5. Introduction to real options

Consider the following statement about real options:

Decision tree analysis is more commonly used in valuing securities than real assets.

True or False: The preceding statement is correct.

a) False

b) True

Which type of real option allows a firm to postpone a project until it can gather more information?

a) Abandonment option

b) Flexibility option

c) Timing option

d) Expansion option

Consider the following example:

Clemens Inc. is considering a $100 million investment in a new line of soft drinks. However, $100 million is a huge investment for Clemens; if things turn bad, it could wipe out the company. A few senior managers have suggested a smaller investment of $20 million to see if the market is as strong as they hope it is. If demand is strong and the opportunity is still available, Clemens will increase its investment at a later date.

This example describes a real option to _______ a)expand b)abandon