ExpertEasy2 marksMultiple Choice
ACCA · Question 04 · Investment Appraisal
Section A
MetroWater PLC, a public utility company, is evaluating a massive infrastructure project to build a new desalination plant. The project has a marginal negative Net Present Value (NPV). However, the board notes that building the plant gives them the exclusive right to expand into neighboring regions in five years if water demand surges.
In the context of investment appraisal, what type of real option does this represent?
Section A
MetroWater PLC, a public utility company, is evaluating a massive infrastructure project to build a new desalination plant. The project has a marginal negative Net Present Value (NPV). However, the board notes that building the plant gives them the exclusive right to expand into neighboring regions in five years if water demand surges.
In the context of investment appraisal, what type of real option does this represent?
Answer options:
A.
An option to delay.
B.
An option to expand.
C.
An option to abandon.
D.
A timing option.
How to approach this question
Identify the nature of the future choice created by the initial investment. The ability to grow the project later is an expansion option.
Full Answer
B.An option to expand.✓ Correct
Real options recognize that management has flexibility to adapt decisions as future events unfold. An 'option to expand' (or follow-on option) exists when an initial investment allows a company to undertake further profitable investments in the future that would not be possible without the initial project. This can make a marginally negative NPV project acceptable.
Common mistakes
Confusing the option to expand with the option to delay. Delaying means not starting now; expanding means starting now to do more later.
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