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How rational are investment decisions in the copper industry?

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  • Auger, Felipe
  • Ignacio Guzmán, Juan
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    Abstract

    This paper examines ex-post 51 investment decisions made in regard to copper mines coming on stream from 1957 through 1999. It discusses two critical variables: investment timing and mine capacity choice. Using a 15% discount rate, results suggest that fewer than half of decisions were made at the right time - i.e., low price periods - confirming countercyclical investment as the optimal policy. In terms of capacity choice, the distortion is even higher, as 36 projects should have entered at least 40% larger or smaller. Realized investment decisions for timing and capacity choice would have caused a 49.1% loss over the NPV potentially achievable under optimal resolutions. Although the difference could be specifically attributed to copper price uncertainty, this paper discusses how investment evaluation methodologies could be contributing to firms not being fully rational (in the neoclassical sense) when investing.

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    Bibliographic Info

    Article provided by Elsevier in its journal Resources Policy.

    Volume (Year): 35 (2010)
    Issue (Month): 4 (December)
    Pages: 292-300

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    Handle: RePEc:eee:jrpoli:v:35:y:2010:i:4:p:292-300

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    Web page: http://www.elsevier.com/locate/inca/30467

    Related research

    Keywords: Capacity choice Investment timing Rationality Uncertainty;

    References

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    1. Majd, Saman & Pindyck, Robert S., 1987. "Time to build, option value, and investment decisions," Journal of Financial Economics, Elsevier, vol. 18(1), pages 7-27, March.
    2. Pindyck, Robert S., 1986. "Irreversible investment, capacity choice, and the value of the firm," Working papers 1802-86., Massachusetts Institute of Technology (MIT), Sloan School of Management.
    3. Moyen, N. & Slade, M. & Uppal, R., 1996. "Valuing Risk and Flexibility: A Comparison of Methods," G.R.E.Q.A.M. 96b08, Universite Aix-Marseille III.
    4. Lawrence H. Summers, 1987. "Investment Incentives and the Discounting of Depreciation Allowances," NBER Chapters, in: The Effects of Taxation on Capital Accumulation, pages 295-304 National Bureau of Economic Research, Inc.
    5. Robert S. Pindyck, 1990. "Irreversibility, Uncertainty, and Investment," NBER Working Papers 3307, National Bureau of Economic Research, Inc.
    6. Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1992. "Waiting to Invest: Investment and Uncertainty," The Journal of Business, University of Chicago Press, vol. 65(1), pages 1-29, January.
    7. Brennan, Michael J & Schwartz, Eduardo S, 1985. "Evaluating Natural Resource Investments," The Journal of Business, University of Chicago Press, vol. 58(2), pages 135-57, April.
    8. Felipe L. Aguerrevere, 2003. "Equilibrium Investment Strategies and Output Price Behavior: A Real-Options Approach," Review of Financial Studies, Society for Financial Studies, vol. 16(4), pages 1239-1272.
    9. McDonald, Robert & Siegel, Daniel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, MIT Press, vol. 101(4), pages 707-27, November.
    10. Abdel Sabour, S. A., 2002. "Mine size optimization using marginal analysis," Resources Policy, Elsevier, vol. 28(3-4), pages 145-151.
    11. Dimitrakopoulos, Roussos G. & Abdel Sabour, Sabry A., 2007. "Evaluating mine plans under uncertainty: Can the real options make a difference?," Resources Policy, Elsevier, vol. 32(3), pages 116-125, September.
    12. Roberts, Mark C., 2009. "Duration and characteristics of metal price cycles," Resources Policy, Elsevier, vol. 34(3), pages 87-102, September.
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