Concept explainers
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.”
a.

To discuss: To respond to the statement on whether to use a decision tree rather using option theories.
Explanation of Solution
The possible response to the given statement is as follows:
Discount rates cannot be used for any of the option payoffs, because the risk of the option varies as the asset value changes time to time.
b.

To discuss: To respond to the statement on whether option pricing methods are plain nutty.
Explanation of Solution
The possible response to the given statement is as follows:
The risky asset might be worth less as an outcome of its riskiness, yet the option on the risky asset is progressively significant on the grounds that the option proprietor can underwrite from upward moves while not losing because of downward moves.
c.

To discuss: To respond to the statement on whether real options methods eliminate the discount cash flow valuation.
Explanation of Solution
The possible response to the given statement is as follows:
The worth of an option relies upon the value of the underlying asset. The discounted cash flow valuation of investment projects is vital so as to decide the worth of the underlying asset.
Want to see more full solutions like this?
Chapter 22 Solutions
PRIN.OF CORPORATE FINANCE
- Inferior Investment Alternatives Although investing requires the individual to bear risk, the risk can be controlled through the construction of diversified portfolios and by excluding any portfolio that offers an inferior return for a given amount of risk. While this concept seems obvious, one of your clients, Laura Spegele, is considering purchasing a stock that you believe will offer an inferior return for the risk she will bear. To convince her that the acquisition is not desirable, you want to demonstrate the trade-off between risk and return. While it is impractical to show the trade-off for all possible combinations, you believe that illustrating several combinations of risk and return and applying the same analysis to the specific investment should be persuasive in discouraging the purchase. Currently, U.S. Treasury bills offer 2.5 percent. Three possible stocks and their betas are as follows: 1. What will be the expected return and beta for each of the following portfolios? a.…arrow_forwardSolve this fin. Qn no aiarrow_forwardYou gave me unhelpful so i also gave you unhelpful.arrow_forward
- What is corporate finance? how many types of corporate finance??arrow_forwardEsfandairi Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $2,350,000. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $3,310,000 in annual sales, with costs of $2,330,000. Assume the tax rate is 23 percent and the required return on the project is 11 percent. What is the project's NPV? Note: A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.arrow_forwardGyygvvv iiiedfarrow_forward
