Technical Note - Technique of Risk Analysis Especially Suitable for the Small Miner

The elaborate analytical techniques for risk analysis used by the large mining companies in conjunction with the valuation of mineral reserve sites are totally inappropriate for the small miner. The small miner does not possess the financial and technical resources which are available to the large companies for such risk analysis. Even if these resources were available to him, the relatively small size of his investment would not justify a huge expenditure for risk analysis. What is required by the small miner is an improvement over the single point estimates provided by the valuation techniques that he currently uses. Such improvement should provide an indication of the extent to which the true value (known only after the fact) might differ from his estimated value of the mineral reserve site. In addition, a rough indication of the chance of occurrence of various differences between the true and estimated values would be helpful to him. These improvements must be obtained at low cost to be useful to the small miner. Such improvements would have to be based on a simple system requiring very few additional estimates by the miner. The small miner is not accustomed to dealing with sophisticated risk analysis techniques. Hence, any complex, time-consuming approach would be doomed to disuse or possible misuse. A simple, uncomplicated approach requiring a minimum of additional estimates by the miner can be based on a system devised by Frederick S. Hillier Although Hillier's method can be applied to various mineral reserve valuation methods used by the small miner, this note is specifically oriented to the discounted cash flow model. The basic discounted cash flow (DCF) approach provides a single point estimate of value and introduces the concept of risk (i.e. the possibility that the annual cash flows may differ from their estimated values and thus lead to an incorrect investment value) through the use of a risk-adjusted discount rate. This approach simply lowers the present value estimate with increases in the discount rate (i.e. increases in the risk assessment). The single point estimate still remains. Although the lower value estimate makes it less likely that the risky investment will be deemed profitable and undertaken, it provides no indication of risk that is suitable for examination and analysis. In addition to the "best guess" estimate of annual net cash flows required in the DCF model, application of the Hillier risk analysis model requires that the miner