Principles of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
12th Edition
ISBN: 9781259144387
Author: Richard A Brealey, Stewart C Myers, Franklin Allen
Publisher: McGraw-Hill Education
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Textbook Question
Chapter 22, Problem 18PS
Real options Respond to the following comments.
- a. “You don’t need option pricing theories to value flexibility. Just use a decision tree. Discount the cash f lows in the tree at the company cost of capital.”
- b. “These option pricing methods are just plain nutty. They say that real options on risky assets are worth more than options on safe assets.”
- c. “Real-options methods eliminate the need for DCF valuation of investment projects.”
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Students have asked these similar questions
Financial advisors generally recommend that their clients allocate more to higher risk–return asset classes (like equities) if their investment horizons are long.
Is this advice consistent with the basic M-V model?
Does adding a shortfall constraint to the M-V model make a difference? If so, how? If not, why not?
Assuming investment opportunities change over time, what type of asset return behavior would justify this advice within the M-V framework?
Real options analysis is an investment analysis tool that looks at an investment or
activity as a series of sequential steps, and for each step, the investors have the
option of: 1) investing additional funds to grow or accelerate, 2) delaying, shrinking
the scale of, or abandoning an activity. However, analyzing and making decisions on
these options is often easier said than done. Which of the following illustrates the
potential pitfalls of real option analysis?
The managers involved with the analysis lose their ability to objectively assess
the options due to an inflated sense of their ability to reduce risks inherent in
the decision-making process.
Due to a lack of subjectivity when formally modeling a real option, managers
may have an incentive to choose variance values that diminish the likelihood of
project approval.
A prevailing tendency on the part of managers to operate in a highly
conservative manner thereby resulting in the investment approval criteria not
being met.
A…
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Chapter 22 Solutions
Principles of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
Ch. 22 - Expansion options Look again at the valuation in...Ch. 22 - Prob. 2PSCh. 22 - Prob. 3PSCh. 22 - Prob. 4PSCh. 22 - Prob. 5PSCh. 22 - Prob. 6PSCh. 22 - Real options True or false? a. Real-options...Ch. 22 - Prob. 8PSCh. 22 - Prob. 9PSCh. 22 - Expansion options Look again at Table 22.2. How...
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