Ashgate Enterprises uses the NPV method for selecting projects, and it does a reasonably good job of estimating projects' sales and costs. However, it never considers real options that might be associated with projects. Which of the following statements is most likely to describe its situation?
A) its estimated capital budget is probably too large due to its failure to consider abandonment and growth options.
B) failing to consider abandonment and flexibility options probably makes the optimal capital budget too large, but failing to consider growth and timing options probably makes the optimal capital budget too small, so it is unclear what impact not considering real options has on the overall capital budget.
C) failing to consider abandonment and flexibility options probably makes the optimal capital budget too small, but failing to consider growth and timing options probably makes the optimal capital budget too large, so it is unclear what impact not considering real options has on the overall capital budget.
D) real options should not have any effect on the size of the optimal capital budget.
E) its estimated capital budget is probably too small, because projects' npvs are often larger when real options are taken into account.

Question

Quizplus · Accepted Answer

By failing to consider real options, the firm's capital budget would probably be too small. The firm might well reject projects that would be seen to have positive expected NPVs if real options had been considered. Therefore, the correct choice is statement e.

Ashgate Enterprises Uses the NPV Method for Selecting Projects, and It