## Valuing a Gold Mine

The "Woe Is Me" gold mine was founded in 1878 on one of the richest veins of gold in the West. Thirty years later, by 1908, the mine had been played out, but occasionally, depending on the price of gold, it is reopened. Currently gold is not actively mined at Woe Is Me, but its stock is still traded on the exchange under the ticker symbol, WOE. WOE has no debt and, with about 20 million outstanding shares, it has a market value (stock price times number of shares outstanding) well above \$1 billion. WOE owns about 160 acres of land surrounding the mine and has a 100-year government lease to mine gold there. However, land in the desert has a market value of only a few thousand dollars. WOE holds cash and securities and other assets worth about \$30 million. What could possibly explain why a company with \$30 million in assets and a closed gold mine that is producing no cash flow whatsoever has the market value that WOE has?

The answer lies in the options that WOE implicitly owns in the form of a gold mine. Assume that the current price of gold is about \$320 per ounce and the cost of extraction and processing at the mine is about \$350 per ounce. It is no wonder that the mine is closed. Every ounce of gold extracted costs \$350 and can be sold for only \$320 for a loss of \$30 per ounce. Presumably, if the price of gold were to rise, the mine could be opened. It costs \$2 million to open the mine and when it is opened, production is 50,000 ounces per year. Geologists believe that the amount of gold in the mine is essentially unlimited, and WOE has the right to mine it for the next 100 years. Under the terms of its lease, WOE cannot stockpile gold and must sell each year all the gold it mines that year. Closing the mine requires equipment to be mothballed and some environmental precautions to be put in place and costs \$1 million. We will refer to the \$2 million required to open the mine as the entry fee or investment and the \$1 million to close it as the closing or abandonment cost. (There is no way to avoid the abandonment cost by simply keeping the mine open and not operating.)

From a financial perspective, WOE is really just a package of options on the price of gold disguised as a company and a mine. The basic option is a call on the price of gold where the exercise price is the \$350 extraction cost. The option is complicated by having an exercise fee of \$2 millionâ€”the opening costâ€”whenever it is exercised and a closing fee of \$1 million when it is abandoned. It is also complicated by the fact that it is a perpetual option with no final maturity.

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