Question 1

Which of the following statements is FALSE?

Accepted Answer

A) In particular,because real options allow a decision maker to choose the most attractive alternative after new information has been learned,the presence of real options adds value to an investment opportunity. 
B) To make an investment decision correctly,the value of embedded real options must be included in the decision-making process. 
C) A key distinction between a real option and a financial option is that real options,and the underlying assets on which they are based,are often traded in competitive markets. 
D) We can compute the value of the real option by comparing the expected profit without the real option to the value with the option. 
A) In particular,because real options allow a decision maker to choose the most attractive alternative after new information has been learned,the presence of real options adds value to an investment opportunity. 
B) To make an investment decision correctly,the value of embedded real options must be included in the decision-making process. 
C) A key distinction between a real option and a financial option is that real options,and the underlying assets on which they are based,are often traded in competitive markets. 
D) We can compute the value of the real option by comparing the expected profit without the real option to the value with the option.

Question 2

Which of the following statements is FALSE?

Accepted Answer

A) It is tempting to use the Black-Scholes formula to value future growth options,but often there are good reasons why this formula might not price these options correctly. 
B) When a firm has a real option to invest in the future it is known as a growth option. 
C) Because growth options have value,they contribute to the value of any firm that has future possible investment opportunities. 
D) Future growth opportunities can be thought of as a collection of real put options on potential projects. 
A) It is tempting to use the Black-Scholes formula to value future growth options,but often there are good reasons why this formula might not price these options correctly. 
B) When a firm has a real option to invest in the future it is known as a growth option. 
C) Because growth options have value,they contribute to the value of any firm that has future possible investment opportunities. 
D) Future growth opportunities can be thought of as a collection of real put options on potential projects.

Question 3

Use the information for the question(s)below.
DM Skateboard company is planning to develop a new electric skateboard.In order for the project to be successful,the company must develop a new deck to accommodate a lightweight battery and a remote that is easy to operate while moving in an open environment.The company estimates the following costs,times,and probabilities of success for each component of the new skateboard:   All three risks are idiosyncratic and the risk-free rate of interest is 5%.The company does not have the resources to develop all the components at the same time.Therefore,management needs to decide in what order to develop the technologies.
-What is the failure cost index of the remote technology?

Accepted Answer

A) 0.00200 
B) 0.99800 
C) 0.00210 
D) 0.99810 
A) 0.00200 
B) 0.99800 
C) 0.00210 
D) 0.99810

Question 4

Use the information for the question(s)below.
You own a small manufacturing plant that currently generates revenues of $2 million per year.Next year,based upon a decision on a long-term government contract,your revenues will either increase by 20% or decrease by 25%,with equal probability,and stay at that level as long as you operate the plant.Other costs run $1.6 million per year.You can sell the plant at any time to a large conglomerate for $5 million and your cost of capital is 10%.
-Assume that it will cost $1 million to shut down the plant,but you are able to sell the plant for $5 million at any time.The value of the option to sell the plant will be closest to:

Accepted Answer

A) $3.0 million. 
B) $6.0 million. 
C) $5.0 million. 
D) $0.5 million. 
A) $3.0 million. 
B) $6.0 million. 
C) $5.0 million. 
D) $0.5 million.

Question 5

Use the information for the question(s)below.
You own a small manufacturing plant that currently generates revenues of $2 million per year.Next year,based upon a decision on a long-term government contract,your revenues will either increase by 20% or decrease by 25%,with equal probability,and stay at that level as long as you operate the plant.Other costs run $1.6 million per year.You can sell the plant at any time to a large conglomerate for $5 million and your cost of capital is 10%.
-Assume that you are not able to sell the plant,but you are able to shut down the plant,at no cost,at any time.Draw a decision tree detailing this problem.

Accepted Answer

The answer of Use the information for the question(s)below.
You own...

Question 6

Use the information for the question(s)below.
DM Skateboard company is planning to develop a new electric skateboard.In order for the project to be successful,the company must develop a new deck to accommodate a lightweight battery and a remote that is easy to operate while moving in an open environment.The company estimates the following costs,times,and probabilities of success for each component of the new skateboard:   All three risks are idiosyncratic and the risk-free rate of interest is 5%.The company does not have the resources to develop all the components at the same time.Therefore,management needs to decide in what order to develop the technologies.
-Assume DM Skateboard Company has estimated that,if all stages are successful,the present value of all future profits will be $4 million (valued at the completion of all three phases of development).If DM does the three stages in the correct order,what is the NPV of the project?

