Exam 22: Real Options

The NPV of a new video game,Dexa 1,is -1.5M 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 10M to start Dexa 2,which will produce 9M of cash flow in year 2.N(d₁)= 0.5785 and N(d₂)= 0.1755.The annual interest rate is 11% and equals the risk-free rate.What is the Dexa 1 APV?

The following are examples of expansion options: I.A mining company acquires mineral rights to land that is not worth developing today but could be profitable if ore prices increase. II.A film studio acquires the rights to produce a film based on the novel. III.A real estate developer acquires a parcel of land that could be turned into a shopping mall. IV.A pharmaceutical company purchases a patent to market a new drug.

Which of the following are examples of applications of real options analysis? I.a strategic investment in the computer business; II.the valuation of an aircraft purchase option; III.the option to develop commercial real estate; IV.the decision to mothball an oil tanker

How does an abandonment option increase the value of a project?

Managers who hold real options should view:

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:

Briefly discuss three practical problems associated with real options analysis.

The first step in a real options analysis is to value the underlying asset using the discounted cash-flow (DCF)method.

If projects have implied options,then:

Production facilities that are flexible,in terms of the potential to use different combinations of raw material inputs,are most valuable when:

Which of the following scenarios fails to describe a possible real option embedded in a project analysis?

The option to wait is a type of real option.

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 least valuable? Let a_c be the annual standard deviation of coal prices,and let a_n be the annual standard deviation of natural gas prices and p the correlation between coal prices and natural gas prices.

Contrast the difference between the NPV of an investment and the value of the option to invest in it. I.The value of the option to invest increases with interest rates while the NPV decreases. II.The value of the option to invest decreases with an increase in short-term cash flows while NPV increases. III.The value of the option to invest and the NPV of the project are unrelated.

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

Which of the following conditions might lead a financial manager to decide to expedite a positive net present value investment project?

Which of the following conditions might lead a financial manager to delay a positive-NPV project? (Assume that project NPV-if undertaken immediately-is held constant.)

Calculate the NPV from investing today.

The binomial method can be used for most abandonment options.

Which of the following are examples of real options? I.the option to expand if an investment project succeeds; II.the option to wait (and learn)before investing; III.the option to shrink or abandon a project; IV.the option to vary the mix of output or the firm's production methods