VERIFICATION OF ECONOMIC EFFICIENCY OF LIGNITE DEPOSIT DEVELOPMENT USING THE SENSITIVITY ANALYSIS

1 Beaa TRZASKUŚ-ŻAK 1, Kazimierz CZOPEK 2 MG 3 1 Trzaskuś-Żak Beaa PhD. (corresponding auhor) AGH Universiy of Science and Technology Faculy of Mining and Geoengineering Al. Mickiewicza 30, 30-59 Krakow, Poland -zak@agh.edu.pl 1 Prof. Kazimierz Czopek AGH Universiy of Science and Technology in Krakow Faculy of Mining and Geoengineering kczopek@agh.edu.pl Absrac: VERIFICATION OF ECONOMIC EFFICIENCY OF LIGNITE DEPOSIT DEVELOPMENT USING THE SENSITIVITY ANALYSIS The aricle presens analysis of an invesmen projec consrucion of a mine in a lignie deposi K. The projec has been assessed using he Ne Presen Volume (NPV) mehod, aking ino accoun he economic efficiency crierion. Lignie has few characerisic properies. Firs of all, lignie is no a marke commodiy iself. In pracice all of i is sold o a nearby power plan associaed wih he mine, and hus elecric energy -MWh is he shared marke commodiy of boh. A he same ime, lignie winning coss o a large exen depend on condiions characerisic for a specific deposi. Lignie exracion cos is grealy affeced by he volume of overburden ha needs o be removed, and hus as regards unis, mass exracion uni cos is as much imporan as uni cos relaed o winning 1 on of lignie. I is no he ulimae facor deciding abou lignie sale price for power plan, since he price is deermined boh by qualiaive parameers of lignie and prices of power in marke. The example used in he aricle i has been used o presen necessary procedure o be followed in lignie condiions. The selecion of disribuion values for parameers needed in he NPV mehod belongs o he mos imporan asks of his procedure. The researchers have employed he sensiiviy analysis o esimae wha he value of NPV parameers should be o reach he economic efficiency of invesmen projec. Key words: invesmen analysis, NPV mehod, profiabiliy, risk, he Mone Carlo mehod, coss of lignie exracion 1. Inroducion The funcioning of lignie mining, as any ype of business aciviy, requires involvemen of financial means (invesing), so as no only o keep he aciviy a curren level, bu also o exend i by predicing probable increase in demand for power. However, each invesmen projec means a need o renounce curren benefis in reurn for profis expeced in fuure. Therefore, when making any invesmen-relaed decision we mus ake ino accoun whole range of crieria confirming righness of ha decision. The five crieria lised below belong o he mos imporan crieria applied when making invesmen-relaed decisions (Czechowski 1999), (Kawa, Wydymus, 1998): - economic efficiency of he invesmen projec, meaning ha income from planned invesmen projec will be higher han expeced expenses relaed wih i, - risk and uncerainy, firs of all inseparable from economic efficiency, generally undersood as a probabiliy of failure o obain expeced effecs or, sraigh ou, suffering a loss, - maerial usefulness of he invesmen projec, undersood as he way o achieve he chosen plan,

2 - social crieria, resuling eiher from all-economic need or local communiy expecaions, - ecological crieria, very imporan, wihou which no invesmen projec should come ino being; in his case, according o hem he so-called susainable developmen is an imporan elemen. This work is limied in is conen o he firs crierion used in he assessmen of invesmen projecs ha is o he crierion of invesmen projec economic efficiency. In his case, from among few mehods used o carry ou economic assessmen of invesmen projecs, he researchers have chosen he discoun mehod. In his mehod he mos imporan crierion allowing o evaluae economic efficiency of an invesmen projec is he value of discouned ne cash flow (ne presen value-npv), calculaed according o he following formula (Brigham, Gapenski 2000), (Czopek, Sierpień 2009), (Kawa, Wydymus 1998): n CF I Re NPV = ( ) + (1) = 1 (1 + r) (1 + r) (1 + r) where: CF financial surplus in year, I invesmen oulays in year, r discoun rae, successive year in assessmen of invesmen projec, Re residual value of an invesmen projec in year. Financial surplus is he following sum: where: EBIT operaing profi in year, A depreciaion amoun in year, NOPAT operaing profi afer axaion, CF = NOPAT + A NOPAT = EBIT ( 1 T ) (2) (3) Operaing profi is he difference beween operaing incomes and operaing coss, ha is: EBIT = P o K o (4) where: P o operaing income in year, K o operaing coss in year, T income ax (CIT) rae. NOPAT = ( P K ) (1 T ) o o (5) Therefore, formula (1) may be expressed as follows:

