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Principles of Corporate Finance Study Set 3

Business

Quiz 22 :

Real Options

Quiz 22 :

Real Options

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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.
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Answer:

A

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

D

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

C

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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?
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Which of the following scenarios fails to describe a possible real option embedded in a project analysis?
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An example of a real option is
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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
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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 percent per year.
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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 percent per year.
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The discounted cash-flow (DCF)approach should be
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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.
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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.
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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.)
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An abandonment option, in effect,
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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
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Which of the following statements about the option to build flexibility into production facilities is true?
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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
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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
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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.
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Managers who hold real options should view
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