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Valuation with Simulation of Options “on” and “in” a System Capital Investment and Engineering Flexibility in the development of the Antamina mine (Peru). Note. This presentation is based on the case developed by Peter Tufano and Alberto Moel from the Harvard Business School.

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  1. Valuation with Simulation of Options “on” and “in” a SystemCapital Investment andEngineering Flexibility in the development ofthe Antamina mine (Peru) Massachusetts Institute of Technology Engineering System Analysis for Design

  2. Note This presentation is based on the case developed by Peter Tufano and Alberto Moel from the Harvard Business School. It contains simplifications. The figures appearing here differ from those presented by Tufano and Moel. They reflect the assumptions of the authors of this presentation about the treatment of uncertainty and the cash flows projection. Massachusetts Institute of Technology Engineering System Analysis for Design

  3. Project Description: Antamina • State-owned copper and zinc mine in Peru, ~480km (300miles) north of Lima • Privatization in 1996: call for bids. Small upfront payment + promise to develop • Little reliable geological information • Geological study to take two years, start after the bidding, be available before construction • Proceed with development if survey suggested the mine could be developed economically Massachusetts Institute of Technology Engineering System Analysis for Design

  4. Project Time Line Close mine Develop: CapX (years 2-5) Produce Metal (year 5-closure) Bid & Win Year 2 Explore (years 0-2) Walk away Massachusetts Institute of Technology Engineering System Analysis for Design

  5. Revenues Mine’s life Future prices of zinc and copper Quantity of ore Costs Operation expenses Capital Expenditures Uncertainty treatment Deterministic Stochastic process (Lattice, Years 0-2) Probability distributions Monte Carlo simulation Sources of Uncertainty Massachusetts Institute of Technology Engineering System Analysis for Design

  6. 1. Probability values for significant factors Monte Carlo Simulation 2. Random selection of factors according to their pdf 3. Determine NPV for each combination 4. Repeat process and obtain NPV distribution Massachusetts Institute of Technology Engineering System Analysis for Design

  7. Price and quantity uncertainty prevails only during the first two years Price risk is assumed to be eliminated in year 2 by entering forward contracts to sell the output of the mine All other sources of uncertainty are modeled in the Monte Carlo simulation after year 2 Simulation result: Realization of expected NPV Sources of Uncertainty Massachusetts Institute of Technology Engineering System Analysis for Design

  8. Mean = $550 M Results: Base Case – No Options Massachusetts Institute of Technology Engineering System Analysis for Design

  9. Mean = $819 Simulation Results: Option to Abandon Massachusetts Institute of Technology Engineering System Analysis for Design

  10. Valuation: Option to Abandon Option to abandon: $819 - $550 = $269 million Massachusetts Institute of Technology Engineering System Analysis for Design

  11. Engineering Flexibility • Add flexibility, add value? • Starting engineering study earlier and faster would allow you to shorten construction to two years and ramp up production faster What would you pay for this option? Massachusetts Institute of Technology Engineering System Analysis for Design

  12. Mean = $567 Simulation Results: Early Development Massachusetts Institute of Technology Engineering System Analysis for Design

  13. Valuation: Option for Early Development Early Development Option (alone): $567 - $550 = $17 million Would easily justify several million $ spent early on design work This real option would in fact be compounded with the option to abandon Generally not additive! Massachusetts Institute of Technology Engineering System Analysis for Design

  14. Mean = $836 Simulation Results: Both Options Massachusetts Institute of Technology Engineering System Analysis for Design

  15. Valuation: Both Options Together Value of both Options together: $ 836- $550 = $286 million Incremental Value of Early Development Option : $ 836- $819 = $17 million Appears additive, but actually a difference. In this case rounded out and insignificant Massachusetts Institute of Technology Engineering System Analysis for Design

  16. References • Tufano, P., Moel, A., (1997) “Bidding for Antamina”, Harvard Business School Case number 9-297-054, Rev. Sept. 15. • Tufano, P., Moel, A., (2000) “Bidding for the Antamina Mine – Valuation and Incentives in a Real Option Context”, in “Project Flexibility, Agency, and Competition,” edited by Brennan, M. and Trigeorgis, L., Oxford University Press • Hertz, D. (1979) “Risk Analysis in Capital Investment”, Harvard Business Review September-October, pp. 169-180 Massachusetts Institute of Technology Engineering System Analysis for Design

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