Application of the option price model in mining industry mergers and acquisitions

Abstract

The traditional corporate finance theory of discounted cash flow valuation (DCF) has many limitations. In order to complement the drawbacks, real option valuations (ROV) have been widely accepted and applied in many industries to evaluate projects or firms because of its ability to analyze flexibilities and uncertainties. In this paper, we focus on the mining industry, and identify its valuation challenges. We review the current developments of DCF and ROV model and apply both methods into a real firm (Barrick Gold) to analyze the value of the firm under Mergers and Acquisitions (M&A). Through the comparison, we discuss the benefits of ROV in mining industry and the premium of the acquirer’s offer price. We also identify areas for further research.