Estimating the Cost of Equity Using a Mining Build‑Up Model

Abstract

Among other methods, build‑up models have been used to value equity. However, the build‑up models are usually general models to appraise business and financial risks, and thus cannot fully mirror the special characteristics of different industries. The article presents a new model called ‘Mining Build‑up Model’ to assess the risks of mining companies. The model has four modules of risks (A – Business risks, B – Financial risks, C – Mining risks, and D – Module of a mining company), altogether roofing 12 areas of different risks. To demonstrate its usefulness, the Mining Build‑up Model was applied on a mining company called OKD, a.s. – a member of the mining group New World Resources (NWR) in the Czech Republic. For the different areas of risks, we quantified the components of risk, which became the starting points to determine the final risk premium. The quantification of the components of risks relies on expert evaluations of the degree of risk of the different components of risk in the risk modules. The weighs of the components of risks were determined using Saaty’s method (the Analytic Hierarchy Process – AHP). We found that in OKD, a. s. – a member of the mining group NWR – the risk premium of cost of equity reached the value of 12.52 % in 2013. As we worked with the risk‑free rate of return at a value of 2.83 %, the cost of equity for OKD, a. s. – a member of the mining group NWR, amounted to 15.35 %. The weighted average cost of capital of NWR Plc was calculated as 12.34 %.

Keywords

• risk
• modular method
• cost of equity
• risk premium
• build‑up model