A land option contract is considered what type of option? a. expansion option b.

Question

A land option contract is considered what type of option? a. expansion option b. investment timing option c. flexibility option d. abandonment option 48. Which of the following can be a benefit of an abandonment option? a. improve project NPV b. allow the company to delay the project c. lower project risk d. both a and c 49. The appropriate interest rate to use in capital budgeting is a. always the company's cost of capital company's b. is the company's cost of capital if the project's risk is about the same as the company's c. the cost of capital plus any additional risk premium required to compensate for the project's higher risk d. b and c 50. Which of the following would not be an appropriate guideline for determining the interest rate to used discounting project cash flows in capital budgeting? a. for replacement projects, given that their risk is consistent with that of the present business, use the cost of capital b. for expansion projects of moderate size, given that their risk is slightly greater than that of the present business, use the cost of capital, plus a small risk premium of one to three percent c. for new ventures, given that their risk can be far greater than current operations, use the cost of capital plus a risk premium of at most five percent since using anything higher usually guarantees rejection d. all of the above are appropriate guidelines 51. Multidivisional companies with diverse operations should use an interest rate for discounting a specific division's estimated cash flows in capital budgeting that is representative of: a. the entire firm's cost of capital b. the riskiness of the specific division's cash flows c. the cost of capital obtained through the application of the pure play method d. b or c 52. Multidivisional firms are often unable to obtain an appropriate surrogate for determining the beta of a division. An acceptable alternative technique is to develop a beta through the division's accounting records. This is accomplished by: a. regressing the division's projected return on equity against the return on a major company in a similar business b. regressing the division's accounting return on equity in previous years against the return on a major stock market index c. regressing the division's projected return on equity against the historic return on a major stock market index d. none of the above

Explanation / Answer

PART 47

Land Option Contract is an investment timing option where the purchaser of the option gets the right but not the obligation to purchase the land at a particular time at a particular price.

PART 48

An abandonment option gives the right to a party to abandon a project in future. If the project is expected to start making losses beyond a certain point the NPV of the project begins to fall. Thus the abandonment option helps in improving the project NPV and reducing the risk of the project.

PART 49

Appropriate interest rate used in capital budgeting is a combination of the cost of capital of the company and the risk of the project relative to average projects of the company. Thus the option D is the correct answer

PART 50

When moderately high risk projects are taken then risk premium is small while for high risk projects the risk premia increases. Thus all guildines are appropriate so answer is D

PART 51

PART D is the answer as a divisions particular cash flows can be discounted at the divisions cost of capital or the cost of capital derived from pure play method

PART 52

The beta of a division of a multi division firm can be obtained by regressing the accounting return on equity in previous years to return on a major stock index. So the answer is B.

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