Projects are also often embedded with different options that can help making decisions under uncertainty. There are techniques used to evaluate these embedded options which are called real options. The models used to value these options are based on the type of the real option available for the project.

Real options (increase/decrease)the value of capital investment projects.

The managers of Collins Construction Co. have included an investment timing option into the design of a proposed capital investment project:

I. This option allows a firm to temporarily terminate operations in order to prevent experiencing negative cash flows

II. This option allows a firm to shut down a project if its cash flows are lower than expected.

III. This option provides a firm with the flexibility to make potentially profitable investments in the future that would not have been possible if the initial project had not been undertaken.

IV. This option allows a firm to postpone a project until it can gather more information or market conditions change.

Which of the listed statementsbestdescribes an investment timing option?

Statement IV

Statement I

Statement II

Statement III

None of the statements listed above describes an investment timing option.

Real option analysis adds value to a project when it is used for which of the following?Check all that apply.

a. Making managers aware of the consequences of their decisions and actions on the creation or destruction of value for a capital project.

b. Identifying real options that can be sold in the financial markets.

c. Making changes to the capital budget before it is started and financed.

d. Modifying the way that decision makers perceive flexibility in capital budgeting activities.