Principles of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
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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Chapter 22, Problem 18PS

Real options Respond to the following comments.

  1. 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.”
  2. 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.”
  3. c. “Real-options methods eliminate the need for DCF valuation of investment projects.”
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Which of the following statements is​ FALSE?       A. You invest today only when the NPV of investing today exceeds the value of the option of​ waiting, which from option pricing theory we know to be always positive.   B. When you do not have the option to​ wait, it is optimal to invest in any positive−NPV project.   C. One way to see why you sometimes choose not to invest in a positive−NPV project is to think about the decision of when to invest as a choice between two mutually exclusive​ projects: (1) invest today or​ (2) wait.   D. When you have the option of deciding when to​ invest, it is usually optimal to invest only when the NPV is positive but close to zero.
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?
d. Consider the following statement "If an analyst decides to use real options methodology to value a project, estimating a standard Discounted Cash Flow model is useless". Do you agree with this statement? Explain your answer.
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