Chapter 14, Problem 1Q

a)

Summary Introduction

To discuss: Meaning of real option, managerial option, strategic option and embedded option.

Explanation of Solution

Real options exist when managers may control the size of cash flows of a project by various actions during the lifespan of the project. These are called real options because, as opposed to financial assets, these deal with real. These are also referred to as managerial options because these offer managers the opportunity to respond to changing market conditions.

These are sometimes referred to as strategic options as they often tackle strategic concerns. At last, they are also called as embedded options as they are also as a part of another project.

b)

Summary Introduction

To discuss: Investment timing option, abandonment option, growth option and flexibility option.

Explanation of Solution

Investment timing strategies offer companies the option of continuing a project instead of immediately implementing it. This waiting option allows a company to reduce market uncertainty before deciding to implement the project.

Capacity options allow a business to respond to changing market conditions and improve the capacity of its output. That involves the prospect of contracting or increasing production. Growth options allow a company to grow if demand on the market is higher than expected.

This includes the opportunity to expand into various geographic markets and introduce additional or second-generation products. It also includes the option to abandon a project if there is too much deteriorate in market conditions.

c)

Summary Introduction

To discuss: Decision tree.

Explanation of Solution

Decision trees are a method of analysis of scenarios where different actions are taken in different scenarios.