You own a copper mine in Chile. If you operate the mine, the first cash flows...
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You own a copper mine in Chile. If you operate the mine, the first cash flows occur today, the second cash flows exactly one year from today, and the third and final cash flows exactly two years from today. Afterwards, the mine is obsolete. The mine can produce 4,000 tons of copper today, 5,000 tons of copper one year from today, and 6,000 tons of copper two years from today. The cost of extracting one ton of copper is $6,000. The price at which you can sell copper is currently $5,800 per ton. Your forecasting team predicts that the price of copper will increase by 20% or fall by 10% with equal probability in each of the next two years. There are no costs associated with opening or closing the mine. The cash flows associated with the mine have a beta of one, the risk-free interest rate is 3% at all maturities, and the expected market risk premium is 5% per year. The CAPM holds. What is the value of the mine? (b.i) (b.ii) Assume the mine is currently open. There are two types of real options embedded in operating this mine. What are these two types of options (which are nested, i.e., the second type only becomes useful once the first type has been exercised)? Please identify the value of each of the two types of options: what is the most you should be willing to pay today for the first option type (assuming you do not have the second one), and what is the most you should be willing to pay today for the second option type (assuming you have the first one)? (b.iii) Your CFO argues that the forecasting team's price distribution is too volatile and that, in fact, copper prices will only rise by 15 percent or fall by 5 percent with equal probability per year. Thus, your CFO argues that the copper mine is less risky and, therefore, more valuable. Do you agree? Please explain (no calculations required). You own a copper mine in Chile. If you operate the mine, the first cash flows occur today, the second cash flows exactly one year from today, and the third and final cash flows exactly two years from today. Afterwards, the mine is obsolete. The mine can produce 4,000 tons of copper today, 5,000 tons of copper one year from today, and 6,000 tons of copper two years from today. The cost of extracting one ton of copper is $6,000. The price at which you can sell copper is currently $5,800 per ton. Your forecasting team predicts that the price of copper will increase by 20% or fall by 10% with equal probability in each of the next two years. There are no costs associated with opening or closing the mine. The cash flows associated with the mine have a beta of one, the risk-free interest rate is 3% at all maturities, and the expected market risk premium is 5% per year. The CAPM holds. What is the value of the mine? (b.i) (b.ii) Assume the mine is currently open. There are two types of real options embedded in operating this mine. What are these two types of options (which are nested, i.e., the second type only becomes useful once the first type has been exercised)? Please identify the value of each of the two types of options: what is the most you should be willing to pay today for the first option type (assuming you do not have the second one), and what is the most you should be willing to pay today for the second option type (assuming you have the first one)? (b.iii) Your CFO argues that the forecasting team's price distribution is too volatile and that, in fact, copper prices will only rise by 15 percent or fall by 5 percent with equal probability per year. Thus, your CFO argues that the copper mine is less risky and, therefore, more valuable. Do you agree? Please explain (no calculations required).
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Answer rating: 100% (QA)
bi To calculate the value of the mine we need to determine the present value of the expected cash flows Well discount the cash flows at the riskfree i... View the full answer
Related Book For
Intermediate Accounting
ISBN: 978-0077400163
6th edition
Authors: J. David Spiceland, James Sepe, Mark Nelson
Posted Date:
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