3 NPV = ( P K ) (1 T ) I + A Re n o o + = 1 (1 + r) (1 + r) (6) 2. The value of ne cash flows in he deerminisic model A hypoheical lignie deposi K has been chosen for he purposes of his aricle. Is basic specificaions are: - indusrial resources, 600 million Mg of lignie, - calorific value, Q i =9300 kj/kg, - ash conen in lignie, A d = 15.60%, - sulphur conen in lignie, S r = 0.80%, - overburden o lignie raio, O:L = 6.7:1. I has been also assumed ha invesmen cycle will las 10 years, ha is: - preparaory works; 4 years - opening cu; 3 years - reaching full producion capaciy; 3 years. Mine operaion period afer having reached arge producion capaciy will be 28 years, and average annual oupu: - overburden; 100.5 million m 3, - lignie; 15 million Mg, - mass; 113 million m 3. Taking ino accoun brown coal specificiy, furher deailed enries have been added o formula (6), ha is (Czopek, Sierpień 2009), (Czopek, Trzaskuś-Żak,2009): (7) Po = p X p and: (8) Ko = X M k jm where: p lignie sale price, PLN/Mg, X p sold lignie volume in year, Mg, X M exraced mass (overburden + lignie) volume in year, m 3, k jm mass exracion uni cos, PLN/m 3. Then final formula allowing o calculae he NPV value will have he following form: NPV = ( p X X k ) (1 T ) I + A Re (1 n p M jm ( ) + = 1 (1 + r) + r) (9) The NPV value has been calculaed for he following inpu parameers in formula (9): - calculaion period; n=38 years (10+28), - lignie sale price; p=67.50 PLN/Mg, - lignie sale volume; X p = 15 million Mg/year, - exraced lignie volume; X = 15 million Mg/year,

- exraced mass volume; X M = 113 million m 3 /year, - mass exracion uni cos; k jm =7.0 PLN/m 3, - income ax (CIT) rae; T=19%, - oal invesmen oulays in 10 years; I = 4430 million PLN, - he value of depreciaion allowances; A = 118.65 million PLN/year, - discoun rae; r = 7.0%, - residual value; Re = 886 million PLN. Deailed daa allowing o calculae sum of discouned ne cash flow which is called Ne Presen Value (able 1). I proves ha for assumed parameers he invesmen projec in deposi K would be profiable, because he ne presen value (NPV) is favourable and is equal 80.35 million PLN. 4

5 Table 1. The Ne Presen Value (NPV) calculaion of analysed lignie deposi Iem Specificaion Uni 1 2 3 4 5 6 7 8 9 10 11 12 13 14 1 Invesmen oulays million PLN 2 Coal sale volume million Mg 3 Sale price PLN/Mg 4 Income from sale million Mg 40.00 200.00 290.90 480.00 480.00 480.00 480.00 500.00 688.10 791.00 5 Mass million m 3 10.00 25.00 50.00 69.20 98.30 7.00 5 Operaing coss million PLN including: 6 Depreciaion million PLN 8 Toal coss million PLN 9 Gross profi million PLN 10 Income ax million PLN 11 Ne profi million PLN 13 Invesmen liquidaion value million PLN 5.00 10.00 15.00 15.00 15.00 15.00 15.00 67.50 67.50 67.50 67.50 67.50 67.50 67.50 337.50 675.00 1 012.50 1 012.50 1 012.50 1 012.50 1 012.50 113.00 113.00 113.00 113.00 113.00 7.00 7.00 7.00 7.00 7.00 7.00 7.00 7.00 791.00 791.00 791.00 791.00 118.65 118.65 118.65 118.65 791.00 791.00 337.50 675.00 1 012.50 221.50 221.50 221.50 221.50 42.09 42.09 42.09 42.09 337.50 675.00 1 012.50 179.42 179.42 179.42 179.42 14 Ne cash flows million PLN 15 Discouning rae (7.0%) -40.00-200.00-290.90-480.00-480.00-480.00-480.00-162.50-13.10 221.50 298.07 298.07 298.07 298.07 0.93458 0.87344 0.81630 0.76290 0.71299 0.66634 0.62275 0.58201 0.54393 0.50835 0.47509 0.44401 0.41496 0.38782 16 Discouned ne cash flows million PLN -37.38-174.69-237.46-366.19-342.23-319.84-298.92-94.58-7.13 17 Cumulaed value of ne cash flows million PLN 18 NPV (Ne Presen Value) million PLN -37.38 112.60 141.61 132.34 123.69 115.59-212.07-449.53-815.72-1 157.96-1 477.80-1 776.72-1 871.30-1 878.42-1 765.82-1 624.21-1 491.87-1 368.18-1252.59

