Real options Respond to the following comments. a. “You don’t need option pricing theories to value flexibility. Just use a decision tree. Discount the cash f lows in the tree at the company cost of capital.” b. “These option pricing methods are just plain nutty. They say that real options on risky assets are worth more than options on safe assets.” c. “Real-options methods eliminate the need for DCF valuation of investment projects.”

Question

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Answer 1

Textbook Question

Chapter 22, Problem 1PS

Real options Respond to the following comments.

a. “You don’t need option pricing theories to value flexibility. Just use a decision tree. Discount the cash f lows in the tree at the company cost of capital.”
b. “These option pricing methods are just plain nutty. They say that real options on risky assets are worth more than options on safe assets.”
c. “Real-options methods eliminate the need for DCF valuation of investment projects.”

a.

Expert Solution

Summary Introduction

To discuss: To respond to the statement on whether to use a decision tree rather using option theories.

Explanation of Solution

The possible response to the given statement is as follows:

Discount rates cannot be used for any of the option payoffs, because the risk of the option varies as the asset value changes time to time.

b.

Expert Solution

Summary Introduction

To discuss: To respond to the statement on whether option pricing methods are plain nutty.

Explanation of Solution

The possible response to the given statement is as follows:

The risky asset might be worth less as an outcome of its riskiness, yet the option on the risky asset is progressively significant on the grounds that the option proprietor can underwrite from upward moves while not losing because of downward moves.

c.

Expert Solution

Summary Introduction

To discuss: To respond to the statement on whether real options methods eliminate the discount cash flow valuation.

Explanation of Solution

The possible response to the given statement is as follows:

The worth of an option relies upon the value of the underlying asset. The discounted cash flow valuation of investment projects is vital so as to decide the worth of the underlying asset.

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Students have asked these similar questions

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.

Which of the following statements is FALSE? A. You invest today only when the NPV of investing today exceeds the value of the option of waiting, which from option pricing theory we know to be always positive. B. When you do not have the option to wait, it is optimal to invest in any positive−NPV project. C. One way to see why you sometimes choose not to invest in a positive−NPV project is to think about the decision of when to invest as a choice between two mutually exclusive projects: (1) invest today or (2) wait. D. When you have the option of deciding when to invest, it is usually optimal to invest only when the NPV is positive but close to zero.

4. 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. True False Which type of real option allows a project to be expanded if demand turns out to be greater than expected? Flexibility option Abandonment option Expansion option Timing option Consider the following example: Smoltz Motors has plants around the country that specialize in specific models of cars. Smoltz has determined that lower demand has led the firm’s inventory of SUVs to be too high. Smoltz wants to stop production for its SUVs and focus on its sedans. This example describes a real option to (expand/ abandon) . Please do not answer in excel, use math formulas Thank you!

Answer 2

Textbook Question

Chapter 22, Problem 1PS

Real options Respond to the following comments.

a. “You don’t need option pricing theories to value flexibility. Just use a decision tree. Discount the cash f lows in the tree at the company cost of capital.”
b. “These option pricing methods are just plain nutty. They say that real options on risky assets are worth more than options on safe assets.”
c. “Real-options methods eliminate the need for DCF valuation of investment projects.”

a.

Expert Solution

Summary Introduction

To discuss: To respond to the statement on whether to use a decision tree rather using option theories.

Explanation of Solution

The possible response to the given statement is as follows:

Discount rates cannot be used for any of the option payoffs, because the risk of the option varies as the asset value changes time to time.

b.

Expert Solution

Summary Introduction

To discuss: To respond to the statement on whether option pricing methods are plain nutty.

Explanation of Solution

The possible response to the given statement is as follows:

The risky asset might be worth less as an outcome of its riskiness, yet the option on the risky asset is progressively significant on the grounds that the option proprietor can underwrite from upward moves while not losing because of downward moves.

c.

Expert Solution

Summary Introduction

To discuss: To respond to the statement on whether real options methods eliminate the discount cash flow valuation.

Explanation of Solution

The possible response to the given statement is as follows:

The worth of an option relies upon the value of the underlying asset. The discounted cash flow valuation of investment projects is vital so as to decide the worth of the underlying asset.

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Answer 3

Textbook Question

Chapter 22, Problem 1PS

Real options Respond to the following comments.

a. “You don’t need option pricing theories to value flexibility. Just use a decision tree. Discount the cash f lows in the tree at the company cost of capital.”
b. “These option pricing methods are just plain nutty. They say that real options on risky assets are worth more than options on safe assets.”
c. “Real-options methods eliminate the need for DCF valuation of investment projects.”

a.

Expert Solution

Summary Introduction

To discuss: To respond to the statement on whether to use a decision tree rather using option theories.

Explanation of Solution

The possible response to the given statement is as follows:

Discount rates cannot be used for any of the option payoffs, because the risk of the option varies as the asset value changes time to time.

b.

Expert Solution

Summary Introduction

To discuss: To respond to the statement on whether option pricing methods are plain nutty.

Explanation of Solution

The possible response to the given statement is as follows:

The risky asset might be worth less as an outcome of its riskiness, yet the option on the risky asset is progressively significant on the grounds that the option proprietor can underwrite from upward moves while not losing because of downward moves.

c.

Expert Solution

Summary Introduction

To discuss: To respond to the statement on whether real options methods eliminate the discount cash flow valuation.

Explanation of Solution

The possible response to the given statement is as follows:

The worth of an option relies upon the value of the underlying asset. The discounted cash flow valuation of investment projects is vital so as to decide the worth of the underlying asset.