Accepted Answer

A) $128.13 thousand 
B) -$34.50 thousand 
C) $65.18 thousand 
D) $3.79 million 
A) $128.13 thousand 
B) -$34.50 thousand 
C) $65.18 thousand 
D) $3.79 million

Question 7

Use the following information to answer the question(s)below.
Rearden Metal can invest in a risk-free technology that requires an up-front investment of $1 million.Rearden's managers are hesitant to invest because of uncertainty over future interest rates.Suppose that all interest rates will be either 8% or 4% in one year and remain there forever.The risk-neutral probability that interest rates will drop to 4% is 40%.The one-year risk-free interest rate is 5% and today's rate on a risk-free perpetual bond is 6%.The rate on an equivalent perpetual bond that is repayable at any time (the callable annuity rate)is 7.65%.
-Assuming that this project will provide Rearden with perpetual annual cash flows of $65,000,the NPV of investing in the project today using the hurdle rate is closest to:

Accepted Answer

A) -$281,000. 
B) -$150,000. 
C) -$83,000. 
D) +$83,000. 
E) +$281,000. 
A) -$281,000. 
B) -$150,000. 
C) -$83,000. 
D) +$83,000. 
E) +$281,000.

Question 8

Use the information for the question(s)below.
Kinston Industries has come up with a new mountain bike prototype and is ready to go ahead with pilot production and test marketing.The pilot production and test marketing phase will last for one year and cost $500,000.Your management team believes that there is a 50% chance that the test marketing will be successful and that there will be sufficient demand for the new mountain bike.If the test-marketing phase is successful,then Kinston Industries will invest $3 million in year one to build a plant that will generate expected annual after-tax cash flows of $400,000 in perpetuity beginning in year two.If the test marketing is not successful,Kinston can still go ahead and build the new plant,but the expected annual after-tax cash flows would be only $200,000 in perpetuity beginning in year two.Kinston has the option to stop the project at any time and sell the prototype mountain bike to an overseas competitor for $300,000.Kinston's cost of capital is 10%.
-Assuming that Kinston has the ability to sell the prototype in year one for $300,000,draw a decision tree detailing the Kinston Industries Mountain Bike Project.

Accepted Answer

The answer of Use the information for the question(s)below.
Kinston Industries...

Question 9

Use the information for the question(s)below.
Kinston Industries has come up with a new mountain bike prototype and is ready to go ahead with pilot production and test marketing.The pilot production and test marketing phase will last for one year and cost $500,000.Your management team believes that there is a 50% chance that the test marketing will be successful and that there will be sufficient demand for the new mountain bike.If the test-marketing phase is successful,then Kinston Industries will invest $3 million in year one to build a plant that will generate expected annual after-tax cash flows of $400,000 in perpetuity beginning in year two.If the test marketing is not successful,Kinston can still go ahead and build the new plant,but the expected annual after-tax cash flows would be only $200,000 in perpetuity beginning in year two.Kinston has the option to stop the project at any time and sell the prototype mountain bike to an overseas competitor for $300,000.Kinston's cost of capital is 10%.
-Assuming that Kinston has the ability to sell the prototype in year one for $300,000,the NPV of the Kinston Industries Mountain Bike Project is closest to:

Accepted Answer

A) $90,000. 
B) $590,000. 
C) $455,000. 
D) -$45,000. 
A) $90,000. 
B) $590,000. 
C) $455,000. 
D) -$45,000.

Question 10

Which of the following statements is FALSE?

Accepted Answer

A) Often,the decision to abandon a project entails costs,which may be either positive or negative. 
B) Mortgage interest rates are higher than Treasury rates because mortgages have an abandonment option that Treasuries do not have: You can prepay your mortgage at any time,while the U.S.government can repay its debt only according to the schedule outlined in the bond contract. 
C) A popular option gives holders of the bond the option to convert the bond into equity.These kinds of bonds are termed callable bonds. 
D) More often than not,there is an opportunity cost of abandoning a project: If you shut down the project and later decide to start it up again,you have to pay the costs of restarting the project. 
A) Often,the decision to abandon a project entails costs,which may be either positive or negative. 
B) Mortgage interest rates are higher than Treasury rates because mortgages have an abandonment option that Treasuries do not have: You can prepay your mortgage at any time,while the U.S.government can repay its debt only according to the schedule outlined in the bond contract. 
C) A popular option gives holders of the bond the option to convert the bond into equity.These kinds of bonds are termed callable bonds. 
D) More often than not,there is an opportunity cost of abandoning a project: If you shut down the project and later decide to start it up again,you have to pay the costs of restarting the project.

