ \text{M}}$$
6. Present Value Ratio. $$\boxed{PVR = \frac{NPV}{K} = \frac{-381.6}{220.0} = -1.73}$$ — every dollar of remaining capital destroys about $1.73 of present value.
7. Payback period (simple, before-tax). Only the years-1–9 cash flow is positive, so the undiscounted cumulative position first turns positive at $$\boxed{t_{payback} = \frac{K}{CF_1} = \frac{220.0}{119.0} \approx 1.85\ \text{years into production}\ (\text{mid-2020})}$$ However the cumulative position then falls steadily through years 10–17 as the loss-making tail accumulates, ending the mine life deep in negative territory — the payback is real but does not survive the life of the project.

iii) Recommendation. On the stated assumptions the project does not clear a 10% hurdle: NPV is strongly negative (about −$382 M, of which $12 M is the present cost of reclamation), PVR is negative (−1.73), and while the undiscounted cash flow recovers the remaining capital quickly (about 1.85 years into production), that gain is entirely reversed — and then some — by eight years of tail production that loses money at the assumed full mill rate and $1,600/oz price. The root cause is visible in steps 2–3: the operating margin all but disappears once grade declines, because the $90/t combined cost is fixed while revenue is not. Recommendation: do not proceed on this analysis as scoped — the go-forward decision should ignore the $295 M sunk cost, but the $220 M still to be committed does not clear a 10% hurdle at the stated price (itself only 50% probable). Before committing further capital, re-examine whether the tail-years mine plan can be re-optimized (reduced throughput or earlier closure once cash flow turns negative) rather than assuming a fixed 17-year, full-capacity schedule, and stress-test the analysis against gold prices both above and below $1,600/oz.