Question

Please answer all:

Give a short summary explaining each type of real option: Investment timing option Growth option Abandonment option Flexibility option

Describe a real life example of each type of real option: Investment timing option Growth option Abandonment option Flexibility option

Answer 1

1. A. Investment timing option will mean that any investment opportunities with positive net present value does not mean that we are going for that investment we can delay that investment in order to have an option to wait so the optimal timing of investment is a tradeoff between cash flows today and cash flows in future.

B. Growth option is a type of real option in which there is option to expand and it is embedded in investment project so the value of investment can be significant and it can even trigger the project to have net present value.

C. Abandonment option is a real option which will give the investor less risk by able to withdraw commitment under certain conditions and it is a clause which will be granting parties the right to withdraw from contract before maturity.

D.flexibility option is an option to vary inputs to the production or change the output from production and these are particularly valuable within industries where lead time can extend for years

2. A. investment timing option can be exampled through when to harvest a forest.

B. Growth option will be exampled through pharmaceutical company which is trying to acquire a patent which will give the right but not the obligation to make a new drug.

C. Example of abandonment option will be that there is natural resource companies who can withdraw from certain contract.

D. Airlines and shipping companies can switch capacity from one route to another and it is an example of flexibility option.