Why quality control is an important aspect of production control

The major insights from the literature are either methodological or concerned with conveying the message that the option to defer investment may be valuable . Moreover the approach often faces criticism from practitioners in resource industries for being overly simplistic . By using the methodology of modern asset pricing , this offers new economic insights that extend beyond the value of deferring investment , as well as a realistic resource production model that compares favorably with what is considered best practice valuation in the resource industry

To illustrate the implications of the first point above

for cutoff grade policy , consider the illustrative example of a resource extraction project (oil , forestry , mining , etc ) with finite reserve levels and maximum extraction capacity of 3 units per period . Suppose that , after extraction , material can be sorted into low , medium and high quality categories , fetching prices of S1 , Sm and h per unit , respectively Naturally , Sh Sm Sl . The different grades of material are assumed to be present in equal amounts . Finally , assume that processing costs are k per unit processed and that the OCE is ? per unit extracted . For the sake of

Simplicity ? is assumed to be constant with respect to the number of units extracted . Consider now a situation where there is no restriction on the amount of material that can be processed . In this case , if it is worthwhile to extract one unit , it is worthwhile to extract the maximum allowable . Production is therefore zero or maximum - the so-called `bang-bang ' solution . The cutoff decision now involves choosing the quality of material to be processed . If the cutoff is zero , all extracted material is processed , resulting in a cash flow of Sl Sm Sh ?3k ?3 . Table 1 shows the cash flows for this and two other cutoff choices . Notice that the quality control decision does...