Option pricing: a new approach to mine valuation

CIM Bulletin, Vol. 79, No. 891, 1986
SCOTT K. PALM, NEIL D. PEARSON, JAMES A. READ, JR., Charles River Associates, Boston, Massachusetts
Abstract Uncertainty is an important feature of many investments, but it is especially important for mineral properties. Mine properties often entail large investments and fixed commitments. Managers in the mining industry often view price uncertainty as undesirable, due to the possibility that the price of the mined commodity -will fall to a level that prevents the firm from recovering its investment and fixed costs. This paper identifies pitfalls in conventional valuation methods and outlines a new approach to valuation based on option pricing theory and dynamic programming. In the process, it identifies generic strategies for organizing mine production in ways that allow the owner to benefit from the uncertainty in mineral prices.
Keywords: Management, Mineral economics, Option pricing, Mine investments, Mine valuation, Risks, Costs.
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