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Multiple Choice Quiz
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1
Among the major reasons that real options are not typically used in capital budgeting are
A)The issues are framed opaquely
B)Real options are theoretical concepts not much relevant to practice
C)Traditional DCF analyses capture all the relevant information about valuation
D)All of the above
E)None of the above
2
Decision tree analysis
A)Uses constant discount rates
B)Is incorrect because it ignores growth opportunities identified using real option techniques
C)Assumes that firm-specific risk is systematic while real option valuation assumes that firm-specific risk cannot be diversified away
D)All of the above
E)None of the above
3
Asset substitution
A)Is an example of agency conflicts between shareholders and managers
B)Happens when managers take low-risk positive NPV projects to lower the risk of going bankrupt
C)Is an agency conflict problem that can be ameliorated if managers are overconfident
D)All of the above
E)None of the above
4
To prevent debt overhang, debtholders can
A)Sue the firm shareholders if they issue too much debt
B)Sell the firm’s debt on in the secondary market
C)Buy shares in the firm
D)Refuse to loan the firm money
E)None of the above
5
Managerial overconfidence can
A)Help reduce debtholder-shareholder conflicts in an asset substitution case
B)Induce managers to choose negative NPV projects
C)Induce managers to reject positive NPV projects
D)All of the above
E)Both a and b are correct
6
Managerial over-optimism can
A)Help reduce debtholder-shareholder conflicts in a debt overhang case by inducing managers to underweight the benefits of waiting
B)Induce managers to over-estimate the expected tax shield benefits
C)Induce managers to under-estimate the expected costs of bankruptcy
D)All of the above
E)Both a and b are correct
7
To avoid overconfident and over-optimistic assumptions when using real option techniques, managers
A)Can use partial differential equations
B)Can increase the probabilities they assign to favorable outcomes
C)Can develop processes for identifying all possible future events, both favorable and unfavorable
D)Can reduce the magnitude they assign to cash flow changes
E)None of the above
8
Sophisticated debtholders who perceive managers to be excessively confident and optimistic
A)Will be less concerned about problems of conflicts of interest such as debt overhang
B)Will be willing to pay higher prices for the firm’s debt
C)Will not be willing to lend as much to the firm
D)All of the above
E)Both a and b are correct





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