A capital investment project that generates new opportunities is more valuable than one that doesn’t. A flexible project, one that does not commit management to a fixed operating strategy is more valuable than an inflexible one. When a project is flexible or generates new opportunities for the company, it is said to contain real options.
In this assignment, you are to discuss the budgeting implications of different option strategies and the cost-benefit issues associated with such decisions.
- Why might recognizing a real option raise but not lower a project’s net present value (NPV) as found in a traditional analysis?
- Why do we tend to underestimate NPV when we ignore the option to abandon?
- What do you suggest as a cost-effective approach to capital budgeting analysis when a project contains real options.
Write a one-page memo in which you explain the answers to any two of the three questions.
Budgeting in any organization, whether it is for-profit, nonprofit, or even a governmental agency, is important for: income planning and monitoring; revenue versus expenses; resource management; and successful financial planning.
- Provide an example as to why these reasons are so important for organizations to budget.
- What are the types of budgets organizations can use? How are they different and why would a company choose one type over another?
- How can you apply what you will learn in this class to your personal and professional life?