Case Study 2
Mine Extension Or Closure?
Summary
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Mine Extension Or Closure
As a mine matures, it is common for additional reserves to be included in the project or for parts of it to be closed. Extensions may be in the form of satellite projects, additional pushbacks and/or the inclusion of underground operations as the surface mining draws to an end. The capital costs for mine extensions may include additional workshops, mining fleets, conveyor extensions and services. Closure of mines or parts of mines has the potential to reduce costs significantly.
The single overarching objective remains to maximise the value of the entire business for the shareholders. When capital is limited and the economics of projects are dropping, the temptation can be to cut those projects with the lowest rates of return or the longest payback periods.
Both of these financial instruments have serious flaws (Principles of Corporate Finance, Brealey & Myers) and shareholders would be better to determine the NPV for the different options.
A set of cases with a range of capital requirements should be optimised to measure value (NPV) from each scenario. Care is needed to ensure that each case is compared with similar optimisation rigour and that it can be implemented in practice. We should not put a lot of energy into only tweaking the value from our favourite case since this can lead to bias in the results. All cases should be optimised to a similar level of rigour so that they can be compared fairly and decisions made that truly improve shareholder value.
During downward cycles, companies tend to quickly spread the message that there is ‘no capital’ available during these times. However, these statements rarely actually mean ‘zero’ capital constraint. Instead, they typically mean that significant justification will be needed for capital requests, and the larger the request the greater the justification. If there truly is a capital limit, then we should undertake the bulk of our analysis within this constraint and be extremely careful of unrealistically ‘unconstrained’ scenarios.
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