Question 1

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

Accepted Answer

Most projects' economic lives are not kn

Question 2

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

Accepted Answer

A) True 
 B)False

Question 3

A firm has a three-year real option to invest in a project that has a present value of $500 million with an exercise price (in year 3)of $800 million.Calculate the value of the option given that N(d1)= 0.3 and N(d2)= 0.15.Assume that the risk-free interest rate is 6% per year.

Accepted Answer

A) $30.00 million 
B) $49.25 million 
C) zero 
D) $7.08 million 
A) $30.00 million 
B) $49.25 million 
C) zero 
D) $7.08 million

Question 4

Temporary abandonment is a very simple real option that allows the firm to stop a project temporarily until conditions improve.

Accepted Answer

A) True 
 B)False

Question 5

The option to expand is a type of financial option.

Accepted Answer

A) True 
 B)False

Question 6

In terms of real options,the cash flows from the project play the same role as:

Accepted Answer

A) the stock price. 
B) the exercise price. 
C) dividends. 
D) the variance of the underlying asset. 
A) the stock price. 
B) the exercise price. 
C) dividends. 
D) the variance of the underlying asset.

Question 7

Suppose that the oil price is uncertain and can be either $60/bbl.or $30/bbl.next year with equal probability.Calculate the expected NPV of the project if it is postponed by one year.

Accepted Answer

A) +50 million 
B) -25 million 
C) +59 million 
D) +47 million 
A) +50 million 
B) -25 million 
C) +59 million 
D) +47 million

Question 8

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. 
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.

Question 9

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 10

You are considering making a "Hillary" action figure to capitalize on popular political fever.Production will cost $5 million.If political fever strikes,you will sell action figures worth $20 million (in present value (PV)).If voters do not catch the political fever,you will only sell action figures worth $2 million (in PV)as only loyal Democrats will buy.Each possibility has a 50% chance.However,before production begins,you can conduct a marketing survey to determine which scenario will happen.The survey costs $1 million.Is it worth conducting the survey? Why?

Accepted Answer

A) Do not conduct the survey as the NPV without a survey = +$6 million. 
B) Conduct the survey as the NPV with a survey = $6.5 million. 
C) Do not conduct the survey as the NPV with a survey = $5 million. 
D) Do not conduct the survey as the NPV with a survey = $4 million 
A) Do not conduct the survey as the NPV without a survey = +$6 million. 
B) Conduct the survey as the NPV with a survey = $6.5 million. 
C) Do not conduct the survey as the NPV with a survey = $5 million. 
D) Do not conduct the survey as the NPV with a survey = $4 million

Question 11

The owner of a pro-football team expects the team to be worth either $270 million next year or $120 million,depending on whether or not she gets the city to build a new stadium.There is a 60% chance she will get a new stadium.There is a buyer willing to pay $175 million for the team right now.However,the buyer will keep his offer open-until the stadium issue is resolved-if offered some form of compensation.Given a discount rate of 7%,how much should she be willing to pay the potential buyer for a one-year option to sell the team (round to the nearest $1 million)?

Accepted Answer

A) 0 
B) $21 million 
C) $42 million 
D) $55 million 
A) 0 
B) $21 million 
C) $42 million 
D) $55 million

Question 12

In an acquisition,the target firm may demand compensation from the acquiring firm if the deal falls through.The acquiring firm's compensation is for the payment of a form of a real call option.

Accepted Answer

A) True 
 B)False

Question 13

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 va

Question 14

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 15

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 16

Assume the following data for Project X: NPV of the project without abandonment: -$2 million; abandonment option value: $4 million.Calculate the adjusted present value (APV)of the project.

Accepted Answer

A) -$2 million 
B) -$4 million 
C) +$2 million 
D) +$4 million 
A) -$2 million 
B) -$4 million 
C) +$2 million 
D) +$4 million

Question 17

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

Accepted Answer

A) True 
 B)False

Question 18

Briefly explain the implied assumption when the risk-neutral method is used for valuing real options.

Accepted Answer

When the risk-neutral method is used to

Question 19

The opportunity to defer investing to a later date may have value because:
I.the cost of capital may increase in the near future;
II.uncertainty may be increased in the future;
III.the project has positive,short-term cash flows;
IV.market conditions may change and increase the NPV of the project

Accepted Answer

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

Exam 22: Real Options

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.

A firm has a three-year real option to invest in a project that has a present value of $500 million with an exercise price (in year 3)of $800 million.Calculate the value of the option given that N(d1)= 0.3 and N(d2)= 0.15.Assume that the risk-free interest rate is 6% per year.

Temporary abandonment is a very simple real option that allows the firm to stop a project temporarily until conditions improve.

The option to expand is a type of financial option.

In terms of real options,the cash flows from the project play the same role as:

Suppose that the oil price is uncertain and can be either $60/bbl.or $30/bbl.next year with equal probability.Calculate the expected NPV of the project if it is postponed by one year.

An example of a real option is:

In an acquisition,the target firm may demand compensation from the acquiring firm if the deal falls through.The acquiring firm's compensation is for the payment of a form of a real call option.

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

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

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

Assume the following data for Project X: NPV of the project without abandonment: -$2 million; abandonment option value: $4 million.Calculate the adjusted present value (APV)of the project.

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

Briefly explain the implied assumption when the risk-neutral method is used for valuing real options.

The opportunity to defer investing to a later date may have value because: I.the cost of capital may increase in the near future; II.uncertainty may be increased in the future; III.the project has positive,short-term cash flows; IV.market conditions may change and increase the NPV of the project

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 three-year real option to invest in a project that has a present value of $500 million with an exercise price (in year 3)of $800 million.Calculate the value of the option given that N(d₁)= 0.3 and N(d₂)= 0.15.Assume that the risk-free interest rate is 6% per year.