Contrast the difference between the NPV of an investment and the value of the option to invest in it.
A)The value of the option to invest increases with interest rates while the NPV decreases.
B)The value of the option to invest decreases with an increase in short-term cash flows while NPV increases.
C)The value of the option to invest and the NPV of the project are unrelated.
D)The value of the option to invest increases with interest rates while the NPV decreases, and the value of the option to invest decreases with an increase in short-term cash flows while NPV increases.

Question

Quizplus · Accepted Answer

The value of an option to invest is affected by interest rates, as higher rates increase the opportunity cost of waiting to invest. At the same time, an increase in short-term cash flows reduces the value of the option to delay the investment. These effects are opposite to the impact on the NPV, which discounts future cash flows at a higher rate when interest rates are higher and considers the net present value of all cash flows, regardless of their timing. Therefore, the option value and NPV may move in opposite directions, depending on the specific circumstances of the project and the market conditions.

Contrast the Difference Between the NPV of an Investment and the Value