Real Options Valuation of the License of a Copper Mine

Abstract

The objective of this paper is to value as a Real Option the License of a copper mine in the exploration stage. We conceive the License of a copper mine, as the value of a call option that gives us the right to invest in the next stage. The underlying asset is the Net Present Value (NPV) of the cash flows of the mine adjusted by the probability of success. The strike price is the investment required for acquiring the phase. For the simulation of the project and the calculation of the volatility of the Real Option using the Copeland and Antikarov methodology, the copper price, fundamental market risk of the project, is modeled using a mean reversion with jumps model. Other alternatives of volatility estimation are discussed. The valuation of the Real Option is made using a binomial lattice which allows introducing in the process the subjective probabilities of success from exploration to production.

Keywords: Real Options with Market and Private Risks, Compound Real Options, Mine Valuation, Binomial Lattices, Project Volatility Estimation, Mean Reverting Processes