Question

2. A mining company is evaluating when to open a gold mine. The mine has 80,000 ounces of gold left that can be mined and mining operations will produce 10,000 ounces per year. When the mine is opened, the company will sign a contract that will guarantee the price of gold for the remaining life of the mine. If the mine is opened today, each ounce of gold will generate an after-tax cash flow (= net or total cash flow) of $1,300 per ounce. If the company waits two years, there is a 70 percent probability that the contract price will generate an after-tax cash flow of $1,600 per ounce and a 30 percent probability that the after-tax cash flow will be $1,200 per ounce. The required return on the gold mine is 15 percent and it will cost $35,000,000 to open the mine regardless of whether the mine is open today or in two years. Find the current value of the option to wait.

Answer 1

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