You own an unused gold mine that will cost $100,000 to reopen. If you open the mine,

Question:

You own an unused gold mine that will cost $100,000 to reopen. If you open the mine, you expect to be able to extract 1,000 ounces of gold a year for each of three years. After that, the deposit will be exhausted. The gold price is currently $500 an ounce, and each year the price is equally likely to rise or fall by $50 from its level at the start of the year. The extraction cost is $460 an ounce and the discount rate is 10 percent.

a. Should you open the mine now or delay one year in the hope of a rise in the gold price?

b. What difference would it make to your decision if you could costlessly (but irreversibly) shut down the mine at any stage?

Discount Rate
Depending upon the context, the discount rate has two different definitions and usages. First, the discount rate refers to the interest rate charged to the commercial banks and other financial institutions for the loans they take from the Federal...