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Grade Latest Submission To pass 55% or
received 27.27% Grade 27.27% higher

1 . The option to defer may have value because: 1 /1 point

The cost of
capital may decline in the near future
Conditions may change, creating upward potential at favorable developments, while limiting losses at the
downside for the investor
Interest rates tend to decline over time
Market
conditions may change and decrease the NPV of the project

Correct
What kind of flexibility does the option to invest provide? Why is this interesting for a firm? What are the
gains and losses?

2 . Consider the company Unilever N.V., a large multinational company within the consumer goods sector. The net 2 / 2 points
present value from its Refreshment division �� evolves over time (with constant factors �� and ��). Unilever N.V. has
the possibility to abandon this business division in five years (t=5).

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

Which statement is most likely to be correct?

The value of the option to abandon increases when we have the possibility to abandon at every period ��

instead of only at ��=5, especially when we now decide to abandon before ��=5.
The value of the option to abandon does not change when we have the possibility to abandon at every
period �� instead of only at ��=5. Even if we now decide to abandon before ��=5.

If we still decide to abandon the option only at t=5, then the value of the option decreases.
The value of the option to abandon decreases when we have the possibility to abandon at every period ��

instead of only at ��=5, because more decisions nodes are added.

Correct
With real options we measure flexibility. In this view flexibility is valuable.

3 . What type of real option is embedded in a production facility that is flexible in terms of possible input 1 /1 point
materials?

Option to switch
Option to invest
Option to temporarily shut down
Option to defer

Correct
The production facilities can switch one type of output for another one.

4 . Given are the following statements: 0 /1 point

I. An increase in the volatility increases the value of the option to defer a project (ceteris paribus)

II. An increase in the risk free rate increases the value of the option to defer a project (ceteris paribus)

Only statement I is true

Neither of the statements are true
Both statements are true
Only statement II is true

Incorrect
Ifthe volatility increases it becomes more likely that the option will be in the money. For the risk free rate
we can ask: To what kind of financial option is the option to defer analogous? How is this option affected
by the mentioned factors? Is the real option affected in the same way?

5 . Consider the acquisition of an oil drilling company as a real option under uncertainty of oil prices. 0 /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 increases the option value
not
It is

possible to say what the effect will be

This event has
no effect on the option value

Incorrect
What kind of real option is an acquisition? To what kind of financial option is this analogous? Consider the
factors which affect the value of this option? Which factor that influences option value does the decision of
the OPEC affect the most?

6 . A private mining company uses real options valuation to assess the value of an exploration investment. What do 1 /1 point
you know about the
risk attitude of the investor?

Risk averse
Impossible to say
Risk seeking
Risk neutral

Correct
What kind of framework do we use for valuing real options? What is one of the main underlying
assumptions? How does risk-attitude affect this assumption and the framework?

7 . Isthe risk 1 /1 point

neutral or hedging probability in a real option valuation higher or lower for a risk-averse investor compared to a
risk-neutral investor?

Lower
Cannot tell

The same
Higher

Correct
How do we calculate the risk neutral probability? How does the risk-attitude of the investor affect this
calculation?

8 . Let the present value of cash flows of a company be denoted by V 0 = 100. This value can move up V u = 110 the next 0 / 2 points
period. The risk free rate is equal to 5%. What is the risk neutral probability? Please use a period to indicate the
decimal place (e.g. 0.67 instead of 0,67).

0.5018

Incorrect
u = V u /V 0 , d= 1/u. The risk neutral probability is calculated as p = ((1+r)-d)/(u-d)

9 . The risk neutral probability is equal to 0.5 and the risk free rate is 4%. Furthermore the present value of cash flows 0 / 2 points
is equal to V = 90. 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).

64.3

Incorrect
p = ( (1+r)-d)/(u-d) = 0.5. Solve for u and use d = 1/u for V*u and V*d

10 . The present value of cashflows is equal to V = 90. This value can move up the next period with u = 1.1 to V = 99. The 0 / 2 points
up 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).

0.0953

Incorrect
The up factor u = e^σ. We can calculate u by u = 99/90 = 1.1

Then σ = ln(1.1).

11 . Consider a production facility, where the present value of expected future cash inflows from production, V = 100, 0 /1 point
may 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 rounded 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 = 196 , F = 100, F = 51
The payoffs, F, of the option in the end note states are respectively: F = 180 , F = 0, F = 0

The payoffs, F, of the option in the end note states are respectively: F = 0 , F = 0, F = 46
The payoffs, F, of the option in the end note states are respectively: F = 0 , F = 0, F = 14

Incorrect
First calculate the values of V at the end nodes by using u and d. Then the option pay-offs are calculated as
F = max(Rc - c*V, 0).

See the Lecture "Answer to practice quiz 'Option to expand or contract'" to review a detailed example
calculation.

12 . Consider again the production facility (from question 11). Again, suppose that management has the option in two 0 / 2 points
years, 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).

Incorrect
The end-node pay-offs are given. Discount these with the risk neutral probability and the risk free rate. For
a downstate we use 1 minus the risk neutral probability. See the Lecture "Answer to practice quiz 'Option
to expand or contract'" to review a detailed example calculation.

13 . Let the present value from production be equal to V = 100, and this value can move either up or down in the next 0 / 2 points
period (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).

120.65

Incorrect
First calculate V*u and V*d. Then calculate the option pay-offs F = max(V*1 - 80, 0). Discount the end-node
pay-offs accordingly. Note that we calculate the additional value option (excluding the value of facility),
hence your expansion factor is 100% (e=1).

14 . Suppose that 0 /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

Incorrect
A shorter time to maturity decreases the option value. The option has now less time to become in the
money.

15 . Let the present value from production be equal to V = 100, and this value can move either up (with factor u = 1.5) 0 / 2 points
or down (with factor d = 1/u) per period. Suppose that at t=3 management has the option to invest 90 million in
order to double the value of production. The risk free rate is 2%.

What is the expanded present value of this production facility if management has the opportunity to expand at t =
3? Please round your answer to two decimal places and use a period to indicate the decimal place (e.g. 100.75
instead of 100,75).

193.45

Incorrect
Calculate the values of V at t=3. E.g., the most upper node is calculated as V*u*u*u. The factors u and d are
obtained by u = V+/V, d=V-/V. Calculate the end-node pay-offs F = max(V*1 - 90, 0). Discount accordingly
with the risk neutral probability p = ( (1+r) - d)/(u-d) and the risk free rate of 2%.

See the Lecture "Answer to practice quiz 'Option to expand or contract'" to review a detailed example
calculation.