Comparison of capital asset pricing mode

Capital is a scarce resource globally and mining projects must compete with projects from other sectors for this resource. A decision to invest available capital in mineral projects requires that valuation be conducted to assess the expected return on the projects. The discounted cash flow (DCF) analysis method is commonly used for the valuation of mining projects whereby future cash flows are discounted to present value using a discount rate. Economic and finance theory provides valuable tools to calculate discount rates. However, there is often uncertainty on an appropriate discount rate to apply to a project, as the discount rate must account for such factors as risk and stage of development of the project, despite the significant impact this parameter has on the outcome of a valuation. There are several methods for determining the cost of equity. This study considers the commonly applied Capital Asset Pricing Model (CAPM) and Gordon’s Wealth Growth Model because of their simplicity and availability of parameters required to estimate the cost of equity. CAPM and Gordon’s Wealth Growth Model are based on different assumptions, resulting in differences in the estimated cost of equity. This study explores how differences in the cost of equity obtained by these two methods can be explained for a mining company environment and proposes a way forward. These models have theoretical superiority when estimating the cost of equity.