Chapter 21 Quiz, Valuing Options
1.
It is not possible to use standard discounted cash flow analysis to value options because:
A.
This is wrong; discounted cash flow analysis may be used to correctly value options
B.
The discount rate changes as the value of the underlying asset changes
C.
The time horizon for options is variable
D.
The risk-free rate is not always applicable
2.
Rejecting an investment today forever might not be a good choice because:
A.
The size of the firm will decline
B.
There are always errors in the estimation of the NPVs
C.
The option value is negative
D.
The company's foregoing future rights or option to the investment
3.
The opportunity to defer investing to a later date may have value because:
A.
The cost of capital may decline in the near future
B.
Uncertainty may be reduced in the future
C.
Investment costs fluctuate in time
D.
Market conditions may change and increase the NPV of the project
4.
The option to build flexibility into production facilities
A.
Typically is more expensive
B.
Must consider the NPV of alternative uses
C.
May be valuable by allowing the rearrangement to produce higher profit of goods
D.
All of the above
5.
If the interest is 8%, the upside change is +20% and the downside change is –20%, calculate the probability of upside change.
A.
0.50
B.
0.70
C.
0.60
D.
None of the above
6.
Which of the following conditions might lead a financial manager to delay a positive-NPV investment project? Assume project NPV if undertaken immediately is held constant.
A.
The risk-free interest rate falls
B.
Uncertainty about future project value increases
C.
The first cash inflow generated by the project is lower than previously thought
D.
Investment required for the project increases
7.
Which of the following conditions might lead a financial manager to decide to expedite a positive Net Present Value investment project that previously she had decided to delay?
A.
The risk-free interest rate falls
B.
Uncertainty about future project value increases
C.
The first cash inflow generated by the project is lower than previously thought
D.
Investment required for the project increases
8.
An example of a real option is:
A.
The option to make follow-on investments
B.
The option to abandon a project
C.
The option to wait before investing
D.
All of the above
9.
In terms of a real option, the cash flows from the project play the same role as:
A.
The stock price
B.
The exercise price
C.
The dividends
D.
The variance
10.
An insight gained by bringing the theory of options into standard capital budgeting analysis is
A.
Independent projects with positive NPVs should very often be rejected
B.
Independent projects with negative NPVs should very often be accepted
C.
Projects, such as call options, can be more valuable if the decision to start up the project is delayed until relevant information is released
D.
Projects, such as call options, can be less valuable if the decision to start up the project is delayed until relevant information is released
11.
A rational manager may be reluctant to commit to a positive Net Present Value project when:
A.
The value of the option to abandon is high
B.
The exercise price is high
C.
The opportunity cost of capital is high
D.
The value of the option to wait is high
12.
Production facilities that are flexible in terms of possible raw materials used are most valuable when:
A.
Product demand is highly volatile
B.
Product price is highly volatile
C.
Raw material prices are highly volatile
D.
Labor costs are highly volatile
13.
A portfolio that replicates the payoffs in the up and down states will:
A.
Last longer because it is synthetic and made of stronger components
B.
Generate the same cash flows and will have the same value as the project
C.
Generate the same cash flows but not necessarily have the same value as the project
D.
None of the above
14.
The option to abandon a project can be valued as a call option.
A.
True
B.
False
15.
Investing in a general purpose machine is equivalent to owning a stock and a put option on stock with an exercise price equal to the sale price of the machine.
A.
True
B.
False
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