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Homework answers / question archive / Are each of the statements below correct? Explain your answer
Are each of the statements below correct? Explain your answer. Statement 1: For independent projects, an analyst must determine a value for the real option that is separate from the project regardless of the profitability of the project. Statement 2: Abandonment options can be valuable, but should only be exercised when the abandonment value is greater than the discounted present value of the remaining cash flows of the project.
ANSWER
ONLY STATEMENT 1 IS CORRECT
The value of a real option is always positive. For an independent project, if the project is already profitable, a manager can accept the project simply knowing that the real option will simply add to the profitability without determining a separate value for the option.
An abandonment option should be exercised when the abandonment value for a project is greater than the discounted present value of the remaining cash flows from the project.
