Marian Evans owns a large ranch in Western Australia[1]. She is considering selling the right to mine a section of her land. Marian expects a mining project to cause her a loss of $25m in farm income (in present value), because of the loss of the use of the land. On the other hand, the mine would build a road, which would save her $5m in transportation costs (in present value) over the life of the ranch.

BHP is the only mining company conducting minerals testing in this region. BHP review their minerals testing budget. BHP conclude that if they increase their testing budget, they will identify more potential developments than just the one on Marian's property, in fact, even more than they have the capacity for.

If they increase their testing budget substantially, they expect to find roughly 3 properties (owned by two other people), with roughly the following types of values:

	Opportunity cost	Expected earnings of the mine
Property 1 (Marian's)	see (a)	100
Property 2	15	90
Property 3	10	80

Question 1

If BHP has the capacity to develop at most 2 mines (because of their limited resources in people and equipment), what would the outcome of negotiations with these property owners be? What is the range of possible prices for each property sold?

Question 2

If they do not increase the testing budget, they will just negotiate with Marian. What are their profits?

Question 3

If they do increase the testing budget, they will find the three properties above, and develop two of them. What are their profits, if the necessary budget increase is $35m? We will assume that negotiated prices split the possible range of prices, where the range is determined by core bargaining.

Question 4

Do BHP find it worthwhile to increase their minerals testing budget? Explain the intuition.

Question 5

Suppose we are in a mining boom. BHP is also negotiating with suppliers of machinery, in order to build and equip mines. They estimate that every excavator they can source will mean they can earn an extra $2m in profits, up to 30 excavators. Caterpillar can produce up to 20 excavators at a marginal cost of $500k each, and Komatsu can produce up to 20 excavators at marginal cost of $800k each. How many excavators do they source from each, and what is the range of possible prices?