168
Mining Royalties
incurred in a period. Others may prefer the use of after-tax cash flow, which would further account for the various tax aspects of the project, which are also real costs and benefits that directly affect economic criteria such as NPV. Variable costs may often be identified as operating expense in economic evaluation cash-flow models. Operating expense is a summation of the cash costs associated with producing and selling products. However, accountants use various methodologies for valuing inventory, and these can cloud the true cash expenditures in a period, at least from the viewpoint of the net income statement. In other words, if units are drawn from inventories, the cost of those items may have been incurred in an earlier period and, therefore, do not represent true cash costs in the period the units are finally sold. At issue is whether a true economic breakeven should reflect the noncash charges related to depreciation, depletion, amortization, and writeoffs. Or should cutoffs be determined by after-tax cash flow? Other issues might include the long-term prospects for a project versus short-term cyclical issues and whether the analysis is of an ongoing operation or a project yet to be determined. Once a company invests millions or billions for a project, the costs are sunk, but given the cyclical nature of commodity pricing, companies won’t want to walk away until they are convinced the project is no longer capable of adding economic value to its shareholders. In most instances the due diligence of evaluating the economic potential is built into the mine model and development scheme, so it’s the extraordinary items, such as the imposition of unexpected taxes or higher energy costs that might force a mine into early closure. The industry to which these concepts are applied really doesn’t matter; all investors must determine when it is no longer economically viable to continue producing and selling a product. Economic theory would suggest that this occurs when the incremental revenues received are just sufficient to cover the incremental costs, or marginal revenues are equal in magnitude to the marginal costs. However, it is also important to recognize that a low-cost producer may still not be an economic producer. Many gold companies advertise their low cash cost of producing an ounce of gold, but does that mean that the operations are profitable in the long run? It certainly helps, but depending on the magnitude of the capital structure of the operation, long-term economics may vary from very profitable to something less so. Hence, many would argue that the depreciation related to preproduction development, capital improve-