Test for certificate Due Jun 14, 12:29 PM IST

Graded Quiz • 45 min

4.1. Introduction to Real

Options

4.2. The Core:

QUIZ • 45 MIN
Test for certificate
Test for certificate
Fundamentals
TOTAL POINTS 22
Video: Timing option
5 min Review Learning Objectives

Video: Risk neutral 1. The opportunity to defer investing to a later date may have value because: 1 point
valuation
6 min I) The cost of capital may decline in the near future

4.3. The Core: Valuation of II) Market conditions may change and decrease the NPV of the project
Real Options
Submit your assignment Only statement I is true
Video: Valuing an R&D Start
project DUE DATE Jun 14, 12:29 PM IST ATTEMPTS 3 every 28 days
Neither of the statements are true
10 min

Video: Option to expand or Both statements are true

Receive grade Grade
contract
7 min TO PASS 55% or higher Only
—statement II is true

Practice Quiz: Option to

invest
4 questions
2. Consider the company Unilever N.V., a large multinational company within the consumer goods sector. The net present 2 points
Video: Answer to practice value from
quiz 'Option to invest' its Refreshment division 𝑉 evolves over time (with constant factors 𝑢 and 𝑑). Unilever N.V. has the possibility to abandon
9 min this business division in five years (t=5).

Practice Quiz: Option to

expand or contract
Now assume that the company can decide to abandon the business in every period t instead of only at t=5.
4 questions

Video: Answer to practice Which statement is most likely to be correct?

quiz 'Option to expand or
contract' The value of the option to abandon increases when we have the possibility to abandon at every period 𝑡 instead of
5 min only at 𝑡=5, especially when we now decide to abandon before 𝑡=5.

Practice Quiz: Option to The value of the option to abandon does not change when we have the possibility to abandon at every period 𝑡
abandon
instead of only at 𝑡=5. Even if we now decide to abandon before 𝑡=5.
4 questions

If we still decide to abandon the option only at t=5, then the value of the option decreases.
Video: Answer to practice
quiz 'Option to abandon'
The value of the option to abandon decreases when we have the possibility to abandon at every period 𝑡 instead of
6 min
only at 𝑡=5, because more decisions nodes are added.
4.4 Beyond the Core:
Technical videos (optional)

Video: Option replication

and risk neutral valuation 3. What type of real option is embedded in a production facility that is flexible in terms of possible input 1 point
13 min materials?

Video: Multi-period, Option to switch

continuous, and compound
models Option to invest
9 min
Option to temporarily shut down
4.5 Discussion
Option to defer
Discussion Prompt: Real
options in venture capital
20 min

Getting the Certificate (3/4)

4. Given are the 1 point
Reading: Checklist following statements:
2 min

Quiz: Test for certificate I. An increase in

15 questions the maturity increases the value of the option to defer a project (ceteris paribus)

Case Study
II. An increase in the
volatility decreases the value of the option to defer a project (ceteris paribus)

Assume that these changes do not affect the underlying value.

Only statement I is true

Neither of the statements are true

Both statements are true

Only statement II is true

5. Consider the acquisition of an oil drilling company as a real option under uncertainty of oil prices. 1 point
Suppose that the OPEC sets production limitations. What is the most likely effect of this event
on the value of the real option to invest?

This event
decreases the option value

This event has

no effect on the option value

It is not
possible to say what the effect will be

This event increases the option value

6. A manufacturer uses risk neutral valuation to assess the value of an opportunity to expand its business. What do you 1 point
know about the
risk attitude of the manufacturer?

Risk seeking

Risk neutral

Risk averse

Impossible to say

7. What do we assume about the rate of return on underlying assets when we use risk-neutral probabilities to value these 1 point
assets?

Risk free rate

WACC

Cost of equity

Cost debt

8. Let the present value of cash flows of a company be denoted by V = 100. This value can move up V = 125 the next period. 2 points
The risk free rate is equal to 4%. What is the risk neutral probability? Please use a period to indicate the decimal place (e.g.
0.67 instead of 0,67).

Enter answer here

9. The risk neutral probability is equal to 0.6 and the risk free rate is 5%. Furthermore the present value of cash flows is 2 points
equal to V = 100. If d = 1/u, then what is the value of V in the downstate in the next period? Please round your answer to
one decimal place and use a period to indicate the decimal place (e.g. 100.7 instead of 100,7).

Enter answer here

10. The present value of cashflows is equal to V = 100. This value can move up the next period with u = 1.3 to V = 130. The up 2 points
factor is u = e^σ and the down factor is d = 1/u. Calculate the volatility σ for one period, expressed in decimals rounded to
two digits. Please use a period to indicate the decimal place (e.g. 0.75 instead of 0,75).

Enter answer here

11. Consider a production facility, where the present value of expected future cash inflows from production, V = 80, may 1 point
fluctuate in line with the random fluctuation in demand (u = 1.4, d = 0.71 per period and the risk-free rate, r = 5%).
Suppose management has the option in two years, to contract to half the scale and half the value of the project (c = 50%),
and recover $40m (Rc = $40m). Thus, in year 2 management has the flexibility either to maintain the same scale of
operations (i.e., receive project value, V, at no extra cost) or contract the scale of operations and receive the recovery
amount, whichever is highest. What are the pay-offs of this option at the end nodes (thus in the different states after 2
periods)?

The payoffs, F, of the option in the end note states are respectively: F = 0 , F = 0, F = 20

The payoffs, F, of the option in the end note states are respectively: F = 0 , F = 0, F = 14

The payoffs, F, of the option in the end note states are respectively: F = 196 , F = 100, F = 51

The payoffs, F, of the option in the end note states are respectively: F = 157 , F = 80, F = 41

12. Consider again the production facility (from question 11). Again, suppose that management has the option in two years, 2 points
to halve the scale and the value of the project and recover some value. Thus, in year 2 management has the flexibility
either to maintain the same scale of operations or contract the scale of operations, whichever is highest.

For this question, assume the end node pay-offs are 0, 0, 20. Calculate the option value by discounting with the risk
neutral probability of 0.3 and a risk free rate of 5%. What is the option value? Please round your answer to two decimal
places and use a period to indicate the decimal place (e.g. 10.75 instead of 10,75).

Enter answer here

13. Let the present value from production be equal to V = 100, and this value can move either up or down in the next period 2 points
(t=1) to V = 130 and V = 77. Suppose that at t=1 management has the option to invest 80 million in order to double the
value of production. The risk free rate is 2%.

You only have to consider the given periods. What is the value of this option? (Hint: consider the option to expand). Please
round your answer to two decimal places and use a period to indicate the decimal place (e.g. 10.75 instead of 10,75).

Enter answer here

14. Suppose that 1 point

management would have the opportunity to expand at t = 2 instead of at t = 3.
Would this increase or decrease the value of the option?

Increase

Decrease

This depends on the volatility

Not possible to say

15. Let the present value from production be equal to V = 100, and this value can move either up (with factor u = 1.3) or down 2 points
(with factor d = 1/u) per period. Suppose that at t=3 management has the option to invest 100 million in order to double
the value of production. The risk free rate is 2%.