FIN302-RealOptionsExtraproblems

FIN302-RealOptionsExtraproblems - More practice problems on...

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More practice problems on Real Option Valuation Questions 1 & 2 are taken from previous exams, and can be completed with a calculator. Questions 3, 4 and 5 are best done in Excel 1) You are considering a project to open Homer’s Doughnut Shop. You estimate the following potential cash flows will occur: Event probability NPV of project (t=0) apartments built next to strip mall 0.6 12000 no apartments built next to strip mall 0.4 -15000 If you wait a year to open Homer’s Doughnut shop, you will know, with certainty, whether the apartments will be built on the adjacent piece of land or not, before you need to make the decision to invest in the shop, or not . However, the cost of the doughnut shop lease will go up if the apartments are built and you wait a year to invest. The NPVs of the investment if you wait a year Event probability NPV (@t=1) NPV (@t=0) apartments built next to strip mall 0.6 8000 7273 no apartments built next to strip mall 0.4 -15000 -13636 1a) What is the NPV of the decision to invest NOW?_____ 1200 ________ (Write answer on line) .6(12000) + .4(-15,000) 1b) What is the NPV of the decision to wait a year to invest, given that you have the option not to invest at that time ?__ 4363.8 __________ (Write answer on line) .6(7273) + .4 (0) 1c) ______What should the investor do? Wait to invest a) Invest NOW b) Wait a year to invest c) Don’t invest NOW or LATER 1
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2)______ You are considering a project to build a Jimmy-John’s Sandwich shop on a vacant piece of land. The NPV of your sandwich shop will depend on the type of development on the
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FIN302-RealOptionsExtraproblems - More practice problems on...

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