CFA Level I · CFA Level I Exam · Capital Investments and Capital Allocation
A manufacturer can build a factory able to switch between two input materials depending on which is cheaper. The additional cost of this flexible design is most likely justified when:
The added cost is justified when the value of the flexibility exceeds that cost. Switching adds value mainly when input prices diverge and the plant lives long enough to use it; closely moving prices or a short life make the option worth less.
- Athe prices of the two inputs move closely together
- Bthe value of the flexibility exceeds its added costCorrect
- Cthe plant is expected to operate for a very short life
Explanation
A flexibility option should be paid for only if its value exceeds its cost. If input prices move together, switching rarely helps, and a short plant life reduces the time over which switching could add value.
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