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

摘要

AbstractThis 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.Highlights•Profitability of metal mining investments is studied from the point of view of the equity holder.•A dynamic leverage dependent discount rate is used and a value maximizing debt level is found.•Increasing leverage causes the value of project real options and project value to decline.•A trade-off is observed to exist between leverage and real option value.