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CFA Level I · CFA Level I Exam · Capital Investments and Capital Allocation

An analyst finds that a project has a negative base-case NPV of -€2 million. The project gives the firm the right to launch a follow-on product, and this option is valued at €3.5 million. The analyst's most appropriate conclusion is that the project should:

The project should be accepted because its NPV including the option is positive: -€2.0 million plus €3.5 million gives €1.5 million. The follow-on right has value regardless of immediate exercise, so ignoring it by relying on the static NPV would wrongly reject the project.

  1. Abe rejected, because the base-case NPV is negative
  2. Bbe accepted, because the NPV including the option is positiveCorrect
  3. Cbe accepted only if the option is exercised immediately

Explanation

Project NPV = base NPV + value of real options = -2.0 + 3.5 = €1.5 million, which is positive. Rejecting based on the static NPV ignores the option value. Immediate exercise is unnecessary because the value lies in the right, not in using it now.

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