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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Answer 1

Textbook Question

Chapter 22, Problem 1PS

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.

Expert Solution

Summary Introduction

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.

Expert Solution

Summary Introduction

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.

Expert Solution

Summary Introduction

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.

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General Finance Question

Consider the following simplified financial statements for the Yoo Corporation (assuming no income taxes): Income Statement Balance Sheet Sales Costs $ 40,000 Assets 34,160 $26,000 Debt Equity $ 7,000 19,000 Net income $ 5,840 Total $26,000 Total $26,000 The company has predicted a sales increase of 20 percent. Assume Yoo pays out half of net income in the form of a cash dividend. Costs and assets vary with sales, but debt and equity do not. Prepare the pro forma statements. (Input all amounts as positive values. Do not round intermediate calculations and round your answers to the nearest whole dollar amount.) Pro forma income statement Sales Costs $ 48000 40992 Assets $ 31200 Pro forma balance sheet Debt 7000 Equity 19000 Net income $ 7008 Total $ 31200 Total 30304 What is the external financing needed? (Do not round intermediate calculations. Negative amount should be indicated by a minus sign.) External financing needed $ 896

Answer 2

Textbook Question

Chapter 22, Problem 1PS

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.

Expert Solution

Summary Introduction

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.

Expert Solution

Summary Introduction

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.

Expert Solution

Summary Introduction

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.

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Answer 3

Textbook Question

Chapter 22, Problem 1PS

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.

Expert Solution

Summary Introduction

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.

Expert Solution

Summary Introduction

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.

Expert Solution

Summary Introduction

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.

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Answer 4

Textbook Question

Chapter 22, Problem 1PS

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.

Expert Solution

Summary Introduction

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.

Expert Solution

Summary Introduction

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.

Expert Solution

Summary Introduction

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.

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Answer 5

Textbook Question

Answer 6

Textbook Question

Answer 7

a.

Expert Solution

Summary Introduction

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.

Expert Solution

Summary Introduction

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.

Expert Solution

Summary Introduction

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.

Answer 8

a.

Expert Solution

Summary Introduction

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.

Answer 9

a.

Expert Solution

Answer 10

a.

Expert Solution

Answer 11

Expert Solution

Answer 12

Summary Introduction

To discuss: To respond to the statement on whether to use a decision tree rather using option theories.

Answer 13

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.

Answer 14

b.

Expert Solution

Summary Introduction

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.

Answer 15

b.

Expert Solution

Answer 16

b.

Expert Solution

Answer 17

Expert Solution

Answer 18

Summary Introduction

To discuss: To respond to the statement on whether option pricing methods are plain nutty.

Answer 19

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.

Answer 20

c.

Expert Solution

Summary Introduction

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.

Answer 21

c.

Expert Solution

Answer 22

c.

Expert Solution

Answer 23

Expert Solution

Answer 24

Summary Introduction

To discuss: To respond to the statement on whether real options methods eliminate the discount cash flow valuation.

Answer 25

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.

Answer 26

Ch. 22 - Real options Respond to the following comments. a....Ch. 22 - Prob. 2PS Ch. 22 - Real options True or false? a. Real-options...Ch. 22 - Prob. 4PS Ch. 22 - Real options Describe each of the following...Ch. 22 - Expansion options Look again at the valuation in...Ch. 22 - Expansion options Look again at Table 22.2. How...Ch. 22 - Prob. 8PS Ch. 22 - Timing options Look back at the Malted Herring...Ch. 22 - Prob. 10PS

Solution Summary: The author responds to the statement on whether to use a decision tree rather than using option theories. Discount rates cannot be used for any of the option payoffs.

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