Question 11

Use the information for the question(s)below.
You own a small manufacturing plant that currently generates revenues of $2 million per year.Next year,based upon a decision on a long-term government contract,your revenues will either increase by 20% or decrease by 25%,with equal probability,and stay at that level as long as you operate the plant.Other costs run $1.6 million per year.You can sell the plant at any time to a large conglomerate for $5 million and your cost of capital is 10%.
-Given the embedded option to sell the plant,the value of your plant will be closest to:

Accepted Answer

A) $5.0 million. 
B) $4.0 million. 
C) $6.5 million. 
D) $8.0 million. 
A) $5.0 million. 
B) $4.0 million. 
C) $6.5 million. 
D) $8.0 million.

Question 12

Use the following information to answer the question(s)below.
Rearden Metal can invest in a risk-free technology that requires an up-front investment of $1 million.Rearden's managers are hesitant to invest because of uncertainty over future interest rates.Suppose that all interest rates will be either 8% or 4% in one year and remain there forever.The risk-neutral probability that interest rates will drop to 4% is 40%.The one-year risk-free interest rate is 5% and today's rate on a risk-free perpetual bond is 6%.The rate on an equivalent perpetual bond that is repayable at any time (the callable annuity rate)is 7.65%.
-Assuming that this project will provide Rearden with perpetual annual cash flows of $55,000,the NPV of investing in the project today is closest to:

Accepted Answer

A) -$281,000. 
B) -$150,000. 
C) -$83,000. 
D) +$83,000. 
E) +$281,000 
A) -$281,000. 
B) -$150,000. 
C) -$83,000. 
D) +$83,000. 
E) +$281,000

Question 13

Which of the following statements is FALSE?

Accepted Answer

A) An alternative to using the Black-Scholes formula is to compute the value of growth options using risk-neutral probabilities. 
B) Future growth options are not only important to firm value,but can also be important in the value of an individual project. 
C) While the Black-Scholes formula values American options,most growth options cannot be exercised at any time. 
D) Out-of-the-money calls are riskier than in-the-money calls,and because most growth options are likely to be out-of-the-money,the growth component of firm value is likely to be riskier than the ongoing assets of the firm. 
A) An alternative to using the Black-Scholes formula is to compute the value of growth options using risk-neutral probabilities. 
B) Future growth options are not only important to firm value,but can also be important in the value of an individual project. 
C) While the Black-Scholes formula values American options,most growth options cannot be exercised at any time. 
D) Out-of-the-money calls are riskier than in-the-money calls,and because most growth options are likely to be out-of-the-money,the growth component of firm value is likely to be riskier than the ongoing assets of the firm.

Question 14

Do out-of-the-money real options have value?

Accepted Answer

Even if an investment opportunity curren

Question 15

Use the information for the question(s)below.
You own a small manufacturing plant that currently generates revenues of $2 million per year.Next year,based upon a decision on a long-term government contract,your revenues will either increase by 20% or decrease by 25%,with equal probability,and stay at that level as long as you operate the plant.Other costs run $1.6 million per year.You can sell the plant at any time to a large conglomerate for $5 million and your cost of capital is 10%.
-Assume that you are not able to sell the plant,but you are able to shut down the plant at no cost at any time.Given the embedded option to abandon production,the value of your plant will be closest to:

Accepted Answer

A) $8.0 million. 
B) $4.0 million. 
C) $5.0 million. 
D) $6.5 million. 
A) $8.0 million. 
B) $4.0 million. 
C) $5.0 million. 
D) $6.5 million.

Question 16

Use the information for the question(s)below.
Kinston Industries has come up with a new mountain bike prototype and is ready to go ahead with pilot production and test marketing.The pilot production and test marketing phase will last for one year and cost $500,000.Your management team believes that there is a 50% chance that the test marketing will be successful and that there will be sufficient demand for the new mountain bike.If the test-marketing phase is successful,then Kinston Industries will invest $3 million in year one to build a plant that will generate expected annual after-tax cash flows of $400,000 in perpetuity beginning in year two.If the test marketing is not successful,Kinston can still go ahead and build the new plant,but the expected annual after-tax cash flows would be only $200,000 in perpetuity beginning in year two.Kinston has the option to stop the project at any time and sell the prototype mountain bike to an overseas competitor for $300,000.Kinston's cost of capital is 10%.
-Assuming that Kinston does not have the ability to sell the prototype in year one for $300,000,the NPV of the Kinston Industries Mountain Bike Project is closest to:

Accepted Answer

A) -$45,000. 
B) $455,000. 
C) $590,000. 
D) $90,000. 
A) -$45,000. 
B) $455,000. 
C) $590,000. 
D) $90,000.

