Introduction to real options

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

1. True or False: The preceding statement is correct.

a. True b. False

2. Which type of real option allows a firm to shut down a project if its cash flows are lower than expected?

a. Expansion option b. Flexibility option c. Timing option d. Abandonment 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 avaliable, Clemens will increase its investment at a later date.

3. This example describes a real option to _____________.

a. abandon b. expand