DQ1: Real options are not part of the passive investment strategy known as the discounted cash flow

(DCF). A real option allows the investor the obligation to take actions to alter the influx of money even after the project is placed in motion. Real options entail expansion, abandonment, investment timing, output and input flexibility. This results in companys necessity to increase their initial investment. Real options are not part of the NPV analysis and the option value is calculated generally as: Value of option = expected NPV with option expected NPV without option. This analysis helps a firm decide if its worth the cost to obtain an option. Reference: Fundamentals of Financial Management, Brigham, Eugene F., Houston, Joel F., Copyright 2009, 12th. edition, South-Western Publishing Co. Hi Sheena, I like the real world example you provided. It clarified the input/output flexibility option as well as the abandonment option. Hi Nancy, True, real options provide an option, not an obligation to invest. Real options leave open the ability to delay (investment timing), invest more (input flexibility) or discontinue (abandon) the option. Hi Sheena, Your example regarding the job market and career choices is a great example of real options. Pursuing all three careers/hobbies may not make it worth the cost to obtain the option. At some point, the individual has to decide what they will pursue as simultaneously pursuing all three would lead to disaster. Hi Nancy, Great summation. By providing so much flexibility, real options can enhance the profitability of a project. Being able to have investment timing flexibility is essential in maximizing profits based on the proven success of the project. DQ2: The weighted average cost of capital (WACC) represents the weighted average of the component costs of debt, preferred stock and common equity. Generally speaking, large companies with stable financial histories can raise capital internally, keeping its WACC lower than smaller higher risk firms. Consequently, smaller firms lacking internal financial resources must seek external sources of financing, thereby raising their capital budget and WACC. Reference:

Fundamentals of Financial Management, Brigham, Eugene F., Houston, Joel F., Copyright 2009, 12th. edition, South-Western Publishing Co. Hi Dana, Great summation. Smaller firms are more likely to seek outside resources to raise external capital and typically are only able to raise a limited amount of capital (capital rationing). These firms have to contend with inflating their net present value so that it doesnt go over their specified, limited ability to raise capital.