The Ad Valorem Method of Valuation
The ordinary commercial method of valuing mineral deposits recognizes the two main elements of value above discussed. This method is sometimes called the rational or ad valorem method. The profit per ton (or per other unit) of the product is established, on the basis either of past performance of the property or of experience with other similar properties. This profit is multiplied by the total tonnage estimated in the deposit, the estimate including known reserves, probable reserves, and in some cases possible and prospective reserves. The product of the profit per ton and the total tonnage gives the total net amount which will be received; it does not, however, give the present value, because the commodity cannot all be taken out and sold at once, but must be mined and absorbed by the market through a considerable period of years. The returns receivable some years in the future have obviously a lower proportionate present worth than amounts to be received at once. The interest rate comes into play, making it necessary to discount each annual payment for the number of years which will elapse before it is received. It is evident, therefore, that an estimate of the life of the property is necessary, involving not only knowledge of the reserves, but also a forecast of the annual extraction or rate of depletion.
As a simple case of ad valorem valuation for illustrative purposes, a deposit containing 1,000,000 tons in reserve has an estimated output of 100,000 tons a year for ten years, on which the profit per ton has in the past averaged $1 and is expected to average $1 in the future. Ten annual instalments or dividends of $100,000 are to be received. The present value of the total of these instalments is figured by an annuity method. It is the value upon which the series of dividends will pay interest at a predetermined rate, in addition to paying to a sinking fund annual instalments which, safely invested each year at a low rate of interest (usually 4%), will repay the present value at the end of the ten years. In our hypothetical case, if an interest rate of 8%