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

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

Abstract

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

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    Cited by:

    1. 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.
    2. Zhixuan Lai & Gaoxiang Lou & Tiantian Zhang & Tijun Fan, 2023. "Financing and coordination strategies for a manufacturer with limited operating and green innovation capital: bank credit financing versus supplier green investment," Annals of Operations Research, Springer, vol. 331(1), pages 85-119, December.
    3. 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, vol. 11(19), pages 1-14, October.
    4. 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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