Discount Rates and the Cost of Capital: Companies Versus Shareholder

Abstract

Applying a discounted cash flow (DCF) methodology in the determination of a mining project’s value is well understood and is typically the evaluation method of choice. This method is often applied in conjunction with the derivation of other specific indicators including a net present value (NPV), or a range of NPVs, an internal rate of return (IRR), and other metrics, which provide more exact decision-based results on which potential investment actions are pursued or discounted. Importantly, in any NPV derivation, the discount rate used to calculate the value is as important as many of the modelled input assumptions incorporated to generate the project’s cash flows. This discount rate is determined to reflect the costs of debt and equity, as well as include a level of additional risk associated with the project being valued.

However, while a discount rate may be an appropriate factor to levy against the cash flows of a mining project or for a mining holding company to determine a value, it is typically not an appropriate rate that a private investor or individual shareholder would use to determine the investment value of its equity holding. This paper addresses this specific issue for shareholders compared against a mining company or mining project.