Risk analysis for discount rate determination in mineral development project: a case study

Abstract

In Ghana alone, Newmont Ghana owns two subsidiaries, Newmont Ghana Gold Limited which operate the Ahafo North and South project and Newmont Golden Ridge Limited which operate the Akyem mine. The Ahafo South mine which has been in operation since 2006 was given permit to start developing another concession, the Awonsu project. As a result, there was the need for the company to evaluate the economic viability of mining this concession using NPV evaluation method which has discount rate as one of its parameters. The development and exploitation of a mine comes with risks and heavy capital investment with longer payback periods. It is therefore important to consider risk when evaluating a mining projects by calculating a risk premium that will compensate investors for taking additional risks in a mineral project.Without a risk premium, Strategic Mine Planners face a challenge of setting an appropriate discount rate for use in NPV project evaluation while investors will also appreciate risk premium which when added to a risk-free rate of return (Interest rate) to get an adjusted-discount rate will compensate these investors for extra risk taken. Some major inherent risks such as technical (grade estimation), economic (varying metal prices) and political risks (tax, environmental regulations) and their accompanying probability and impact scores were identified through questionnaires and these two values multiplied to get a risk value for each risk identified. The risk values for each of the risk were summed up to get an overall risk value which was then converted into a risk premium of 9% for the project. An adjusted-discount rate of 28.8% was finally calculated by adding a risk-free rate of return (bond rate) to the risk premium of 9%. The adjusted- discount rate of 28.8% determined represent the returns that compensate investors for extra risk taken when they decide to ignore other investment instrument and choose this project. With this, investors are now better placed to make sound investment decisions on projects. The researcher therefore recommends that mining companies in Ghana should use a discount rate that is between 25.8% and 39.8% for their mineral projects.