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Answer 4

Textbook Question

Chapter 22, Problem 1PS

Real options Respond to the following comments.

a. “You don’t need option pricing theories to value flexibility. Just use a decision tree. Discount the cash f lows in the tree at the company cost of capital.”
b. “These option pricing methods are just plain nutty. They say that real options on risky assets are worth more than options on safe assets.”
c. “Real-options methods eliminate the need for DCF valuation of investment projects.”

a.

Expert Solution

Summary Introduction

To discuss: To respond to the statement on whether to use a decision tree rather using option theories.

Explanation of Solution

The possible response to the given statement is as follows:

Discount rates cannot be used for any of the option payoffs, because the risk of the option varies as the asset value changes time to time.

b.

Expert Solution

Summary Introduction

To discuss: To respond to the statement on whether option pricing methods are plain nutty.

Explanation of Solution

The possible response to the given statement is as follows:

The risky asset might be worth less as an outcome of its riskiness, yet the option on the risky asset is progressively significant on the grounds that the option proprietor can underwrite from upward moves while not losing because of downward moves.

c.

Expert Solution

Summary Introduction

To discuss: To respond to the statement on whether real options methods eliminate the discount cash flow valuation.

Explanation of Solution

The possible response to the given statement is as follows:

The worth of an option relies upon the value of the underlying asset. The discounted cash flow valuation of investment projects is vital so as to decide the worth of the underlying asset.

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Answer 5

Textbook Question

Answer 6

Textbook Question

Answer 7

a.

Expert Solution

Summary Introduction

To discuss: To respond to the statement on whether to use a decision tree rather using option theories.

Explanation of Solution

The possible response to the given statement is as follows:

Discount rates cannot be used for any of the option payoffs, because the risk of the option varies as the asset value changes time to time.

b.

Expert Solution

Summary Introduction

To discuss: To respond to the statement on whether option pricing methods are plain nutty.

Explanation of Solution

The possible response to the given statement is as follows:

The risky asset might be worth less as an outcome of its riskiness, yet the option on the risky asset is progressively significant on the grounds that the option proprietor can underwrite from upward moves while not losing because of downward moves.

c.

Expert Solution

Summary Introduction

To discuss: To respond to the statement on whether real options methods eliminate the discount cash flow valuation.

Explanation of Solution

The possible response to the given statement is as follows:

The worth of an option relies upon the value of the underlying asset. The discounted cash flow valuation of investment projects is vital so as to decide the worth of the underlying asset.

Answer 8

a.

Expert Solution

Summary Introduction

To discuss: To respond to the statement on whether to use a decision tree rather using option theories.

Explanation of Solution

The possible response to the given statement is as follows:

Discount rates cannot be used for any of the option payoffs, because the risk of the option varies as the asset value changes time to time.

Answer 9

a.

Expert Solution

Answer 10

a.

Expert Solution

Answer 11

Expert Solution

Answer 12

Summary Introduction

To discuss: To respond to the statement on whether to use a decision tree rather using option theories.

Answer 13

Explanation of Solution

The possible response to the given statement is as follows:

Discount rates cannot be used for any of the option payoffs, because the risk of the option varies as the asset value changes time to time.

Answer 14

b.

Expert Solution

Summary Introduction

To discuss: To respond to the statement on whether option pricing methods are plain nutty.

Explanation of Solution

The possible response to the given statement is as follows:

The risky asset might be worth less as an outcome of its riskiness, yet the option on the risky asset is progressively significant on the grounds that the option proprietor can underwrite from upward moves while not losing because of downward moves.

Answer 15

b.

Expert Solution

Answer 16

b.

Expert Solution

Answer 17

Expert Solution

Answer 18

Summary Introduction

To discuss: To respond to the statement on whether option pricing methods are plain nutty.

Answer 19

Explanation of Solution

The possible response to the given statement is as follows:

The risky asset might be worth less as an outcome of its riskiness, yet the option on the risky asset is progressively significant on the grounds that the option proprietor can underwrite from upward moves while not losing because of downward moves.

Answer 20

c.

Expert Solution

Summary Introduction

To discuss: To respond to the statement on whether real options methods eliminate the discount cash flow valuation.

Explanation of Solution

The possible response to the given statement is as follows:

The worth of an option relies upon the value of the underlying asset. The discounted cash flow valuation of investment projects is vital so as to decide the worth of the underlying asset.

Answer 21

c.

Expert Solution

Answer 22

c.

Expert Solution

Answer 23

Expert Solution

Answer 24

Summary Introduction

To discuss: To respond to the statement on whether real options methods eliminate the discount cash flow valuation.

Answer 25

Explanation of Solution

The possible response to the given statement is as follows:

The worth of an option relies upon the value of the underlying asset. The discounted cash flow valuation of investment projects is vital so as to decide the worth of the underlying asset.

Answer 26

Ch. 22 - Real options Respond to the following comments. a....Ch. 22 - Prob. 2PS Ch. 22 - Real options True or false? a. Real-options...Ch. 22 - Prob. 4PS Ch. 22 - Real options Describe each of the following...Ch. 22 - Expansion options Look again at the valuation in...Ch. 22 - Expansion options Look again at Table 22.2. How...Ch. 22 - Prob. 8PS Ch. 22 - Timing options Look back at the Malted Herring...Ch. 22 - Prob. 10PS

Solution Summary: The author responds to the statement on whether to use a decision tree rather than using option theories. Discount rates cannot be used for any of the option payoffs.

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