Question

Real options Projects are also often embedded with different options that can help making decisions under uncertainty. There are techniques used to evaluate these embedded options which are called real options. The models used to value these options are based on the type of the real option available for the project.
A real option embedded in a capital project gives the investing firm the right but not the obligation to buy, sell, or transform an asset at a set price during a specified period of time.
a. True
b. False
The managers of Atlanta Aeronautics Co. have included a shutdown option into the design of a proposed capital investment project:
I. This option provides a firm with the flexibility to make potentially profitable investments in the future that would not have been possible if the initial project had not been undertaken
II. This option allows a firm to temporarily terminate operations in order to prevent experiencing negative cash flows.
III. This option allows a project to be expanded if demand turns out to be greater than expected.
IV. This option allows the outputs of the production process to be altered if market conditions change during a project's life. Which of the listed statements best describes a shutdown option?
Statement II
Statement I
Statement III
Statement IV
None of the statements listed above describes a shutdown option.
Real option analysis adds value to a project when it is used for which of the following?
a. Modifying the way that decision makers perceive flexibility in capital budgeting activities
b. Expanding the way that managers view risk and uncertainty, seeing them as phenomena to be appreciated and exploited rather than feared and avoided.
c. Making managerial decision making less deliberate and analytical
d. Making managers aware of the consequences of their decisions and actions on the creation or destruction of value for a capital project.

Answer 1

Answer:

i) TRUE

ii)  II

iii) All except option 3

Explanation:

i) A real option embedded in a capital project gives the investing firm the right but not the obligation to buy, sell, or transform an asset at a set price during a specified period of time.   TRUE

ii) The statement that best describes a shutdown is : This option allows a firm to temporarily terminate operations in order to prevent experiencing negative cash flows

iii) . Modifying the way that decision makers perceive flexibility in capital budgeting activities ;

 Expanding the way that managers view risk and uncertainty, seeing them as phenomena to be appreciated and exploited rather than feared and avoided.

Making managers aware of the consequences of their decisions and actions on the creation or destruction of value for a capital project.