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Valuation of mining projects under dynamic model framework

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Abstract

The proper solution to the optimal investment decision plays an important role in the decision-making process. Compared to the classical net present value rule, the real option approach captures the value of the flexibility embedded in the investment opportunity. In this paper we study relevant dynamic models interpreting the project as well as flexibility value as the option premium, namely investment projects from the mining industry. Specifically, the problem we face is described by systems of partial differential equations of the Black-Scholes type in terms of time and output price, equipped with the terminal condition enforced at time instants resulting from the specific timing and type of the flexibility that such an investment provides. As a result of that, the comprehensive methodological concept, based on the discontinuous Galerkin approach, is proposed to improve the numerical valuation process. The resulting numerical procedure is sufficiently robust to cope with an early exercise constraint as well as a wide range of model parameters. Finally, the performance of the solving procedure is accompanied within the conceptual case study arising from mining industry, supplemented by comments of practical importance.

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Acknowledgements

All authors were supported through the Czech Science Foundation (GAČR), Czech Republic under project 22-17028 S. The support is greatly acknowledged.

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Authors and Affiliations

  1. Faculty of Science, Humanities and Education, Technical University of Liberec, Studentská 1402/2, 461 17, Liberec, Czech Republic

    Jiří Hozman

  2. Faculty of Economics, VSB – Technical University of Ostrava, Sokolská 33, 702 00, Ostrava, Czech Republic

    Tomáš Tichý & Hana Dvořáčková

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  1. Jiří Hozman
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  2. Tomáš Tichý
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Jiří Hozman, Tomáš Tichý and HanaDvořáčková, contributed equally to this work

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Hozman, J., Tichý, T. & Dvořáčková, H. Valuation of mining projects under dynamic model framework. Ann Oper Res (2023). https://doi.org/10.1007/s10479-023-05569-y

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