Question

Consider the following statement about real options:

The value of a real option is found by taking the difference between the expected NPV of a project with the option and the expected NPV of the project without the option.

True or False: The preceding statement is correct.

False

True

Which type of real option allows a firm to shut down a project if its cash flows are lower than expected?

Abandonment option

Investment timing option

Growth

Flexibility option

Consider the following example:

Smoltz Motors has plants around the country that specialize in specific models of cars. Smoltz has determined that lower demand has led the firm’s inventory of SUVs to be too high. Smoltz wants to stop production for its SUVs and focus on its sedans.

This example describes a real option to ______ .

Abondon

Expand

Answer 1

1) The value of a real option is found by taking the difference between the expected NPV of a project with the option and the expected NPV of the project without the option

This statement is Correct

Hence correct answer is TRUE

2)

Abandonment Option real option allows a firm to shut down a project if its cash flows are lower than expected

3)

Smoltz Motors has plants around the country that specialize in specific models of cars. Smoltz has determined that lower demand has led the firm’s inventory of SUVs to be too high. Smoltz wants to stop production for its SUVs and focus on its sedans

This is an example of a real option to Abandon