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51.As the manager of a sporting goods company, you presented

Question : 51.As the manager of a sporting goods company, you presented : 1400613

 

51.As the manager of a sporting goods company, you are presented with a new golf project. An inventor has recently patented the design for a new golf club that makes playing golf much easier. Your company has made contact with the inventor, who is willing to sell the exclusive rights to the technology, but if you don’t act fast he will sell the rights to a rival company. You are not certain whether the new golf club will become popular, but your analysts have completed a basic NPV analysis. Given the available information, the project has a positive NPV. However, you know there are several real options associated with the project, including the option to abandon the project and the option to make follow-on investments. Which one of the following statements regarding the project is correct?

a.Based on the NPV analysis, you should accept the project. The value of the project may be worth more than the NPV analysis but not less.

b.Based on the NPV analysis, you should accept the project. The NPV analysis contains all the information about the value of the project.

c.Based on the NPV analysis, you should reject the project. Without additional information about the value of the real options, there is no way to make a decision.

d.Based on the NPV analysis, you should reject the project. The NPV analysis contains all the information about the value of the project.

52.A start-up company is making a decision on whether to develop a new internet social networking site. The site will cost $1 million to develop, but it is unclear whether the new technology critical to the site will work correctly. If development is successful, it will cost an additional $20 million next year to advertise the site to Internet users. If the site becomes popular with Internet users, it is expected to generate a present value of $100 million in advertising revenue. There is a 10 percent chance that the site will be successfully developed and subsequently become popular with Internet users. The company’s cost of capital is 15 percent. Should the company pursue the project?

a.No, the project has a negative NPV.

b.Yes, the project has a positive NPV.

c.It doesn’t matter. The project has zero NPV.

d.There is not enough information to make a decision.

53.The employment contracts for professional athletes often contain options for either the player or the team. Consider one recent contract in Major League Baseball. The player’s salary was guaranteed for the first couple years. However, after several years, the team had the option to cancel the contract if the player became injured. If we think of each player as a project for the team, this option feature of the contract is best described as

a.the option to defer investment.

b.the option to make follow-on investments.

c.the option to change operations.

d.the option to abandon projects.

54.RealEstates LLP is considering the construction of a new development of condominiums in downtown Austin, Texas. The site for the new development is currently occupied by an office building owned by the city. The project’s profitability will depend largely on the population increase in Austin over the next several years. Rather than buy the site, RealEstates has entered into an agreement with the city to pay $200,000 for the right to purchase the site for $10 million two years from now. The real option embedded in this contract is best described as

a.the option to defer investment.

b.the option to make follow-on investments.

c.the option to change operations.

d.the option to abandon projects.

55.Consider a new firm that is working on the first generation of long-awaited consumer jet packs. The project will take a tremendous amount of R&D expenditure. Even if the development is successful, manufacturing the first generation of jet packs is likely to be so expensive that only a select few consumers will be able to afford them. The projected sales of the first generation of jet packs almost certainly won’t cover the development and manufacturing costs—the project has a negative NPV. Which of these reasons would validate the firm’s decision to pursue the jet pack project?

a.If development is unsuccessful, it can abandon the project before spending money on manufacturing.

b.If the project is successful, it may lead to a very profitable second project—a cheaper jet pack that will be a positive-NPV project.

c.Because it is a high-tech firm, the cash flows generated by a project are not important to valuing the company.

d.None of these reasons support the decision to pursue the project.

56.A local city government has awarded a contract to sequentially build five new elementary schools over the next 10 years. The price for each school has been spelled out in the contract, but at the beginning of each year the city can cancel the order for the remaining schools. The city government is concerned that if the population of the town does not grow as expected it may not need all of the schools. What sort of financial option does the option to cancel the order resemble?

a.Owning a call option on the value of the new schools

b.Owning a put option on the value of the new schools

c.Selling a call option on the value of the new schools

d.Selling a put option on the value of the new schools

57.Purchasing a house is a somewhat complicated process. Typically, if the buyer’s offer is accepted by the seller, the transaction will not be completed or “closed” for several weeks. During this time the buyer may gather more information about the house or research other houses in the area. Some home purchase contracts include an option fee. The buyer may pay the seller a few hundred dollars for the right to walk away from the contract prior to closing for any reason. This option fee is best described as

a.the option to defer investment.

b.the option to make follow-on investments.

c.the option to change operations.

d.a put option on the house.

58.The management at Socrates Motors considered the option to abandon when building their new manufacturing plant. The design of the plant allows it to easily be converted to manufacture other types of large machinery. If their new line of cars is poorly received, their plant should be easy to sell to another manufacturing company. In this example, the extra cost of building the plant in such a way that it can easily be converted for other uses resembles

a.the premium of a put option on the plant.

b.the premium of a call option on the plant.

c.the strike price of a put option on the plant.

d.the strike price of a call option on the plant.

59.Franklin Foods has made the decision to invest in a new line of organic microwave dinners. The new line of dinners is a negative-NPV project; paying its suppliers to convert to organic practices will be expensive. However, the company will be in a good position to expand into more profitable lines of food if consumer demand for organic foods grows more then expected. The negative value of the organic dinner project most closely resembles:

a.the premium of a put option on future organic projects.

b.the premium of a call option on future organic projects.

c.the strike price of a put option on future organic projects.

d.the strike price of a call option on future organic projects.

60.Gnu Homes, Inc., is a developer of planned residential communities. It has entered into an option contract with a land owner outside Austin, Texas. It will pay the land owner $100,000 for the option to buy the land in two years at a price of $20 million. During that time Gnu Homes will evaluate population and real estate trends in Austin. Their plan is to buy the land if real estate prices in Austin increase enough that developing the land would be worth more then the $20 million price. The $20 million purchase price resembles

a.the premium price of a put option on the land.

b.the premium price of a call option on the land.

c.the strike price of a put option on the land.

d.the strike price of a call option on the land.

 

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