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You are examining the financial viability of investing in some abandoned copper mines in Chile,...

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Accounting

You are examining the financial viability of investing in some abandoned copper mines in Chile, which still have significant copper deposits in them. A geologist survey suggests that there might be 10 million pounds of copper in the mines still and that the cost of opening up the mines will be $3 million (in present value dollars). The capacity output rate is 400,000 pounds a year and the price of copper is expected to increase 4% a year. The Chilean Government is willing to grant a twenty-five year lease on the mine. The average production cost is expected to be 40 cents a pound and the current price per pound of copper is 85 cents (The production cost is expected to grow 2.5% a year, once initiated). The monthly standard deviation in copper prices is 7% and the twenty-five year bond rate is 7%. Consider 1/25 as cost of delay (dividend yield in the Black-Scholes formula).

a) Estimate the value of the mine using traditional capital budgeting techniques.

b) Estimate th value of the mine based upon an option pricing model.

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