Lighthouse Corporation Uses the NPV Method for Selecting Projects, and It

question 18

Multiple Choice

Lighthouse Corporation uses the NPV method for selecting projects, and it does a reasonably good job of estimating projects' sales and costs. However, it never considers real options that might be associated with projects. Which of the following statements is most likely to describe its situation?

• A) Its estimated capital budget is probably too small, because projects' NPVs are often larger when real options are taken into account.
• B) Its estimated capital budget is probably too large due to its failure to consider abandonment and growth options.
• C) Failing to consider abandonment and flexibility options probably makes the optimal capital budget too large, but failing to consider growth and timing options probably makes the optimal capital budget too small, so it is unclear what impact not considering real options has on the overall capital budget.
• D) Failing to consider abandonment and flexibility options probably makes the optimal capital budget too small, but failing to consider growth and timing options probably makes the optimal capital budget too large, so it is unclear what impact not considering real options has on the overall capital budget.
• E) Real options should not have any effect on the size of the optimal capital budget.

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Definitions:

Cash Donation

A monetary contribution made to support a cause, organization, or individual, typically without expecting anything in return.

Fair Value

A financial metric that represents the price at which an asset would be bought or sold in an orderly transaction between market participants at the measurement date.

Journal Entries

Journal entries are records in financial accounting that document transactions in chronological order, affecting at least two accounts.

Not-for-Profit

An organization that operates for purposes other than generating profit, focusing instead on serving a public or mutual benefit.