Exam 22: Real Options

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 dollars per year.You can sell the plant at any time to a large conglomerate for $5 million and your cost of capital is 10%. -If you are awarded the government contract and your sales increase by 20%,then the value of your plant will be closest to:

Assume that it will cost you $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:

The rate on a risk-free annuity that can be called at any time is known as the:

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:

The two different types of node on a decision tree are:

Assuming that this project will provide Rearden with perpetual annual cash flows of $65,000,the NPV of investing in the project next year is closest to:

Which of the following statements is FALSE?

Which of the following statements is FALSE?

Which of the following is an example of a way in which companies can create value by exploiting real options?

Unicorn Medical Devices is developing a new technology.After initial development of the device,the company must test it.If the tests go well and the device is successful,it can be marketed immediately.If the tests do not go well,Unicorn will revise the original device and repeat the process.The outcome of the tests is on a(n)________ node in a decision tree.

Given the embedded option to sell the plant,the value of your plant will be closest to:

Mutually dependent investments occur when:

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.

Assuming that Kinston does not have the ability to sell the prototype in year one for $300,000,draw a decision tree detailing the Kinston Industries Mountain Bike Project.

Which of the following statements is FALSE?

Luther Industries is considering launching a new toy just in time for the Christmas season.They estimate that if Luther launches the new toy this year it will have an NPV of $25 million.Luther has the option to wait one year until the next Christmas season to launch the toy,however,the demand next year will depend upon what new toys Luther's competitors introduce and therefore greater uncertainty about next years demand.Launching the new today will involve a total capital expenditure of $100 million.If the risk-free rate is 5%,N(d₁)is .62 and N(d₂)is .65,then what is the value of the option to wait until next year to launch the new toy?

Which of the following statements is FALSE?

Which of the following statements is FALSE?

When the value of one project depends on the outcome of one or more other projects,this is known as:

Assuming that this project will provide Rearden with perpetual annual cash flows of $55,000,the NPV of investing in the project next year is closest to: