EVALUATING CYCLICAL PROJECTS

A cyclical price environment introduces risks, but also opportunities, that require careful managerial attention and planning. A primary tool in dealing with the economic implications of metal price cyclicality is proper project valuation. Conventional approaches to project valuation are well known and include various derivatives of the discounted cash flow (DCF) method. These methods break down, however, when applied to actively managed investments. The flexibility of managerial response to external developments, including price fluctuations, is not considered in the DCF methodology. The capital asset pricing model and the arbitrage pricing theory have been developed to address the valuation of investments subject to various forms of business risk; but they suffer from limitations herein discussed. A new approach based on option pricing theory is being developed which offers promise. However, the approach is not as yet sufficiently developed to provide a practical substitute for the DCF methods.