Consider the following statement about real options: Sometimes real options can give managers the flexibility to decide to invest in a project or wait to make a more calculated decision. True or False: The preceding statement is correct. O False 0 True Which type of real option allows a project to be expanded if demand turns out to be greater than expected? O Abandonment option O Expansion option O Flexibility option Timing option Consider the following example: Clemens Inc. is considering a $100 million investment in a new line of soft drinks. However, $100 million is a huge Investment for Clemens; if things turn bad, it could wipe out the company. A few senior managers have suggested a smaller investment of $20 million to see if the market is as strong as they hope it is. If demand is strong and the opportunity is still available, Clemens will increase its investment at a later date. This example describes a real option to expand expand abandon Albert do is considering a four-year project that will require an initial investment of $12,000. The base-case cash Ihows for this project are projected to be $12,000 per year. The best-case cash flows are projected to be $19,000 per year and the worst-case cash flows are projected to be -$3,000 per year. The company's analysts have estimated that there is a 50% probability that the project will generate the base-case cash flows. The analysts also think that there is a 25% probability of the project generating the best-case cash flows and a 25% probability of the project generating the worst-case cash flows. What would be the expected net present value (NPV) of this project if the project's cost of capital is 13%? O $18,632 O $17,745 $19,520 $15,971 Albert now wants to take into account its ability to abandon the project at the end of year 2 if the project ends up generating the worst-case scenario cash flows. If it decides to abandon the project at the end of year 2, the company will receive a one-time net cash inflow of $4,000 (at the end of year 2). The $4,000 the company receives at the end of year 2 is the difference between the cash the company receives from selling off the project's assets and the company's - $3,000 cash outflow from operations. Additionally, if it abandons the project, the company will have no cash flows in years 3 and 4 of the project. Using the information in the preceding problem, find the expected NPV of this project when taking the abandonment option into account. $20,095 O $18,086 O $26,124 $21,100 What is the value of the option to abandon the project? $2,350 $1.998 9. Capital budgeting and the post-audit process Aa Aa In January 2014, Commonwealth Biofuels LLC opened a production facility that is capable of producing 2 million gallons per year of ethanol from cellulosic material. The company wants to expand and open three more ethanol production facilities within the next two years. The venture capital firm that financed the company's first project has asked the company's management team to perform a post-audit on the initial project. The venture capital firm will use the information from the post-audit to help evaluate the company's plans for expansion. Which of the following would be part of the post-audit? Check all that apply. The management team will need to compare the projected selling price of ethanol to the actual selling price of ethanol In instances where the company's estimated costs were different from the actual costs, the management team will need to explain why these differences occurred. The management team will need to determine if it wants to use straight-line or accelerated depreciation to depreciate the property, plant, and equipment used in the initial project. positive NPV When a firm is forced to employ capital rationing, it generally means that the firm has projects than it can finance. less more