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What are real options in capital budgeting

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Question - The Metrics electronic Company is considering a three-year project to market a device that measure the number of calories used up by athletes based on a new technology. A market study indicates a 60% probability that demand will be good and a 40% chance that it will be poor.

It will cost $5M to bring the new device to market. Cash flow estimates indicate inflows of $3M per year for three years at full manufacturing capacity if demand is good, but just $1.5M per year if it's poor. The firm's cost of capital is 10%.

A. Analyze the project by developing a decision tree for the project then calculate the projects expected NPV.

B. Should the project be accepted or abandoned?

C. What are real options in capital budgeting? Give two examples of the type of options available in capital budgeting.

D. Why is the application of real options in capital budgeting is considered to be more effective than just only applying NPV to capital projects?

Reference no: EM132980470

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