6 Table 1 (coninue). The Ne Presen Value (NPV) calculaion of analysed lignie deposi Iem Specificaion Uni 15 16 17 18 19 20 21 22 23 24 25 26 27 28 1 Invesmen oulays million PLN 2 Coal sale volume million Mg 3 Sale price PLN/Mg 4 Income from sale million Mg 5 Mass million m 3 7.00 6 Mass uni cos (7.0 PLN/m 3 ) PLN/m 3 791.00 5 Operaing coss million PLN 15.00 15.00 15.00 15.00 15.00 15.00 15.00 15.00 15.00 15.00 15.00 15.00 15.00 15.00 67.50 67.50 67.50 67.50 67.50 67.50 67.50 67.50 67.50 67.50 67.50 67.50 67.50 67.50 1 012.50 1 012.50 1 012.50 1 012.50 1 012.50 1 012.50 1 012.50 1 012.50 1 012.50 1 012.50 1 012.50 1 012.50 1 012.50 1 012.50 113.00 113.00 113.00 113.00 113.00 113.00 113.00 113.00 113.00 113.00 113.00 113.00 113.00 113.00 7.00 7.00 7.00 7.00 7.00 7.00 7.00 7.00 7.00 7.00 7.00 7.00 7.00 791.00 791.00 791.00 791.00 791.00 791.00 791.00 791.00 791.00 791.00 791.00 791.00 791.00 including: 6 Depreciaion million PLN 8 Toal coss million PLN 9 Gross profi million PLN 10 Income ax million PLN 11 Ne profi million PLN 118.65 118.65 118.65 118.65 118.65 118.65 118.65 118.65 118.65 118.65 118.65 118.65 118.65 118.65 791.00 791.00 791.00 791.00 791.00 791.00 791.00 791.00 791.00 791.00 791.00 791.00 791.00 791.00 221.50 221.50 221.50 221.50 221.50 221.50 221.50 221.50 221.50 221.50 221.50 221.50 221.50 221.50 42.09 42.09 42.09 42.09 42.09 42.09 42.09 42.09 42.09 42.09 42.09 42.09 42.09 42.09 179.42 179.42 179.42 179.42 179.42 179.42 179.42 179.42 179.42 179.42 179.42 179.42 179.42 179.42 13 Invesmen liquidaion value million PLN 14 Ne cash flows million PLN 15 Discouning rae (7.0%) 16 Discouned ne cash flows million PLN 17 Cumulaed value of ne cash flows million PLN 18 NPV (Ne Presen Value) million PLN 298.07 298.07 298.07 298.07 298.07 298.07 298.07 298.07 298.07 298.07 298.07 298.07 298.07 298.07 0.36245 0.33873 0.31657 0.29586 0.27651 0.25842 0.24151 0.22571 0.21095 0.19715 0.18425 0.17220 0.16093 0.15040 108.03 100.96 94.36 88.19 82.42 77.03 71.99 67.28 62.88 58.76 54.92 51.33 47.97 44.83 15.00 15.00 15.00 15.00 15.00 15.00 15.00 15.00 15.00 15.00 15.00 15.00 15.00 15.00-1 144.56-1 043.59-949.23-861.04-778.63-701.60-629.61-562.34-499.46-440.70-385.78-334.45-286.49-241.66

