What is real option analysis? How is it a better method of making investment decisions than using traditional capital budgeting analysis?
What will be an ideal response?
Answer: Real options is a different way of thinking about investment values. At its core, it is a cross between decision-tree analysis and pure option-based valuation. It is particularly useful when analyzing investment projects that will follow very different value paths at decision points in time where management decisions are made regarding project pursuit. This wide range of potential outcomes is at the heart of real option theory. Real option valuation also allows us to analyze a number of managerial decisions that in practice characterize many major capital investment projects:
1. The option to defer
2. The option to abandon
3. The option to alter capacity
4. The option to start up or shut down (switching)
Real option analysis treats cash flows in terms of future value in a positive sense, whereas DCF treats future cash flows negatively (on a discounted basis). Real option analysis is a particularly powerful device when addressing potential investment projects with extremely long life spans or investments that do not commence until future dates.
Real option analysis acknowledges the way information is gathered over time to support decision-making. Management learns from both active (searching it out) and passive (observing market conditions) knowledge-gathering and then uses this knowledge to make better decisions.
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Which of the following was listed as an effective table guideline?
A) Use no or only one decimal place (12% or 12.2%) unless more are called for by convention ($12.23). B) Place items you want the reader to compare in the same column, not the same row. C) If you have many rows, darken alternate entries or double-space after every five entries to assist the reader to accurately line up items. D) Total columns and rows when appropriate (100%). E) Avoid totaling columns as this extra information can be confusing.
Projected free cash flows should be discounted at the firm's weighted average cost of capital to find the firm's total corporate value.
Answer the following statement true (T) or false (F)
Ethel's Exercise World plans to order three weight machines from Pete's Push, Pedal, and Pull, Inc. for a total of $15,000. Pete's demands that Ethel's friend, Moneybags, a wealthy independent businesswoman (not connected with Ethel's business in any way) promise to pay Pete's for the three machines if Ethel's Exercise World does not. Which of the promises in this problem must be in writing to be enforceable?
A. The promise made by Ethel's Exercise World to buy the weight machines. B. Moneybag's promise to pay if Ethel's Exercise World doesn't. C. Both Moneybag's promise and Ethel's Exercise World's promise. D. None of the promises in this problem need to be in writing.
Component-based software development is generally ________
A) more expensive than a traditional approach B) very slow C) vertical D) horizontal