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7/19/17

Discount rate feedback

Several decent mails by way of feedback on this post yesterday, 5% discount rate stupidity and all that. All mailers kept anonymous and some are just excerpts, to protect IDs of both innocent and guilty:

Some people just grouched along with me:

"Well said - there is no capital available to junior mining for 5% or 10%. My biggest issue is that the purchase price of the project is not included in the financial analysis in the 43-101. It's just a sunk cost, prior to the feasibility study, and so can be neglected in the NPV and  AISC calcs. Its no wonder that the cash flow is marginal compared to what you would expect with an AISC of $700."

Some people still don't get how 43-101s are being used for ulterior motives...

"Hey Otto - I couldn't agree more that if you take the company's stated 5% discount rate or whatever they choose as the correct one, you shouldn't be investing in the mining space at all.

With that being said, I have always had a viewpoint that there was a purpose to the 5% discount rate for golds or let's say 8% for base metal projects. Is it really the 43-101's job to assess the level of geopolitical risk? From an operating / construction / processing etc. side, sure, but that's where I would stop. I would say that the 5% is simply a rule of thumb that let's anyone reading the 43-101 report generally speaking compare the relative quality of one project versus another, without considering geopolitical and other risks. Obviously there are limitations as the price decks are not uniform, which I think is something the industry should be pushing for to change, but it is a starting point.

Everyone's perception or tolerance for risk is different and an investor is solely responsible for applying a discount rate he/she believes addresses risks external to the project. I guess in my mind the 43-101 on the npv side is aimed at providing you with a relative data point rather than a factual one - once you have gotten past that point then other risks can be factored in, which in my mind are more external than internal to a project's quality."

Some people do and defend the system (a bit), but still miss the promo BS angle:
"There is another way at looking at discount rates – granted that a junior in an exploration phase pays say 12% interest, however when they find an economic deposit that promises to make a very good return, interest rates for the junior will go down and approach that paid by producing companies. Accordingly it does not really make sense to use a very high discount rate in an EPA, or Feas. as this could cause a company to discard what otherwise could be a money maker once producing. Therefore using a discount rate equal to a junior’s explorers’ cost of capital while in the exploration stage would be a huge mistake."

Other people really get it, like this one:
"The 5% rate serves only one very important purpose: it allows the entire junior market industry to function (raise and pay $$). If actual cost of capital rates were used (only) 10% of projects would be economic..."
And this one:
"My dearest Mr. Otto,... I once questioned an analyst on whether a 5% discount properly reflected risk for a sketchy project in a difficult mining jurisdiction and his answer was, if everyone uses a 5% discount, it is easy to compare project to project.  I guess I just never spent enough time to understand  the incredible similarities of the risk profiles of a project in BC to a project in the DRC.  Silly me."

But I'll leave the final word to a geologist:
"FWIW I don't quietly masturbate over 43-101 reports. I try to make it as loud as possible (and) put on 'Ace of Spades' for tempo."

Nuff said.