7 Table 1 (coninue). The Ne Presen Value (NPV) calculaion of analysed lignie deposi Iem Specificaion Uni 29 30 31 32 33 34 35 36 37 38 Suma 1 Invesmen oulays million PLN 2 Coal sale volume million Mg 3 Sale price PLN/Mg 4 Income from sale million Mg 4 430.00 15.00 15.00 15.00 15.00 15.00 15.00 12.50 10.00 7.50 5.00 425.00 67.50 67.50 67.50 67.50 67.50 67.50 67.50 67.50 67.50 67.50 1 012.50 1 012.50 1 012.50 1 012.50 1 012.50 1 012.50 843.75 675.00 506.25 337.50 28 687.50 5 Mass million m 3 113.00 113.00 113.00 113.00 113.00 113.00 97.90 88.30 73.50 54.20 3 391.40 6 Mass uni cos (7.0 PLN/m 3 ) PLN/m 3 7.00 7.00 7.00 7.00 7.00 7.00 7.00 7.00 7.00 7.00 5 Operaing coss million PLN 791.00 791.00 791.00 791.00 791.00 791.00 685.30 618.10 514.50 379.40 21 181.30 including: 6 Depreciaion million PLN 8 Toal coss million PLN 9 Gross profi million PLN 10 Income ax million PLN 11 Ne profi million PLN 13 Invesmen liquidaion value million PLN 14 Ne cash flows million PLN 15 Discouning rae (7.0%) 118.65 118.65 118.65 118.65 118.65 118.65 102.80 92.72 77.18 56.91 3 177.20 791.00 791.00 791.00 791.00 791.00 16 611.00 221.50 221.50 221.50 221.50 221.50 221.50 158.45 56.90-8.25-41.90 7 506.20 42.09 42.09 42.09 42.09 42.09 42.09 30.11 10.81 0.00 0.00 967.96 179.42 179.42 179.42 179.42 179.42 179.42 128.34 46.09-8.25-41.90 6 455.24 0.00 886.00 886.00 298.07 298.07 298.07 298.07 298.07 298.07 231.14 138.80 68.93 901.01 6 088.44 0.14056 0.13137 0.12277 0.11474 0.10723 0.10022 0.09366 0.08754 0.08181 0.07646 16 Discouned ne cash flows million PLN 41.90 39.16 36.59 34.20 31.96 29.87 21.65 12.15 5.64 68.89 80.35 17 Cumulaed value of ne cash flows million PLN -199.76-160.60-124.01-89.81-57.85-27.98-6.33 5.82 11.46 80.35 18 NPV (Ne Presen Value) million PLN 80.35

3.Invesmen risk assessmen for deposi K developmen 8 No oo high value of discouned ne cash flow (NPV = 80.35 million PLN) suggess ha if his invesmen projec would be acually implemened, i would be necessary o perform broader analysis of is cos-effeciveness. For insance, because i has been assumed in he above calculaions ha all parameers in formula (9) have deerminisic characer, which is no rue in pracice. Only income ax rae T, depreciaion allowances A, and residual value Re may be deemed deerminisic values, while all oher parameers would be subjec o changes, and ha would involve occurrence of risk relaed o successful implemenaion of an invesmen projec. Tha is why researchers employed he sensiiviy analysis. This mehod is employed very ofen. As we know, his analysis involves change of individual inpu parameers by predeermined percen and calculaion of his change impac on he NPV value. The following scope of changes in parameers mos significanly affecing he NPV has been used in case of he analysed deposi K : - invesmen oulays; I, he researchers assumed higher invesmen oulays han hose analysed in deerminisic model, reaching 4620 million PLN, i is unlikely ha hey will be lower; Table 2 presens disribuion of oulays in invesmen cycle, - mass exracion uni cos; k jm = 6.50; 7.00; 7.50 PLN/m 3, - lignie sale price; p = 62.50 77.50 PLN/Mg, - discoun rae; r = 6.50%; 7.00%, 7.50%, In he example, he researchers decided no o change oher parameers in formula (9). Table 2. Disribuion of invesmen oulays deposi K, million PLN The sum of invesmen Invesmen cycle, years oulays, Reaching full producion Preparaory works Opening cu million PLN capaciy 1 2 3 4 5 6 7 8 9 10 4 430.00 40.00 200.00 290.90 480.00 480.00 480.00 480.00 500.00 688.10 791.00 4 620.00 40.00 200.00 300.00 495.00 495.00 500.00 500.00 505.25 737.25 847.50 Iem Mass exracion uni cos, PLN/m 3 1. 6.50 2. 7.00 3. 7.50 Table 3. The NPV value for invesmen oulays reaching 4430 million PLN NPV, million PLN Discoun Lignie sale price, PLN/Mg rae, % 62.50 65.00 67.50 70.00 72.50 75.00 77.50 6.50-8.03 235.39 478.64 721.90 964.97 1208.01 1451.05 7.00-139.68 83.84 307.22 530.60 753.82 977.02 1200.22 7.50-253.93-48.34 157.12 362.59 567.93 773.25 978.56 6.50-257.96-14.36 229.24 472.65 715.90 959.15 1202.27 7.00-366.99-143.32 80.35 303.86 527.23 750.61 973.87 7.50-460.99-255.28-49.57 156.00 361.47 566.94 772.30 6.50-508.62-264.53-20.69 222.91 466.51 709.91 953.16 7.00-594.92-370.83-146.96 76.71 300.38 523.87 747.25 7.50-668.58-462.52-256.64-50.92 154.79 360.35 565.82 Iem Mass exracion uni cos, PLN/m 3 1. 6.50 2. 7.00 3. 7.50 Table 4. The NPV value for invesmen oulays reaching 4620 million PLN Discoun NPV, million PLN rae, % Lignie sale price, PLN/Mg 62.50 65.00 67.50 70.00 72.50 75.00 77.50 6.50-217.33 22.30 364.24 607.49 850.57 1093.60 1336.64 7.00-250.63-27.11 196.26 419.64 642.87 866.07 1089.26 7.50-361.51-155.92 49.54 255.01 460.35 665.67 870.98 6.50-372.36-128.76 114.84 358.24 601.50 844.75 1087.86 7.00-477.94-254.27-30.60 192.90 416.28 639.66 862.92 7.50-568.57-362.86-157.15 48.43 253.89 459.36 664.73 6.50-623.02-378.93-135.09 108.51 352.11 595.50 838.76 7.00-705.87-481.79-257.91-34.24 189.42 412.92 636.30 7.50-776.16-570.10-364.22-158.50 47.21 252.77 458.24

