(a)

You are considering a project that could either be undertaken immediately or, in one year. If undertaken immediately, the project costs 200 and has future cash flows of 42 per year forever. If undertaken next year, it will cost 240 because of inflation and the cash flows will be 48 per year forever.

If these are the only two relevant options (invest into the project now or in one year) and the appropriate discount rate for this project is fixed at the level of 6% per annum, what

should be done? What is the pure value of the option to wait?

b)

Consider the case as in (a) but now the appropriate discount rate is 12% per annum. How does this influence your answer to the value of the option to wait?

(c)

Briefly explain why Discounted Cash Flow (DCF) method cannot be used for valuing

options.

(d)

Outline exactly what an abandonment option and a timing option are. Your discussion should highlight the characteristics of these real options and you should provide an overview as to how they can contribute to the investment opportunities for companies.