Valuing management flexibility : A basis to compare the standard DCF and MAP valuation frameworks

The value of a mining project is typically influenced by many underlying economic and physical uncertainties, a dynamic project risk structure built on top of these uncertainties, and the possibility of multiple an mutually exclusive project operation options. The discounted cash flow (DCF) valuation method is widely used in the mining industry to value projects even though it is ill suited to consider these influences on project ject value. Modern asset pricing (MAP) provides an alternative valuation technique. It was developed for use in markets for derivative securities, where these complexities are common. As a result, MAP is able to incorporate these influences on value more reliably and consistently than the DCF method. The authors have used both techniques to value a small copper property, where management has an option to exploit large lower grade reserves near the end of the project and an option to abandon the project at any time. The MAP method indicates that the project, in the absence of the options to abandon or forego development of the lower grade reserves, is attractive only if an initial decision is made not to develop the low-grade reserves. The DCF method, as implemented, also indicates this but gives less understanding as to why this is the case. Moreover, the MAP valuation technique can extend the valuation exercise further by examining the project with different combinations of management flexibility. This additional analysis indicates that the existence of the lower grade reserves is valuable when combined with either the option to forego their development or with the option to abandon the project, or both.