Sequential investment decisions for mining projects using compound multiple volatility real options approach

Atul Chandra and Peter Hartley

Resources Policy, 2024, vol. 97, issue C

Abstract: Managers evaluating investment decisions in mining projects have reported using the net present value approach (NPV). However, NPV has the drawback of collapsing variations from uncertainties in future project cash flows into a fixed expected project value today. Ignoring future uncertainties and contingencies can lead managers to make incorrect up-front binary decisions, such as investing in or abandoning the project now. The real options analysis approach (ROA) instead captures variations from uncertainties as volatilities in project value and allows flexibility in investment decisions to be contingent on information as it is revealed. Managers we consulted agreed that ROA is superior to NPV in principle, but too complex to apply in practice. The advanced mathematics and restrictive assumptions required by analytical ROAs make them especially impractical for real-world projects exposed to multiple uncertainties. Furthermore, real-world projects are often multistage and involve valuing a compound option, which is an option on an underlying option, for sequential investment decisions. Extant numerical compound ROAs have been applied to such projects but suffer from various drawbacks. Amongst other issues, they combine variations from multiple uncertainties into a consolidated volatility of project value. This conceals the impact of each source of uncertainty, resulting in inaccurate project valuation and incorrect investment decisions. We present an innovative compound multiple volatility real options approach (C-MVR) to value a multistage project while accommodating separate volatilities of project value arising from multiple uncertainties for making sequential investment decisions. The resultant value is termed the compound enhanced net present value. Implementing C-MVR for a real coal mining project demonstrates how other ROAs can be seen as inaccurate simplifications that produce erroneous investment decisions. C-MVR provides a rigorous and versatile approach that can be applied to many investment decisions across various industries.

Keywords: Compound real option; Sequential investment decision; Multistage mining project valuation; Real option decision tree (search for similar items in EconPapers)
Date: 2024
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0301420724006081
Full text for ScienceDirect subscribers only

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:jrpoli:v:97:y:2024:i:c:s0301420724006081

DOI: 10.1016/j.resourpol.2024.105241

Access Statistics for this article

Resources Policy is currently edited by R. G. Eggert

More articles in Resources Policy from Elsevier
Bibliographic data for series maintained by Catherine Liu ().