Question 1

Explain the difference between the value of a project and the value of real options associated with a project.

Accepted Answer

The value of a project is the present value of all the cash flows from a project. It is usually calculated using a discounted cash-flow method. The value of a real option on the project comes from the opportunity to change or modify the cash flow from the project.

Question 2

A project is worth $12 million today without an abandonment option if the interest rate is 5 percent per year. Suppose the value of the project is either $18 million one year from today (if product demand is high)or $8 million (if product demand is low). It is possible to sell off the project for $10 million if product demand is low. Calculate the value of the abandonment option if the discount rate is 5 percent per year.

Accepted Answer

A) $1.03 million 
B) $0.88 million 
C) $1.90 million 
D) $5.14 million 
A) $1.03 million 
B) $0.88 million 
C) $1.90 million 
D) $5.14 million A

Question 3

A firm in the mining industry whose major assets are cash, equipment, and a closed facility may sell at a premium to the market value of its assets. This premium is most plausibly attributed to

Accepted Answer

A) nearsighted investors. 
B) the low exercise price held by its shareholders. 
C) the option to open the facility when prices rise dramatically. 
D) all of the options are correct. 
A) nearsighted investors. 
B) the low exercise price held by its shareholders. 
C) the option to open the facility when prices rise dramatically. 
D) all of the options are correct. C

Question 4

How does an option to wait or postpone a project add value to the project?

Accepted Answer

The option to wait or postpone a project

Question 5

If projects have implied options, then

Accepted Answer

A) the shorter the forecasted life of the project, the less valuable the option is. 
B) the longer the forecasted life of the project, the less valuable the option is. 
C) the shorter the forecasted life of the project, the more valuable the option is. 
D) project life does not change the value option. 
A) the shorter the forecasted life of the project, the less valuable the option is. 
B) the longer the forecasted life of the project, the less valuable the option is. 
C) the shorter the forecasted life of the project, the more valuable the option is. 
D) project life does not change the value option.

Question 6

Briefly explain how abandonment value can be used to help determine project life.

Accepted Answer

Most projects' economic lives are not kn

Question 7

A project is worth $15 million today without an abandonment option. Suppose the value of the project is either $20 million one year from today (if product demand is high)or $10 million (if product demand is low). It is possible to sell off the project for $13 million if product demand is low. Calculate the value of the abandonment option if the discount rate is 5 percent per year.

Accepted Answer

A) $1.21 million 
B) $2.86 million 
C) $1.90 million 
D) $1.64 million 
A) $1.21 million 
B) $2.86 million 
C) $1.90 million 
D) $1.64 million

Question 8

The option to make a follow-on investment is a put option.

Accepted Answer

A) True 
 B)False

Question 9

APV = NPV (without expansion option)+ value of the expansion option.

Accepted Answer

A) True 
 B)False

Question 10

The NPV of a new video game, Dexa 1, is −1.5 million after discounting all expected cash flows. However, if high demand in the market evolves, Dexa 2 is a possible follow-on opportunity in two years. In two years it will cost 10 million to start Dexa 2, which will produce 9 million of cash flow in year 2. N(d1)= 0.5785 and N(d2)= 0.1755. The annual interest rate is 11 percent and equals the risk-free rate. What is the Dexa 1 APV?

Accepted Answer

A) $1.95 million 
B) $1.30 million 
C) $2.28 million 
D) $2.80 million 
A) $1.95 million 
B) $1.30 million 
C) $2.28 million 
D) $2.80 million

Question 11

Consider an electric utility that may use either coal or natural gas to generate electricity. Under which of the following conditions is co-firing equipment most valuable? Let ac be the annual standard deviation of coal prices, and let an be the annual standard deviation of natural gas prices and p the correlation between coal prices and natural gas prices.

Accepted Answer

A) ac high, an high, p low 
B) ac high, an low, p low 
C) ac low, an high, p low 
D) ac low, an low, p high 
A) ac high, an high, p low 
B) ac high, an low, p low 
C) ac low, an high, p low 
D) ac low, an low, p high

Question 12

What are the four main types of real options?

Accepted Answer

(I)The option to expand if the immediate

Question 13

An electric utility plant that can operate on either oil or natural gas is an example of flexibility in production.

Accepted Answer

A) True 
 B)False

Question 14

Tech Com announces a major expansion into Internet services. This announcement causes the price of Tech Com stock to increase, but also causes an increase in the volatility of the stock price. Which of the following correctly identifies the impact of these changes on the price of Tech Com call options?

