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The document presents a quiz for a finance course focusing on Project X's financial analysis, including its NPV without and with growth options. The expected NPV without considering real options is -$0.447 million, while considering the growth option, it is $2.807 million. Additionally, it poses a multiple-choice question regarding the impact of a profitable abandonment option on expected cash flows and risk, along with a bonus question about subjective risk factors.

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9 views1 page

Q2 - Key

The document presents a quiz for a finance course focusing on Project X's financial analysis, including its NPV without and with growth options. The expected NPV without considering real options is -$0.447 million, while considering the growth option, it is $2.807 million. Additionally, it poses a multiple-choice question regarding the impact of a profitable abandonment option on expected cash flows and risk, along with a bonus question about subjective risk factors.

Uploaded by

Fatmah
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

FIN 327 – Spring 2020

Quiz #2
Dr. Saad Alnahedh

Student Name: Student Number:

Short Answer: 3 points


Martin Development Co. is deciding whether to proceed with Project X. The cost would be $9 million in
Year 0. There is a 50% chance that X would be hugely successful and would generate annual after-tax
cash flows of $6 million per year during Years 1, 2, and 3. However, there is a 50% chance that X would
be less successful and would generate only $1 million per year for the 3 years. If Project X is hugely
successful, it would open the door to another investment, Project Y, which would require an outlay of $10
million at the end of Year 2. Project Y would then be sold to another company at a price of $20 million at
the end of Year 3. Martin’s WACC is 11%.
a) If the company does not consider real options, what is Project X’s NPV?
b) What is X’s NPV considering the growth option?
c) How valuable is the growth option?
a)
0 1 2 3 NPV @ Yr. 0
50% Prob. | | |
6 6 6 $5.662
-9
| | | -6.556
50% Prob. 1 1 1
Expected NPV = 0.5($5.662) + 0.5(-$6.556) = -$0.447 million. The project will not be undertaken.

b)
0 1 2 3 NPV @ Yr. 0
50% Prob. | | |
6 6 6
-10 +20 $12.170
-9 -4 26
| | | -6.556
50% Prob. 1 1 1
Expected NPV = 0.5($12.170) + 0.5(-$6.556) = $2.807 million

c) Value of growth option: $2.807 – 0 = $2.807 million

Multiple Choice (Choose the best answer): 1 point each


1. Which of the following best describes the impact that a profitable abandonment option would have on a
project's expected cash flow and risk?
a) No impact on the PV of expected cash flows, but risk will decrease.
b) The PV of expected cash flows increases and risk decreases.
c) The PV of expected cash flows increases and risk increases.
d) The PV of expected cash flows decreases and risk decreases.
e) The PV of expected cash flows decreases and risk increases.

BONUS: 1 point
Name one subjective risk factor that must be considered when applying timing/delay options in real life.
Losing market share, or losing first mover advantage, or losing competitive edge, etc.

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