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On the trade-off between the leverage effect and real options thinking: A simulation-based model on metal mining investment


  • Savolainen, Jyrki
  • Collan, Mikael
  • Kyläheiko, Kalevi
  • Luukka, Pasi


This paper studies the effects of financing conditions to managerial flexibility and project value and focuses on the point of view of the equity holder of a mining company. Simulation based analysis is performed with a dynamic system model of a metal mine investment. The leverage effect of the equity holder's discount rate change as a function of the debt/equity ratio is separately modelled. Our empirical results show that the choice of a financing structure is important for the value maximization for the equity holder, since different debt/equity ratios differently condition the management's ability to make operational decisions, such as temporary shut downs, which could raise the value of the mining project. The trade-off between the leverage effect (decreasing need for equity) and real option flexibility (increasing need for working capital) will be scrutinized both theoretically and by using simulation-based analysis for numerical results.

Suggested Citation

  • Savolainen, Jyrki & Collan, Mikael & Kyläheiko, Kalevi & Luukka, Pasi, 2017. "On the trade-off between the leverage effect and real options thinking: A simulation-based model on metal mining investment," International Journal of Production Economics, Elsevier, vol. 194(C), pages 43-51.
  • Handle: RePEc:eee:proeco:v:194:y:2017:i:c:p:43-51
    DOI: 10.1016/j.ijpe.2017.06.002

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    References listed on IDEAS

    1. Moyen, Nathalie & Slade, Margaret & Uppal, Raman, 1996. "Valuing risk and flexibility : A comparison of methods," Resources Policy, Elsevier, vol. 22(1-2), pages 63-74.
    2. Rossen, Anja, 2015. "What are metal prices like? Co-movement, price cycles and long-run trends," Resources Policy, Elsevier, vol. 45(C), pages 255-276.
    3. Trigeorgis, Lenos, 1993. "The Nature of Option Interactions and the Valuation of Investments with Multiple Real Options," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 28(1), pages 1-20, March.
    4. Baur, Dirk G., 2014. "Gold mining companies and the price of gold," Review of Financial Economics, Elsevier, vol. 23(4), pages 174-181.
    5. Bengtsson, Jens, 2001. "Manufacturing flexibility and real options: A review," International Journal of Production Economics, Elsevier, vol. 74(1-3), pages 213-224, December.
    6. Brennan, Michael J & Schwartz, Eduardo S, 1985. "Evaluating Natural Resource Investments," The Journal of Business, University of Chicago Press, vol. 58(2), pages 135-157, April.
    7. Crowson, Phillip, 2003. "Mine size and the structure of costs," Resources Policy, Elsevier, vol. 29(1-2), pages 15-36.
    8. Alberto Moel, 2002. "When Are Real Options Exercised? An Empirical Study of Mine Closings," Review of Financial Studies, Society for Financial Studies, vol. 15(1), pages 35-64, March.
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    Cited by:

    1. Chuan-Chuan Ko & Chien-Yu Liu & Zan-Yu Chen & Jing Zhou, 2019. "Sustainable Development Economic Strategy Model for Reducing Carbon Emission by Using Real Options Approach," Sustainability, MDPI, Open Access Journal, vol. 11(19), pages 1-1, October.
    2. De Giovanni, Domenico & Massabò, Ivar, 2018. "Capacity investment under uncertainty: The effect of volume flexibility," International Journal of Production Economics, Elsevier, vol. 198(C), pages 165-176.
    3. Sarkar, Sudipto, 2018. "Optimal DOL (degree of operating leverage) with investment and production flexibility," International Journal of Production Economics, Elsevier, vol. 202(C), pages 172-181.


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