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Financial Management: Theory & Practice

16th Edition

ISBN:9781337909730

Author:Brigham

Publisher:Brigham

Chapter8: Financial Options And Applications In Corporate Finance

Section: Chapter Questions

Problem 2MC

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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 available, Clemens will increase its investment at a later date.

This example describes a real option to ______

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