10% discount rate, $2.2b npv , page-16

Belloh, I like you way fo thinking. You speak my language and understand the technicalities behind such calculations. Thank you for your insight.

Here is mine for consideration:

The cost of equity (Ke) for a junior ore miner can be determined via the Capital Asset Pricing Model (CAPM). Given that there?s no debt (as at today), the discount rate will be determined solely from Ke with no cost of debt (Kd) being factored into the equation:

Ke = Rf + Beta x (Rm ? Rf)

Assumptions as follows:

Ke = cost of equity

Rf = Risk Free Rate. In my profession, we find that the five year Bank Bill Swap Rate (BBSW) is appropriate, given that it determines a VERY low base rate to determining debt pricing and risk free deposit pricing. But, for Maigret1?s sake, we?ll use a three year BBSW to try and get as close to a Ke of 10% as possible. Today, the three year BBSW is 5.61%. The RBA cash rate is a too unrealistic benchmark now days, given its diminishing relevance to the cost of debt for Australian banks whose lending books are on average, 50% financed by global credit markets. AND, Term Deposits from AA rated Australian Banks (Big 4) are paying higher than 5.61%, so you can assume that the three year BBSW a fair Risk Free Rate rather than the cash rate.

Beta = 1.08 (FMS Beta as per Comsec, although probably not updated) for Maigret1?s sake, this is a very riskless Beta value given that junior mining companies are actually more volatile than the ASX 200. I.e. when the industry moves up, mining will move up in a higher in proportion, and conversely, we noticed during the GFC than as general industry declined, mining stocks declined further. I.e. mining will move in line with the general economy, but in higher proportions. So, a Beta of 1.08 is pretty low which will help get us to a Ke of 10%.

Market Return = Let?s assume 7% (again for Maigret1?s sake to get a low Ke). This is slightly higher than the average Term Deposit rate for 3 ? 5 years, so it?s appropriate if we?re looking for a low discount rate like FMS has applied. And, prior to the GFC, general market returns (average) were as high as 10% (conservative), so let?s discount this by little to be more realistic for today?s environment (7%). This will also help us get to a Ke of 10%.

So, applying the formula with the above (fairly low risk inputs), we actually arrive at a Ke of 13.2%

Hence, the discount rate applied should be closer to 13.2% rather than 10%, particularly when considering the above inputs are quite riskless and are more appropriate to conservative industries rather than mining.

Even using today?s cash rate at 4.75%, Ke is 12.3%

Even more riskless (again for Maigret1?s sake), using a beta of 1 (which assumes this mining companies moves in line with the market) gives us a Ke of 11.8%.

So, that?s the theory behind my questioning of a 10% discount rate. Sure, if debt is to be factored into the capital structure for the future CAPEx, this will lower the weighted average cost of capital, but in my profession, junior miners aren?t able to rase debt financing for such projects in this phase unless it?s through the debt capital markets or a syndicated facility given such a high value of $400m is needed. For this type of project, however, we see equity capital as more likely rather than debt- hence, the above formula being appropriate.

You can?t argue with me that the above inputs I?ve used don?t consider some rather riskless figures to try and get as close to 10% as possible. But still, with amending the inputs to be as low risk as possible, we can only get is as low as 11.8%.