Loose Leaf for Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
11th Edition
ISBN: 9781259709685
Author: Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe
Publisher: McGraw-Hill Education
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Textbook Question
Chapter 23, Problem 6CQ
Real Options Star Mining buys a gold mine, but the cost of extraction is currently too high to make the mine profitable. In option terminology, what type of option(s) does the company have on this mine?
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Q. A friend of yours tells you she holds an American call option that is very deep-in-the-money. She tells you she’s going to exercise it now and cash in on her winnings. Is this a wise move to make?
- The answer to this question is given below but I don't understand the explanation, please clearly explain in simple terms.
No, she should sell it. Sell now you get intrinsic value PLUS time value, rather than exercise now which leads to just S-X.
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?
Investment timing option
Flexibility option
Abandonment option
Growth option
King Snowplows began operations in New York City two years ago. As an independent contractor, the company does the majority of its business working for the city. The company also had offers from surrounding cities in New Jersey and Long Island, but these offers would have required the company to invest in additional snowplows—which have high up-front costs. King Snowplows decided to purchase only the snowplows necessary to handle its contract with New York…
4. 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.
True or False: The preceding statement is correct.
False
True
Which type of real option allows the output and/or inputs in the production process to be altered, depending on how market conditions change during a project’s life?
A. Expansion option
B. Flexibility option
C. Abandonment option
D. 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…
Chapter 23 Solutions
Loose Leaf for Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
Ch. 23 - Employee Stock Options Why do companies issue...Ch. 23 - Real Options What are the two options that many...Ch. 23 - Project Analysis Why does a strict NPV calculation...Ch. 23 - Real Options Utility companies often face a...Ch. 23 - Prob. 5CQCh. 23 - Real Options Star Mining buys a gold mine, but the...Ch. 23 - Real Options You are discussing real options with...Ch. 23 - Real Options and Capital Budgeting Your company...Ch. 23 - Insurance as an Option Insurance, whether...Ch. 23 - Real Options How would the analysis of real...
Ch. 23 - Prob. 1QPCh. 23 - Prob. 2QPCh. 23 - Binomial Model Gasworks, Inc., has been approached...Ch. 23 - Real Options The Webber Company is an...Ch. 23 - Real Options Jet Black is an international...Ch. 23 - Real Options Sardano and Sons is a large, publicly...Ch. 23 - Real Options Wet for the Summer, Inc.,...Ch. 23 - Prob. 8QPCh. 23 - Binomial Model In the previous problem, assume...Ch. 23 - Real Options You are in discussions to purchase an...Ch. 23 - Prob. 1MCCh. 23 - Prob. 2MCCh. 23 - Your options, like most employee stock options,...Ch. 23 - Why do you suppose employee stock options usually...Ch. 23 - Prob. 5MCCh. 23 - Prob. 6MC
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Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Similar questions
- Buying a unit of forward and buying a unit of put option (the underlying asset is the same, the expiration date is the same) is equivalent to () Urgent need fast pls A. Sell a unit of call option B. Buy the underlying asset C. Buy a unit of call option D. Sell the underlying assetarrow_forwardQUESTION ONE Options What is a call option? A put option? Under what circumstances might you want to buyeach? Which one has greater potential profit? Why? Options Complete the following sentence for each of these investors: 1. A buyer of call options. 2. A buyer of put options. 3. A seller (writer) of call options. 4. A seller (writer) of put options.“The (buyer/seller) of a (put/call) option (pays/receives) money for the (right/obligation) to(buy/sell) a specified asset at a fixed price for a fixed length of time.” American and European Options What is the difference between an American option and aEuropean option?arrow_forward7. 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.…arrow_forward
- which one is correct please confirm? Q2" Which of the following strategies will be profitable if the price of the underlying asset is expected to decrease? (There may be more than one correct response.) Buying a put Buying a call. Selling a put Selling a call.arrow_forwardWhich of the below statements is false about real options? A. Real options increase firm value B.Investing in a project can be priced as an American call option C.Abandoning a project can be priced as an American put option D.Growth options have no impact on the market value of the firmarrow_forwardConsider 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. True or False: The preceding statement is correct. True False Which type of real option allows a project to be expanded if demand turns out to be greater than expected? Expansion option Flexibility option Abandonment option Timing option Consider the following example: King Snowplows began operations in New York City two years ago. As an independent contractor, the company does the majority of its business working for the city. The company also had offers from surrounding cities in New Jersey and Long Island, but these offers would have required the company to invest in additional snowplows—which have high up-front costs. King Snowplows decided to purchase only the snowplows necessary to handle its contract with New York City. The company…arrow_forward
- Calculate the NPV Calculate the IRR (to the nearest percent) Would you accept this project. Sam Parkington has a nontransferable option to mine for gold on a certain piece of land. He has three choices of actions: He can start mining immediately. He can conduct further tests to see whether there is a good promise of finding gold. He can drop the option. The cost of the test would be $45,000, and the cost of mining would be $150,000. If he find gold, he expect s to net $600,000. He estimates the following probabilities. If he starts mining without further tests, he estimates that the probability of finding gold is 55 percent. He expects that the probability of the test being successful is 60 percent. If the test is favorable, the probability is 85 percent that there is gold in the ground, but if the test is not favorable it is only 10 percent. Using a decision tree (that you must show in the paper), make a recommendation.arrow_forwardCompanies often have to increase their initial investment costs to obtain real options. Whymight this be so, and how could a firm decide whether it was worth the cost to obtain agiven real option?arrow_forwardNow assume that the equipments residual value could be as low as 0 or as high as 400,000, but 200,000 is the expected value. Because the residual value is riskier than the other relevant cash flows, this differential risk should be incorporated into the analysis. Describe how this could be accomplished. (No calculations are necessary, but explain how you would modify the analysis if calculations were required.) What effect would the residual values increased uncertainty have on Lewis lease-versus-purchase decision?arrow_forward
- To hedge, a user of an energy resource wants price protection from rising prices. The user decides to buy a call option to protect against rising prices. But they want a lower cost of hedging and decide to construct a collar strategy. What other action should they take along with the purchase of the call option? Buy a call option Sell a call option Buy a put option Sell a put option None of the abovearrow_forwardQUESTION 1You are the mine manager of Mine X and you want to expand your operations. The feasibility study shows that you have two options to consider.Option A is to sell your product to a local consumer.Option B is to export your product. The feasibility study yielded the following results for Options A and B.Option A Total reserve base 80 million tonsCapital required R1 000 millionMining rate 8 million tons per yearYield 100%Production cost R35,00 ROM per tonSales price R80,00 per tonTax rate 30%NPV 47,09 millionIRR 22%Option B Total reserve base 80 million tonsCapital required R2 000 millionMining rate 8 million tons per yearYield 70%Production cost R35,00 per ROM tonBeneficiation cost R45,00 per ROM tonTransport…arrow_forwardWhich of the following will NOT increase the value of a real (call) option? Group of answer choices: A decrease in the probability that a competitor will enter the market of the project in question. An increase in the risk-free rate A decrease in the cost of obtaining the real option Lengthening the time in which a real option must be exercised. A decrease in the volatility of the underlying source of risk.arrow_forward
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