Accepted Answer

A) Both changes cause the price of the call option to decrease. 
B) Both changes cause the price of the call option to increase. 
C) The greater uncertainty will cause the price of the call option to decrease. The higher price of the stock will cause the price of the call option to increase. 
D) The greater uncertainty will cause the price of the call option to increase. The higher price of the stock will cause the price of the call option to decrease. 
A) Both changes cause the price of the call option to decrease. 
B) Both changes cause the price of the call option to increase. 
C) The greater uncertainty will cause the price of the call option to decrease. The higher price of the stock will cause the price of the call option to increase. 
D) The greater uncertainty will cause the price of the call option to increase. The higher price of the stock will cause the price of the call option to decrease.

Question 15

Imagine that you are the producer of Harry Potter films. You are trying to decide whether to film the next two Harry Potter movies at the same time. If you film them both at once, you can save money on production costs, but you could lose a lot of money if the first one flops and no one goes to see the second one. Specifically, if you film them both at once, it will cost a total of $300 million, but if you film them separately, they will cost $200 million each. If the first one is successful, it will have revenues of $1 billion and the second one will have revenues of $1.5 billion. If the first one fails, it will only have revenues of $150 million and the second one will have revenues of only $50 million. If you decide to film them separately and the first one flops, you don't have to film the second one. The first film has a 50 percent chance of succeeding and a 50 percent chance of failing. Assume that all figures are given as present values (you do not need to do any additional discounting). Should you film both of them now or film them separately? Why?

Accepted Answer

A) Film them together now as NPV = $1,050 million. 
B) Film them separately as NPV = $1,125 million. 
C) Film them separately as NPV = $1,025 million. 
D) None of the options are correct. 
A) Film them together now as NPV = $1,050 million. 
B) Film them separately as NPV = $1,125 million. 
C) Film them separately as NPV = $1,025 million. 
D) None of the options are correct.

Question 16

The discounted cash-flow (DCF)approach should be

Accepted Answer

A) augmented by real options analysis even if there are no imbedded options. 
B) augmented by added analysis if a decision has significant imbedded options. 
C) jettisoned if there are any embedded options. 
D) computed carefully to identify the options. 
A) augmented by real options analysis even if there are no imbedded options. 
B) augmented by added analysis if a decision has significant imbedded options. 
C) jettisoned if there are any embedded options. 
D) computed carefully to identify the options.

Question 17

Permanently rejecting an investment today might not be a good choice because
I.the size of the firm will decline;
II.there are always errors in the estimation of NPVs;
III.the project's real option value is negative;
IV.the company is forgoing the option to make the investment in the future if economic and industry conditions change for the better

Accepted Answer

A) I only 
B) II only 
C) I, II, and III only 
D) IV only 
A) I only 
B) II only 
C) I, II, and III only 
D) IV only

Question 18

Real options analysis can be used to link project life to the performance of the project.

Accepted Answer

A) True 
 B)False

Question 19

How does a large firm like Intel hold a natural real option on a new technology, whereas a smaller firm would not have the same option if they owned the same technology?

Accepted Answer

The ability to commercialize a new techn

Question 20

An example of a real option is

Accepted Answer

A) the option to make follow-on investments. 
B) the option to abandon a project. 
C) the option to wait before investing. 
D) all of the options are correct. 
A) the option to make follow-on investments. 
B) the option to abandon a project. 
C) the option to wait before investing. 
D) all of the options are correct.

Exam 22: Real Options

Explain the difference between the value of a project and the value of real options associated with a project.

A firm in the mining industry whose major assets are cash, equipment, and a closed facility may sell at a premium to the market value of its assets. This premium is most plausibly attributed to

How does an option to wait or postpone a project add value to the project?

If projects have implied options, then

Briefly explain how abandonment value can be used to help determine project life.

The option to make a follow-on investment is a put option.

APV = NPV (without expansion option)+ value of the expansion option.

What are the four main types of real options?

An electric utility plant that can operate on either oil or natural gas is an example of flexibility in production.

The discounted cash-flow (DCF)approach should be

Real options analysis can be used to link project life to the performance of the project.

How does a large firm like Intel hold a natural real option on a new technology, whereas a smaller firm would not have the same option if they owned the same technology?

An example of a real option is

Introduction to Corporate Finance

How to Calculate Present Values

Valuing Bonds

The Value of Common Stocks

Net Present Value and Other Investment Criteria

Making Investment Decisions With the Net Present Value Rule

Introduction to Risk and Return

Portfolio Theory and the Capital Asset Pricing Model

Risk and the Cost of Capital

Project Analysis

How to Ensure That Projects Truly Have Positive Npvs

Agency Problems and Investment

Efficient Markets and Behavioral Finance

An Overview of Corporate Financing

How Corporations Issue Securities

Payout Policy

Does Debt Policy Matter

How Much Should a Corporation Borrow

Financing and Valuation

Understanding Options

Valuing Options

Credit Risk and the Value of Corporate Debt

The Many Different Kinds of Debt

Leasing

Managing Risk

Managing International Risks

Financial Analysis

Financial Planning

Working Capital Management

Mergers

Corporate Restructuring

Governance and Corporate Control Around the World

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