Describe the real option in each of the following cases: a. Deutsche Metall postpones a major plant
Question:
Describe the real option in each of the following cases:
a. Deutsche Metall postpones a major plant expansion. The expansion has positive NPV on a discounted-cash-flow basis but top management wants to get a better fix on product demand before proceeding.
b. Western Telecom commits to production of digital switching equipment specially designed for the European market. The project has a negative NPV, but it is justified on strategic grounds by the need for a strong market position in the rapidly growing, and potentially very profitable, market.
c. Western Telecom vetoes a fully integrated, automated production line for the new digital switches. It relies on standard, less-expensive equipment. The automated production line is more efficient overall, according to a discounted-cash-flow calculation.
d. Mount Fuji Airways buys a jumbo jet with special equipment that allows the plane to be switched quickly from freight to passenger use or vice versa.
e. The British–French treaty giving a concession to build a railroad link under the English Channel also required the concessionaire to propose by the year 2000 to build a “drive-through link” if “technical and economic conditions permit . . . and the decrease in traffic shall justify it without undermining the expected return on the first [rail] link.” Other companies will not be permitted to build a link before the year 2020.
Expected ReturnThe expected return is the profit or loss an investor anticipates on an investment that has known or anticipated rates of return (RoR). It is calculated by multiplying potential outcomes by the chances of them occurring and then totaling these...
Step by Step Answer:
Principles of Corporate Finance
ISBN: 978-0072869460
7th edition
Authors: Richard A. Brealey, Stewart C. Myers