Question 17

Use the following information to answer the question(s)below.
Rearden Metal can invest in a risk-free technology that requires an up-front investment of $1 million.Rearden's managers are hesitant to invest because of uncertainty over future interest rates.Suppose that all interest rates will be either 8% or 4% in one year and remain there forever.The risk-neutral probability that interest rates will drop to 4% is 40%.The one-year risk-free interest rate is 5% and today's rate on a risk-free perpetual bond is 6%.The rate on an equivalent perpetual bond that is repayable at any time (the callable annuity rate)is 7.65%.
-Assuming that this project will provide Rearden with perpetual annual cash flows of $55,000,the NPV of investing in the project today using the hurdle rate is closest to:

Accepted Answer

A) -$281,000. 
B) -$150,000. 
C) -$83,000. 
D) +$83,000. 
E) +$281,000. 
A) -$281,000. 
B) -$150,000. 
C) -$83,000. 
D) +$83,000. 
E) +$281,000.

Question 18

Use the information for the question(s)below.
DM Skateboard company is planning to develop a new electric skateboard.In order for the project to be successful,the company must develop a new deck to accommodate a lightweight battery and a remote that is easy to operate while moving in an open environment.The company estimates the following costs,times,and probabilities of success for each component of the new skateboard:   All three risks are idiosyncratic and the risk-free rate of interest is 5%.The company does not have the resources to develop all the components at the same time.Therefore,management needs to decide in what order to develop the technologies.
-What is the failure cost index of the battery technology?

Accepted Answer

A) 0.00375 
B) 0.00392 
C) 0.99875 
D) 0.99892 
A) 0.00375 
B) 0.00392 
C) 0.99875 
D) 0.99892

Question 19

Use the table for the question(s)below.
Consider the following mutually exclusive projects:  
-The equivalent annual benefit of project B is closest to:

Accepted Answer

A) $5.05. 
B) $5.75. 
C) $3.45. 
D) $3.40. 
A) $5.05. 
B) $5.75. 
C) $3.45. 
D) $3.40.

Question 20

The idea that after making a large investment,a manager should not abandon the project is known as the:

Accepted Answer

A) negative NPV fallacy. 
B) abandonment fallacy. 
C) sunk cost fallacy. 
D) dependence fallacy. 
A) negative NPV fallacy. 
B) abandonment fallacy. 
C) sunk cost fallacy. 
D) dependence fallacy.

Which of the following statements is FALSE?

Which of the following statements is FALSE?

Which of the following statements is FALSE?

Which of the following statements is FALSE?

Do out-of-the-money real options have value?

Use the table for the question(s)below. Consider the following mutually exclusive projects: -The equivalent annual benefit of project B is closest to:

The idea that after making a large investment,a manager should not abandon the project is known as the:

The Corporation

Introduction to Financial Statement Analysis

Financial Decision Making and the Law of One Price

The Time Value of Money

Interest Rates

Valuing Bonds

Investment Decision Rules

Fundamentals of Capital Budgeting

Valuing Stocks

Capital Markets and the Pricing of Risk

Optimal Portfolio Choice and the Capital Asset Pricing Model

Estimating the Cost of Capital

Investor Behavior and Capital Market Efficiency

Capital Structure in a Perfect Market

Debt and Taxes

Financial Distress,managerial Incentives,and Information

Payout Policy

Capital Budgeting and Valuation With Leverage

Valuation and Financial Modeling: a Case Study

Financial Options

Option Valuation

Raising Equity Capital

Debt Financing

Leasing

Working Capital Management

Short-Term Financial Planning

Mergers and Acquisitions

Corporate Governance

Risk Management

International Corporate Finance

Filters

Exam 22: Real Options

Which of the following statements is FALSE?

Which of the following statements is FALSE?

Which of the following statements is FALSE?

Which of the following statements is FALSE?

Do out-of-the-money real options have value?

Use the table for the question(s)below. Consider the following mutually exclusive projects: -The equivalent annual benefit of project B is closest to:

The idea that after making a large investment,a manager should not abandon the project is known as the:

The Corporation

Introduction to Financial Statement Analysis

Financial Decision Making and the Law of One Price

The Time Value of Money

Interest Rates

Valuing Bonds

Investment Decision Rules

Fundamentals of Capital Budgeting

Valuing Stocks

Capital Markets and the Pricing of Risk

Optimal Portfolio Choice and the Capital Asset Pricing Model

Estimating the Cost of Capital

Investor Behavior and Capital Market Efficiency

Capital Structure in a Perfect Market

Debt and Taxes

Financial Distress,managerial Incentives,and Information

Payout Policy

Capital Budgeting and Valuation With Leverage

Valuation and Financial Modeling: a Case Study

Financial Options

Option Valuation

Raising Equity Capital

Debt Financing

Leasing

Working Capital Management

Short-Term Financial Planning

Mergers and Acquisitions

Corporate Governance

Risk Management

International Corporate Finance

Filters