Corporate Finance
12th Edition
ISBN: 9781259918940
Author: Ross, Stephen A.
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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Companies 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?
4. Introduction to real options
Consider the following statement about real options:
Decision tree analysis is more commonly used in valuing securities than real assets.
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?
Flexibility option
Abandonment option
Expansion option
Timing 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 (expand/ abandon) .
Please do not answer in excel, use math formulas
Thank you!
TRUE OR FALSE - brief explanation
As a call option is an option to buy and a put option an option to sell, the opposite position to buying an option to buy is buying an option to sell. Therefore, any factor that increases the value of a call option will decrease the value of a put option written on the same asset.
Chapter 23 Solutions
Corporate Finance
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...
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- Now 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_forwardBuying 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_forwardTo 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_forward
- How does option value factor into this decision to acquire MGM? What factors should Amazon consider when bidding on MGM? How does competition affect Amazon's decision to acquire MGM?arrow_forwardAs a call option is an option to buy and a put option an option to sell, the opposite position to buying an option to buy is buying an option to sell. Therefore, any factor that increases the value of a call option will decrease the value of a put option written on the same asset. Identify whether it is TRUE or FALSE. Why? Give an explanation.arrow_forwardWhat does the option contract payoff diagram look like for NeedOil. Co. if it chooses to buy a call option with a strike price of $15 and sell another call option with a strike price of $18? (Ignore the option premiums.)•What risk does this option combo hedge against, and what may be the reason that NeedOil engages in the above transactions?arrow_forward
- Which 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_forwardA call option written on a foreign currency without owning the underlying stock: a) can subject the call option writer to unlimited losses b) can provide the valuable right of buying the foreign currency c) cannot result in retaining the premium on the call option for option writerarrow_forwardTrue/false An option is a financial contract that gives the owner the right to buy or sell some asset at a fixed price on or before a given date. The put-call parity is derived based on the principal of no arbitrage. That is, the put-call parity equation holds only when the market is reasonably good enough so that arbitrage opportunities are not allowed. Today Jim bought a call option and Jill wrote a call option. The options are exactly the same (with the same underlying asset, same exercise price, same expiration date, same in every aspect). When the underlying stock price changes, for every dollar Jim gains, Jill loses a dollar, and vice versa. In reality, stock option contracts are based on the unit of 100 shares and expire on the third Friday of the month. An out of the money option means that if you exercise the option now you will be able to get money out of it.arrow_forward
- Which 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_forward4. 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…arrow_forwardwhich 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_forward
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