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:

Output

The quantity of goods or services produced in a given time period by a firm, industry, or country.

Opportunity Cost

The value of the best alternative forgone when a choice is made between competing options.

Additional Project

An extra task or plan of action that is undertaken to achieve a specific goal or objective.

Space Shuttle Launch

The process of propelling the Space Shuttle, a partially reusable low Earth orbital spacecraft system, from the Earth's surface through the atmosphere into space.