Answered: Consider the following statement about…

Fundamentals of Financial Management (MindTap Course List)

14th Edition

ISBN:9781285867977

Author:Eugene F. Brigham, Joel F. Houston

Publisher:Eugene F. Brigham, Joel F. Houston

Chapter13: Real Options And Other Topics In Capital Budgeting

Section: Chapter Questions

Problem 1Q: Explain in general terms what each of the following real options is and how it could change projects...

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7. Introduction to real options

Consider the following statement about real options:

Sometimes real options can give managers the flexibility to decide to invest in a project or wait to make a more calculated decision.

A. True or False: The preceding statement is correct.

True

False

B. Which type of real option allows a firm to postpone a project until it can gather more information?

Flexibility option

Expansion option

Abandonment option

Timing option

Consider the following example:

Clemens Inc. is considering a $100 million investment in a new line of soft drinks. However, $100 million is a huge investment for Clemens; if things turn bad, it could wipe out the company. A few senior managers have suggested a smaller investment of $20 million to see if the market is as strong as they hope it is. If demand is strong and the opportunity is still available, Clemens will increase its investment at a later date.

C. This example describes a real option to .

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