Valuing Managerial Flexibility: An Application of Real-Option Theory to Mining Investments

The value of managerial flexibility is assessed using data on prices, costs, grades, reserves, ore extraction, and metal output for a panel of Canadian copper mines. A real-option model is estimated and solved for project and option values. Most empirical researchers (i) consider the initial-investment decision but neglect flexible operation thereafter, (ii) assume that price is stochastic but ignore cost and reserve uncertainty, and (iii) model price as a nonstationary stochastic process. The evolution of three state variables, price, cost, and reserves, is assessed here. Differences in assumptions compared to others are found to lead to large differences in estimated project and option values.