Exam 10: Project Analysis

Tangible assets usually have higher abandonment values than intangible ones.

Briefly discuss various real options associated with capital budgeting projects.

Expansion options generally show as an asset on a corporation's balance sheet.

You are planning to produce a new action figure called "Hillary". However, you are very uncertain about the demand for the product. If it is a hit, you will have net cash flows of $50 million per year for three years (starting next year [i.e., at t = 1]). If it fails, you will only have net cash flows of $10 million per year for two years (also starting next year). There is an equal chance that it will be a hit or failure (probability = 50 percent). You will not know whether it is a hit or a failure until the first year's cash flows are in . You have to spend $80 million immediately for equipment and the rights to produce the figure. If you can sell your equipment for $60 million immediately after the first year's cash flows are received, calculate Hillary's NPV with this abandonment option. (The discount rate is 10 percent. The equipment can only be resold at the end of the first year.)

The following options associated with a project increase managerial flexibility: I.option to expand; II.option to abandon; III.production options; IV.timing options

The Taj Mahal Tour Company proposes to invest $3 million in a new tour package project. Fixed costs are $1 million per year. The tour package costs the company $500 to produce and can be sold at $1,500 per package to tourists. This tour package will last for the next five years. If the cost of capital is 20 percent, what is the NPV break-even number of tourists per year? (Ignore taxes. Round to the nearest 1,000.)

Adding a fudge factor to the cost of capital will penalize longer-term projects more due to compounding.

Explain the usefulness of decision trees in project analysis.

Which of the following does not represent an option to abandon a project?