Question 1

Adjusted present value of project (APV)= NPV (without abandonment option)+ value of abandonment option.

Accepted Answer

A) True 
 B)False

Question 2

How can managers take advantage of real options? Briefly explain.

Accepted Answer

Managers are not passive onlookers in a

Question 3

A rational manager may be reluctant to commit to a positive net present value project when:

Accepted Answer

A) the value of the option to abandon is high. 
B) the exercise price is high. 
C) the opportunity cost of capital is high. 
D) the value of the option to wait is high. 
A) the value of the option to abandon is high. 
B) the exercise price is high. 
C) the opportunity cost of capital is high. 
D) the value of the option to wait is high.

Question 4

Real options cannot be valued using the risk-neutral method since real assets do not trade in a liquid market where prices are readily observable and arbitrage opportunities are exploited immediately.

Accepted Answer

A) True 
 B)False

Question 5

The risk-neutral approach is an application of the certainty equivalent method.

Accepted Answer

A) True 
 B)False

Question 6

An abandonment option,in effect,

Accepted Answer

A) limits the flexibility of management's decision-making. 
B) limits the downside risk of an investment project. 
C) limits the profit potential of a proposed project. 
D) applies only to new projects. 
A) limits the flexibility of management's decision-making. 
B) limits the downside risk of an investment project. 
C) limits the profit potential of a proposed project. 
D) applies only to new projects.

Question 7

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 8

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 9

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% 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 10

Explain the main difference between the Black-Scholes formula and the binomial method.How does this relate to real options analysis?

Accepted Answer

The Black-Scholes formula is a continuou

Question 11

A project is worth $12 million today without an abandonment option.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% 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

Question 12

If an oil well allows the investor the option to drill later,what must happen for the option to be exercised?

Accepted Answer

A) Interest rates must increase. 
B) The probability of oil prices increasing must be less than the probability of oil prices decreasing. 
C) Oil prices must exceed the present value of future expected oil prices. 
D) The present value of oil must be higher than the future value of oil. 
A) Interest rates must increase. 
B) The probability of oil prices increasing must be less than the probability of oil prices decreasing. 
C) Oil prices must exceed the present value of future expected oil prices. 
D) The present value of oil must be higher than the future value of oil.

Question 13

Briefly explain how temporary abandonment can be thought of as a complex option.

Accepted Answer

Firms often face situations that allow t

Question 14

Suppose that the oil price is uncertain and can be $60/bbl.or $30/bbl.next year with equal probability.Then the value of the option to postpone the project by one year equals:

Accepted Answer

A) +34 million 
B) +25 million 
C) +59 million 
D) -13 million 
A) +34 million 
B) +25 million 
C) +59 million 
D) -13 million

Question 15

A firm has a two-year real option to invest in a project that has a present value of $400 million with an exercise price (in year 2)of $600 million.Calculate the value of the option given that N(d1)= 0.6 and N(d2)= 0.4.Assume that the risk-free interest rate is 6% per year.

Accepted Answer

A) $26.4 million 
B) zero 
C) $239.59 million 
D) $13.58 million 
A) $26.4 million 
B) zero 
C) $239.59 million 
D) $13.58 million

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

What are the four main types of real options?

Accepted Answer

I)The option to expand if the immediate

Question 18

Which of the following statements about the option to build flexibility into production facilities is true?

Accepted Answer

A) Typically,production flexibility is more expensive. 
B) One should consider the NPV of alternate production configurations. 
C) Production flexibility may be valuable by enabling the firm to choose the inputs with the lowest available costs. 
D) All of the options are true. 
A) Typically,production flexibility is more expensive. 
B) One should consider the NPV of alternate production configurations. 
C) Production flexibility may be valuable by enabling the firm to choose the inputs with the lowest available costs. 
D) All of the options are true.

Question 19

In real options,the required investment is considered the exercise price.

Accepted Answer

A) True 
 B)False

Question 20

The following are practical challenges in applying real-options analysis:
I.Real options can be complex.
II.The real options problems may not be well structured.
III.Competition may reduce or change the value of real options.

Accepted Answer

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

Exam 22: Real Options

Adjusted present value of project (APV)= NPV (without abandonment option)+ value of abandonment option.

How can managers take advantage of real options? Briefly explain.

A rational manager may be reluctant to commit to a positive net present value project when:

Real options cannot be valued using the risk-neutral method since real assets do not trade in a liquid market where prices are readily observable and arbitrage opportunities are exploited immediately.

The risk-neutral approach is an application of the certainty equivalent method.

An abandonment option,in effect,

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?

Explain the main difference between the Black-Scholes formula and the binomial method.How does this relate to real options analysis?

If an oil well allows the investor the option to drill later,what must happen for the option to be exercised?

Briefly explain how temporary abandonment can be thought of as a complex option.

Suppose that the oil price is uncertain and can be $60/bbl.or $30/bbl.next year with equal probability.Then the value of the option to postpone the project by one year equals:

A firm has a two-year real option to invest in a project that has a present value of $400 million with an exercise price (in year 2)of $600 million.Calculate the value of the option given that N(d1)= 0.6 and N(d2)= 0.4.Assume that the risk-free interest rate is 6% per year.

The discounted cash-flow (DCF)approach should be:

What are the four main types of real options?

Which of the following statements about the option to build flexibility into production facilities is true?

In real options,the required investment is considered the exercise price.

The following are practical challenges in applying real-options analysis: I.Real options can be complex. II.The real options problems may not be well structured. III.Competition may reduce or change the value of real options.

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

Investment, Strategy, and Economic Rents

Agency Problems, Compensation, and Performance Measurement

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

Filters

A firm has a two-year real option to invest in a project that has a present value of $400 million with an exercise price (in year 2)of $600 million.Calculate the value of the option given that N(d₁)= 0.6 and N(d₂)= 0.4.Assume that the risk-free interest rate is 6% per year.