Entry and exit criteria under price uncertainty for dwindling mine

Abstract

This thesis develops a model using real options for finding entry and exit criteria for dwindling mine under uncertainty of the output price. Entry and exit criteria are upper and lower output price boundaries at which one should launch or stop mine’s operations to maximize mine’s value. Extraction rate is assumed to be fixed percentage of reserves available and output price is assumed to follow geometric Brownian motion. The numerical results for copper mine are compared with ones from Dixit and Pindyck (1994). The approximation formula for entry criterion and respective mine’s value is derived. The set of tables for exit criterion calculation suitable for variety of cases have been constructed. Moreover, set of matlab functions for calculation of entry and exit criteria has been written and present in the appendix to this thesis. Additionally, it is shown that widely used method of option value calculation based on random walk representation of geometric Brownian motion shows low precision in the case of dwindling mine considered in the thesis.