Comment on the problem that, once money has been allocated to the process, people might become “hooked” into the project and be tempted to go ahead regardless of high risks.

July 12, 2006: Peter’s firm acquires the rights to an ore body in the Canadian Shield region. The firm is considering developing a new mine there, and Peter is responsible for proposing a project plan to the board in September. The mine will take a few years to reach full production, and there is much uncertainty as to the price of gold when that happens. Peter includes in his proposal a history of the gold price (Figure 4.21).
August 2, 2006: Peter meets with Bruce, a mining engineer with 20 years of experience in Australian gold mines, and Sam, a geologist who a few years back did exploratory work on gold deposits in the Canadian Shield region. They discuss known facts about the ore body, the likelihood of unforeseen geological phenomena that could jeopardize mine development, production figures that might be achieved, and production costs and technical problems that might arise in extracting gold from the ore. A quick calculation shows that 300,000 ounces of gold per year at $700 per ounce would be very lucrative, but a figure of 150,000 ounces at $400 per ounce, 3 years from now, would lead to large losses that could ruin the company. Current information about the ore body is inadequate, however, and it will be necessary to drill exploration holes to learn more about the general geology of the area.
Peter summarizes: “To the best of our knowledge, we could produce anywhere between 150,000 and 300,000 ounces a year. The capital cost for developing the shaft will be US$150 million to $260 million, and annual operational costs could be $60 million to $100 million. Exploration to provide information on the ore body would require drilling 200 exploration holes at a cost of between $1.2 million and $1.6 million. Rock samples from these holes will be analyzed in a laboratory to determine the gold content.”