Question

Companies often have to increase their initial investment costs to obtain real options such as Abandonment,...

Companies often have to increase their initial investment costs to obtain real options such as Abandonment, Timing, Growth & Flexibility. Why might this be so, and how could a firm decide if it was worth the cost to obtain a given real option?

Business   Finance   
0 0
Add a commentTranscribed image text
Next >

Homework Answers

Answer #1

Many a times, one doesnt know the market perfectly well and in those cases one would be stuck with initial capacity or production if the demand is not as high as was anticiapted. Also, one can lose out if it is not able to expand in the case of demand being more than anticipated. Hence, company needs real options which provides them the rights but do not obligate them, for uncertainty, to give significant flexibility for changing the course of project in favorable direction.

THe firm can do a scenario analysis by calculating the NPV in those scenarios and then would be able to tell whether the cost was justified or not. Investment opportunities can be plotted in "option space" with dimensions such as "volatility" and value-to-cost ("NPVq")

0 0
Know the answer?
Your Answer:

Post as a guest

Your Name:

What's your source?

Earn Coins

Coins can be redeemed for fabulous gifts.

Log In

Sign Up

Not the answer you're looking for?
Ask your own homework help question
Similar Questions
Consider the following statement about real options: The value of a real option is found by...
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...
Make sure to show the excel calculations and formula What to do: Evaluate using the Real...
Make sure to show the excel calculations and formula What to do: Evaluate using the Real Options Approach (all cash flows are after tax). A company must decide whether to invest $100 million in developing and implementing a new enterprise system in the face of considerable technological and market (demand for product and market share) uncertainty. The firm's cost of capital is 10%. The probability of a successful project (or pilot) is now 70% and the probability of an unsuccessful...
Decisions involving capital expenditures often require managers to weigh the costs and benefits of different options...
Decisions involving capital expenditures often require managers to weigh the costs and benefits of different options related to the financing of a project. For instance, deciding when to call a bond before maturity due to changing interest rates can lower the overall cost of a project significantly through refinancing. So, it is important to be able to understand the real interest rate being paid out to your bondholders (yield) at any given time. You will utilize the information in this...
Suppose you have calculated a $1,500,000 NPV for a capital investment by discounting the investment’s expected...
Suppose you have calculated a $1,500,000 NPV for a capital investment by discounting the investment’s expected future cash flows (over the expected 5 year operating period) using the firm’s current cost of capital and after subtracting the upfront costs associated with the investment. If you accept this investment, which you should do given the $1,500,000 NPV estimate, discuss why the investment is not guaranteed to increase firm value.
(Divisional costs of capital and investment decisions​) In May of this year Newcastle Mfg.​ Company's capital...
(Divisional costs of capital and investment decisions​) In May of this year Newcastle Mfg.​ Company's capital investment review committee received two major investment proposals. One of the proposals was put forth by the​ firm's domestic manufacturing​ division, and the other came from the​ firm's distribution company. Both proposals promise internal rates of return equal to approximately 16 percent. In the​ past, Newcastle has used a single firm wide cost of capital to evaluate new investments. However, managers have long recognized...
Companies invest in expansion projects with the expectation of increasing the earnings of its business. Consider...
Companies invest in expansion projects with the expectation of increasing the earnings of its business. Consider the case of Garida Co.: Garida Co. is considering an investment that will have the following sales, variable costs, and fixed operating costs: Year 1 Year 2 Year 3 Year 4 Unit sales 4,200 4,100 4,300 4,400 Sales price $29.82 $30.00 $30.31 $33.19 Variable cost per unit $12.15 $13.45 $14.02 $14.55 Fixed operating costs $41,000 $41,670 $41,890 $40,100 This project will require an investment...
In May of this​ year, Newcastle Mfg.​ Company's capital investment review committee received two major investment...
In May of this​ year, Newcastle Mfg.​ Company's capital investment review committee received two major investment proposals. One of the proposals was put forth by the​ firm's domestic manufacturing​ division, and the other came from the​ firm's distribution company. Both proposals promise a return on invested capital to approximately 15 percent. In the​ past, Newcastle has used a single​ firm-wide cost of capital to evaluate new investments. ​However, managers have long recognized that the manufacturing division is significantly more risky...
n May of this year Newcastle Mfg. Company's capital investment review committee received two major investment...
n May of this year Newcastle Mfg. Company's capital investment review committee received two major investment proposals. One of the proposals was put forth by the firm's domestic manufacturing division, and the other came from the firm's distribution company. Both proposals promise internal rates of return equal to approximately 16 percent. In the past, Newcastle has used a single firm wide cost of capital to evaluate new investments. However, managers have long recognized that the manufacturing division is significantly more...
Will rate, thank you. Part 1: A project requires an initial investment of $100,000 and is...
Will rate, thank you. Part 1: A project requires an initial investment of $100,000 and is expected to produce a cash inflow before tax of $27,500 per year for five years. Company A has substantial accumulated tax losses and is unlikely to pay taxes in the foreseeable future. Company B pays corporate taxes at a rate of 34% and can depreciate the investment for tax purposes using the five-year MACRS tax depreciation schedule. Suppose the opportunity cost of capital is...
To raise some revenue to fund other operations, Monroe County is considering turning the stretch of...
To raise some revenue to fund other operations, Monroe County is considering turning the stretch of IN-46 that passes through the county into a toll road.  You are an analyst for New Capital, an investment firm that is considering whether to contract with Monroe County to lease and operate the toll road.  You are writing this memo to Susan Jansen, the director of New Capital, given the following information provided by the county. All project data, and appreciation rates, are in NOMINAL...
ADVERTISEMENT
Need Online Homework Help?

Get Answers For Free
Most questions answered within 1 hours.

Ask a Question
ADVERTISEMENT