Financial Management: Theory & Practice
16th Edition
ISBN: 9781337909730
Author: Brigham
Publisher: Cengage
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Chapter 26, Problem 4Q
Summary Introduction
To determine: The reason that the company should accept the project if it has an option to abandon the project in future.
Introduction: The option gives an opportunity to the company to invest today and discontinue if starts earning during the definite period as per option contract.
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If a company has an option to abandon a project, would this tend to makethe company more or less likely to accept the project today?
Is the project viable or not? Suggest reasons
Financially, what is the economic worth of outbidding thecompetitors for a project?
Chapter 26 Solutions
Financial Management: Theory & Practice
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- Companies often have to increase their initial investment costs to obtain real options. Whymight this be so, and how could a firm decide whether it was worth the cost to obtain agiven real option?arrow_forwardwhat does it mean if the NPV and IRR are both positive, should the company invest on the project or not?arrow_forwardWhich of the following will NOT increase the value of a real (call) option? Group of answer choices: A decrease in the probability that a competitor will enter the market of the project in question. An increase in the risk-free rate A decrease in the cost of obtaining the real option Lengthening the time in which a real option must be exercised. A decrease in the volatility of the underlying source of risk.arrow_forward
- What alternatives do companies have for evaluating alternative projects or investments?arrow_forwardIs it feasible for a new company endeavor to be lucrative while still experiencing financial difficulties?arrow_forwardWhy might recognizing the existence of a real option raise, but not lower, a project’sNPV as found in the traditional manner?arrow_forward
- Suppose that a firm must choose between two mutually exclusive projects, both of which have negative NPVs. Explain how a firm can legitimately choose between two such projects.arrow_forwardFurther suppose that the same Firm XYZ from Question 1 is considering investments in two projects. Assume that the projects are mutually exclusive. Further assume the following information for the two projects (values are in 1000s): Project A -5,600 1,325 2,148 4,143 Project B -8,400 1,325 2,148 8,055 Year 1 3 Assume that the required return for the two projects is 8%. Show all work for each part of the problem that requires computation. a) What is the NPV for Project A? b) What is the NPV for Project B? c) What is the IRR for Project A? d) What is the IRR for Project B?arrow_forwardDoes the benefit-cost analysis result in definite proof that the project would have little value to the tax-payers in the long run?arrow_forward
- Why must real options have positive value? (Select all the choices that apply.) A. Having the real option but not the obligation to act is valuable. B. Real options must have positive value because they can always be sold to recover the initial investment. C. Real options must have positive value because they are only exercised when doing so would increase the value of the investment. D. If exercising the real option would reduce value, managers can allow the option to go unexercised.arrow_forwardI think question 3 is not answered clearly. If Project A is rejected due to negative NPV, then all positive NPVs projects should be accepted. The answer is not clear. Please correct me if I am missing something. Question 3) If the firm uses the discounted-payback rule, will it accept any negative NPV projects? Will it turn down any positive NPV projects? How do you know? Your answer is: No Due to Project A's negative NPV, it cannot cover the initial investment within its useful life. Will it turn down any positive NPV projects? It will reject projects with positive NPVs but not those with negative NPVs. If all potential cash flows are taken into account but the project still doesn't reach the designated cutoff point, the NPV can still be positive.arrow_forwardWhat is the value added by the design of the financing package? How does it alter both the return and the risk of the new project? Is it effective at reducing the project’s operating risks?arrow_forward
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