A capital investment project that generates new opportunities is more valuable than one that doesn’t. A flexible project, one that does not commit management to a fixed operating strategy is more valuable than an inflexible one. When a project is flexible or generates new opportunities for the company, it is said to contain real options.
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In this assignment, you are to discuss the budgeting implications of different option strategies and the cost-benefit issues associated with such decisions.
- Why might recognizing a real option raise but not lower a project’s net present value (NPV) as found in a traditional analysis?
- Why do we tend to underestimate NPV when we ignore the option to abandon?
- What do you suggest as a cost-effective approach to capital budgeting analysis when a project contains real options.
Write a one-page memo in which you explain the answers to any two of the three questions