Asked by Juana Jacal on Jun 10, 2024
Verified
The NPV computed using static DCF analysis is _________ if the project gives us the opportunity to abandon the project if things go poorly; that is, it includes an option to abandon.
A) Understated.
B) Overstated.
C) Accurately stated even.
D) Not conservative enough.
E) Useless.
NPV
A financial metric used to assess the profitability of an investment by calculating the present value of expected future cash flows.
Static DCF Analysis
A method of valuing a project or investment by estimating future cash flows and discounting them to present value using a fixed discount rate.
Option to Abandon
A clause in an investment contract granting the investor the right to withdraw from the project under certain conditions, typically to minimize losses.
- Conduct sensitivity analysis to determine the consequence of changes in variables on the Net Present Value of a project.
- Use discounted cash flow (DCF) analysis correctly, including understanding the impact of options such as the option to abandon or expand a project.
Verified Answer
DM
Denise MujicaJun 11, 2024
Final Answer :
A
Explanation :
The NPV computed using static DCF analysis is understated if the project includes an option to abandon because this analysis does not account for the value of flexibility that the option to abandon provides.
Learning Objectives
- Conduct sensitivity analysis to determine the consequence of changes in variables on the Net Present Value of a project.
- Use discounted cash flow (DCF) analysis correctly, including understanding the impact of options such as the option to abandon or expand a project.