Managers can often take positive actions after the investment has been made to alter a project's cash flows. but not the obligation to take some future action. Types of real options include abandonment, investment timing, expansion, output flexibility, and input flexibility. The existence of options can projects' expected profitability, their calculated NPVs$,$ and $|$ their risk.

The abandonment option is the option to shut down a project if operating cash flows turn out to be lower than expected. To analyze the abandonment option you can draw a decision tree, which is a diagram that lays out different branches that are the result of different decisions made or the result of different economic situations. When analyzing real options you consider the project with and without the option. The option value is calculated as the difference between the expected NPVs with and without the relevant option. $($If the value of the project without the option is negative and the NPV of the project with the option is positive, then the option value is simply the calculated NPV of the option.$)$ It is the value that is not accounted for in a traditional NPV analysis and a positive option value expands the firm's opportunities.

Quantitative Problem: Sunshine Smoothies Company $($SSC$)$ manufactures and distributes smoothies. SSC is considering the development of a new line of highprotein energy smoothies. SSC$\text{'}$s CFO has collected the following information larding the proposed project, which is expected to last $3$ years:

The project can be operated at the company's Charleston plant, which is currently vacant.

The project will require that the company spend $$4\mathrm{.}1$ million today $)=(0$ to purchase additional equipment. For tax purposes the equipment will be depreciated on a straight$-$line basis over $5$ years. Thus, the firm's annual depreciation expense is $$4,100,\frac{000}{5}=$$$820,000.$ The company plans to use the equipment for all $3$ years of the project. At $t=3($which is the project's last year of operation$),$ the equipment is expected to be sold for $$1,500,000$ before taxes.

The project will require an increase in net operating working capital of $$730,000$ at $t=0.$ The cost of the working capital will be fully recovered at $t=3($which is the project's last year of operation$).$