CFA Level I · CFA Level I Exam · Capital Investments and Capital Allocation
A firm values a project with a growth option. All else equal, the value of the growth option will most likely be highest when the volatility of the project's expected cash flows is:
The growth option is worth most when volatility is high and time to expiry is long. Like a call option, it gains from greater uncertainty because losses are limited while upside is open, and a longer life gives more time for favorable outcomes to emerge.
- Ahigh and the time to expiry of the option is longCorrect
- Blow and the time to expiry of the option is long
- Chigh and the time to expiry of the option is short
Explanation
A growth option is like a call option. Higher volatility raises the chance of large payoffs while downside is limited to the cost of the option, and a longer time to expiry adds more time for value to appear. Both drivers favor the high-volatility, long-expiry combination.
Did you get it right without looking?
One question tells you little. A timed set on Capital Investments and Capital Allocation shows your real accuracy, how long you take and where you lose marks.
More Capital Investments and Capital Allocation questions
- A project requires an initial investment of $250,000 and has a present value of future cash inflows of $290,000. The profitability index and…
- When estimating incremental cash flows for a proposed capital project, which of the following items is most likely excluded from the analysi…
- An analyst has a budget of 100 million and three indivisible projects. Project X needs 60 million with NPV of 14 million. Project Y needs 40…
- A project requires an outlay of 50,000 today and produces a single cash inflow of 66,550 at the end of Year 3. The company's cost of capital…
- A project generates annual sales of $800,000 and cash operating expenses of $500,000. Depreciation is $100,000 per year, and the tax rate is…
- The reinvestment rate assumption that underlies the NPV and IRR methods is best described as: