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4.1. Introduction to Real

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4.3. The Core: Valuation of

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1. The option to defer may have value because: 0 / 1 point
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15 questions conditions may change and decrease the NPV of the project
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Interest rates tend to decline over time

The cost of
capital may decline in the near future

Incorrect
What kind of flexibility does the option to invest provide? Why is this interesting for a firm? What are the gains
and losses?

2. Consider the company Dyonis Ltd., a producer of luxury soaps. The net present value from 2 / 2 points
its current production process 𝑉 evolves over time (with constant factors 𝑢 and 𝑑) . Dyonis Ltd. has the possibility to
abandon its business in three years (t=3).

Now assume that the company can decide to abandon the business in every period t instead of only at t=3.

Which statement is most likely to be correct?

If we still decide to abandon the option only at t=3, then the value of the option decreases.

The value of the option to abandon does not change when we have the possibility to abandon at every period 𝑡
instead of only at 𝑡=3. Even if we now decide to abandon before 𝑡=3.

The value of the option to abandon decreases when we have the possibility to abandon at every period 𝑡 instead of
only at 𝑡=3, because more decisions nodes are added.

The value of the option to abandon increases when we have the possibility to abandon at every period 𝑡 instead of
only at 𝑡=3, especially when we now decide to abandon before 𝑡=3.

Correct
With real options we measure flexibility. In this view flexibility is valuable.

3. Nike Inc. wants to test a new sport jacket through a pilot project. If the project turns out to be a success, the company will 0 / 1 point
include the jacket in the collection and produce it on a larger scale. If not, the company will stop the production, and
recover some of the costs by selling the leftover stock to other retailers. What type of option(s) are embedded in this
project once the pilot has started? (multiple answers are possible)

Option to expand

Correct
It can decide to increase its production.

Option to contract

This should not be selected

Has information been given that the company can decrease it's production? Or does it stop entirely?

Option to switch

Option to abandon

4. Given are the 1 / 1 point

following statements:

I. An increase in
the volatility increases the value of the option to defer a project (ceteris paribus)

II. An increase in the

risk free rate increases the value of the option to defer a project (ceteris paribus)

Only statement I is true

Neither of the statements are true

Both statements are true

Only statement II is true

Correct
If the volatility increases does it become more likely that the option will be in the money? For the risk free rate
we can ask: To what kind of financial option is the option to defer analogous? How is this option affected by
the mentioned factors? Is the real option affected in the same way?

5. The management of Artic Oil wants your advice on investing in a new oil drilling platform. You know that the oil price is 0 / 1 point
declining and will not soon rise again.

What is the most likely effect of this event on the value of the real option to invest?

This increases the option value

This decreases the option value

This doesn't change the option value

Impossible to say

Incorrect
What kind of real option is this? To what kind of financial option is this analogous? Consider the factors which
affect the value of this option. Which factor that influences option value does the oil price relate to?

6. A manufacturer uses risk neutral valuation to assess the value of an opportunity to expand its business. What do you 0 / 1 point
know about the
risk attitude of the manufacturer?

Risk seeking

Risk neutral

Risk averse

Impossible to say

Incorrect
What kind of framework do we use for valuing real options? What is one of the main underlying assumptions?
How does risk-attitude affect this assumption and the framework?

7. Is the risk 0 / 1 point

neutral or hedging probability in a real option valuation higher or lower for a risk-averse investor compared to a
risk-neutral investor?

Lower

The same

Cannot tell

Higher

Incorrect
How do we calculate the risk neutral probability? How does the risk-attitude of the investor affect this
calculation?

8. Let the present value of cash flows of a company be denoted by V = 100. This value can move up V = 125 the next period. 2 / 2 points
The risk free rate is equal to 4%. What is the risk neutral probability? Please use a period to indicate the decimal place (e.g.
0.67 instead of 0,67).

0.53

Correct
u = Vu/V0 , d= 1/u. The risk neutral probability is calculated as p = ((1+r)-d)/(u-d)

9. The risk neutral probability is equal to 0.6 and the risk free rate is 5%. Furthermore the present value of cash flows is 2 / 2 points
equal to V = 100. If d = 1/u, then what is the value of V in the downstate in the next period? Please round your answer to
one decimal place and use a period to indicate the decimal place (e.g. 100.7 instead of 100,7).

84.1

Correct
p = ( (1+r)-d)/(u-d) = 0.6. Solve for u and use d = 1/u for V*u and V*d

10. The present value of cashflows is equal to V = 100. This value can move up the next period with u = 1.1 to V = 110. The up 2 / 2 points
factor is u = e^σ and the down factor is d = 1/u. Calculate the volatility σ for one period, expressed in decimals rounded to
two digits. Please use a period to indicate the decimal place (e.g. 0.75 instead of 0,75).

0.10

Correct
The up factor u = e^σ. We can calculate u by u = 110/100 = 1.1

Then σ = ln(1 1)