Question

Consider the following statement about real options:

Decision tree analysis is more commonly used in valuing securities than real assets.

True or False: The preceding statement is correct.

True


False


Which type of real option allows a firm to shut down a project if its cash flows are lower than expected?

Flexibility option


Abandonment option


Timing option


Expansion option


Consider the following example:
Smoltz Motors has plants around the country that specialize in specific models of cars. Smoltz has determined that lower demand has led the firm’s inventory of SUVs to be too high. Smoltz wants to stop production for its SUVs and focus on its sedans.

This example describes a real option to .


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Answer 1

Step-by-step explanation:

1. Answer : True

Organisations use decision tree analysis to make their decisions on investments. The problems in decision making is listed in the form of tree which helps to find the alternatives easily.

2. Answer : Abandonment option

When the project is not feasible and they are not as per the expected cash flow then business ceases to do the project. If the recovered value is better than the present value of the project then it is wise to abandon the project.

3. Answer : Abandonment option

Smoltz motors faces a situation where there is excess inventory of SUV so the company would temporarily stop the production of SUV and focus on the sedan. This is known as abandonment option.