Antamina Copper Mine

a)    

To develop a copper mine like Antamina, enterprises can often defer their investment after the exploration period, so that they can decide whether to develop or not when they have new information about ore reserves. In this way, the development of a copper mine is split into two phases: exploration and development. To defer the investment phase after the exploration phase can be regarded as a call option.

For the bidding structure, bidders can return Antamina in two years, provided they have invest no less than 13.5 million. Given exploration expenditures is about 24 Mn and much more than 13.5 Mn, bidders can exit by returning Antamina to Centromin and get their initial payment back. In this way, the auction procedures seem to be a put option which provides a minimum price, namely the initial payment, for winning bidders to exit.

These real options represent certain types of management decisions. Whether to develop the Antamina mine further depends on the potential costs and possible revenues after the exploration. The correspondence is that it is the option, not the obligation for the management to exercise it. Management team has flexibility in responding to new information. Real options value these opportunities with option-pricing model as financial options.

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Figure 1: Decision tree for developing Antamina

b)    

RT-CRA viewed Antamina mine as a stand-alone project which could generate positive value. The NPV of this project is the discounted value of expected future revenue streams from the sale of copper and zinc, less the feasibility study, development and extraction costs. The costs would also be related to the amount of ore found.

There are different scenarios for the winner:

• Exercise the option at the end of year 2 and finish at the end of year 5 without penalty
• End at the end of year 5 with penalty (The penalty that would equal 30% of the difference between their investment commitment less the actual investment)
• Option to abandon at the end of year 2 (exit by returning properties to Centromin)

The premium of this real option is just the feasibility study plus the exploration costs and they are not recoverable whether the option is exercised or not. The cost of feasibility study (approximate 24 Mn) is quite like the sunk cost.

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Figure 2: properties of the real option

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Then use the risk neutrality to simulate the value of the option. For simplicity, we use the two-period binomial tree to price this transaction. We need to know the expected value of NPV of this project and its volatility. We estimate the NPV for this project is -92.02 Mn from Exhibit and the volatility is 60%. We assume bidder decide whether to invest after completing the exploration and the final penalty as another form of initial payment to Centromin and we only consider the main option.

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Value of option=[pic 7]

Subtract the exploration fees, the value of this project is 45.87-24=21.87 Mn.

c)

Government goals: in part to raise funds, most interested in ensuring the development of this property and this sector by attracting quality companies and their investment. The privatization program is also regarded as a stimulation of free-market and as an action to affect country’s balance-of-trade. Generally, the rules are set to meet these goals.

The minimum amount of the initial payment and investment commitment, along with the required qualification (100-million net worth) for bidders were set to ensure the company would have ability to finance this project and could invest enough to improve, modernize and expand the production units.

The bid is evaluated by the sum of initial payment and 30% investment commitment. The highest bid can be awarded the project. The incentive for this rule is to encourage bidders to commit more investment, not only the initial payment.

The bidders could return Antamina provided that they had invested more than 13.5 Mn. This rule is set to show that government is confident of the copper ore reserve and willing to provide such an option. This rule could also attract more quality bidders and a high price. Since the trigger of returning requires a minimum investment, the government would not lose too much.