Real options

Real options

1. 1. Which of the following are common types of real options?

   Option to defer (timing)Option to expand (growth)Option to abandonOption to issue equity
2. 2. Why does conventional DCF systematically UNDERVALUE projects with embedded optionality?

   DCF treats uncertainty as pure risk to be discounted; it can't capture the asymmetric upside-only payoff from management's right to wait, expand, or abandonDCF doesn't use a discount rateDCF ignores capital structureDCF assumes negative NPV
3. 3. A drug development project: invest $100M today or wait 1 year. Next year is 50% blockbuster (PV=$300M) or 50% flop (PV=$50M). Discount rate 10%. NPV with deferral option (only invest in blockbuster state)?

   Answer for question 3$M
4. 4. When are real-options effects on project value MOST important?

   When project cash flows are perfectly predictableWhen the project has high volatility, long time horizons, and substantial asymmetry between upside and downsideWhen the firm is privately heldWhen the discount rate is below 5%