Suppose That the Cost of a Real Option Is $1

question 105

Multiple Choice

Suppose that the cost of a real option is $1 million, and that using the real option will improve the expected NPV of a project by $900,000. How should management react to the use of this real option?

• A)Since the real option costs more than it generates in NPV, it should not be considered for implementation.
• B)If the real option provides more flexibility in how management reacts to various project outcomes, it should at least be considered for implementation.
• C)Management should study whether or not the use of this real option will reduce the risk of the project. They will have to weigh the $100,000 potential loss against the reduced risk.
• D)Both b. and c. are correct.

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Definitions:

Aggregate Demand Curve

A curve that shows the relationship between the overall price level in the economy and the total demand for goods and services at that price level.

Demand Curves

Graphs showing the relationship between the price of a good and the quantity demanded by consumers.

Market Price

The equilibrium price determined through the interaction of supply and demand in a competitive market.

Demand Curves

Graphical representations showing the relationship between the price of a good and the quantity demanded by consumers.