9 4.Summary Lignie has few characerisic properies. Firs of all, lignie is no a marke commodiy iself. In pracice all of i is sold o a nearby power plan associaed wih he mine, and hus elecric power - MWh is he shared marke commodiy of boh. A he same ime, lignie winning coss o a large exen depend on condiions characerisic for a specific deposi. Lignie producion cos is grealy affeced by he volume of overburden ha needs o be removed, and hus as regards unis, n Krakówmass exracion uni cos is as much imporan as uni cos relaed o winning 1 on of coal. I is no he ulimae facor deciding abou lignie sale price for power plan, since he price is deermined boh by qualiaive parameers of lignie and prices of power in marke. Calculaion resuls for employed sensiiviy analysis are compared in Tables 3 and 4. The following general conclusions may be drawn on heir basis: - increase in invesmen oulays resuls in reducion of projec economic effec, ha is NPV value drop, - he projec would be cos-effecive in case of lignie sale price no lower han 65.00 PLN/Mg, only hree varians would be cos-effecive for his price, - in case of mining coss represened in he example by mass exracion uni cos, all varians would be cos-effecive only for lignie sale price p 72.50 PLN/Mg, - for he adoped discoun rae range, aking ino accoun remaining lignie parameers, all varians would be cos-effecive only for lignie sale price p 72.50 PLN/Mg; increase in discoun rae reduces he number of cos-effecive varians. References 1. Brigham E.F., Gapenski L.C., 2000 Managemen of Finances. Warszawa, PWE 2. Czechowski L. e al., 1999 Invesmen Projecs. Financing. Mehods and Procedures: Gdańsk, ODDK 3. Czopek K., Sierpień M., 2009 Varian Analysis of Economic Efficiency of a New Brown Coal Deposi Developmen: Power Indusry Policy Vol. 12, Z.2/2, The Commiee of Susainable Mineral Resources Managemen - PAN (Polish Academy of Science), p. 57 75 4. Czopek K., Trzaskuś-Żak B., 2009 Brown Coal Coss and Prices in Marke Condiions. Power Indusry Policy Vol. 12, Z.2/2, The Commiee of Susainable Mineral Resources Managemen - PAN (Polish Academy of Science), p. 77 89 5. Kawa P., Wydymus S., 1998 Mehodology of Economic Efficiency Assessmen for Invesmen Projecs According o European Union Sandards. Krakow, WSzZiB This aricle has been prepared in he scope of sauory research (nr 11.11.100.481) a AGH Universiy of Science and Technology in Kraków

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