Dwight Wrote: ------------------------------------------------------- > Yes it is. They’ve already spent the cash to > develop the prototype. > > To figure out if it is a sunk cost ask the > question: can they get it back? > > No. No matter what they do with the project, they > have already spent money on the prototype. > > I can’t believe we are arguing about this… Exactly my thoughts
I took 5050/1 in North America and the question I got was definitely different than this: “The management of the company now evaluates the project, which by investing in a prototype, can allow them additional information 1 year down the road based on product acceptance.” It was definitely a sunk cost in my question.
Undoubtedly sunk cost. The more pertinent question in my mind is whether the timing option needed to be considered and I agree with kabhii that we didn’t need to since the NPV > 0 though I answered that it should be taken into account -1 for me
mark@dirtbags Wrote: ------------------------------------------------------- > I remember just being…“The firm is going to > delay the project a year” > > Not considering, contemplating, etc. > > Maybe, I read through that thing pretty damn fast. > F It. Unless I was seeing things, I also remember the question explicitly stating that delay is already a forgone conclusion, meaning that management has no choice in the matter (hence, no remaining option). As previously stated, if this is a delay and not an “option to delay”, we would definitely have to recalculate the NPV of the project. Of coarse there is no way to prove the wording of the question without seeing an exact copy of the exam… Once CFAI releases these questions in the 2010 curriculum, I will make a point to getting a hold of someone’s L2 books to put an end to this argument. Until then, it is pointless…
I believe the option value should be considered no matter what. Even of there is already a positive NPV, the option adds value to the project and could impact its ranking. Even if this is the only project, the fact that it changes the value even if it only makes it more positive means you must consider it as the old value is now innacurate, end of story. I believe I even remember a question creating NPV with real option impacts in the cfai texts. So I believe it is definitely no/yes.
the word ‘option’ was not explicitly said in the question for sure. regardless it is option or not, it will affect the NPV. even it is not an option, it will affect the NPV.
slouiscar Wrote: ------------------------------------------------------- > … lets not argue, lets start with what we agree > on. > > 1. We are examining a project to manufacture and > market a new camera. > 2. Analysis of the projected CF’s results in a > positive NPV. > 3. A sunk cost of $500,000 was made to develop a > prototype. > 4. Mgmt was delaying the project to analyze the > market’s response to the prototype. slouiscar Wrote: ------------------------------------------------------- > CFAI Volume 3 pg. 56: > > “Timing Options: Instead of investing now, the > company can delay investing. Delaying an > investment and basing the decision on hopefully > improved information that you might have in, say, > a year could help improve the NPV of the projects > selected…” > > “There are several approaches to evaluating > capital budgeting projects with real options. One > of the difficulties with real options is that the > analysis can be very complicated. Although some > of the problems are simple and can be readily > solved, many of them are so complex that they are > expensive to evaluate or you may not have much > confidence in the analysis. Four common sense > approaches to real options analysis are presented > below. > > 1. Use DCF analysis without considering options. > If the NPV is positive without considering real > options, and the project has real options that > would simply add more value, it is unnecessary to > evaluate the options. Just go ahead and make the > investment.”
The question said should it be considered, even in the above scenario, the real option is still being considered slouiscar.
Black Swan Wrote: ------------------------------------------------------- > The question said should it be considered, even in > the above scenario, the real option is still being > considered slouiscar. Agreed.
Also, this just came to me while I was walking around trying to find wifi, but I believe they said they were delaying so they could do study’s on the marketability or demand as they felt the demand may have changed or something along those lines. If that is the case, then the the old positive NPV figures may not be relevant as the increased certainty may lower npv based upon either altered cash flows, or an increased discount rate. Either way, the simple fact that they are choosing to excercise the real option to delay tells you that circumstances have not been as favorable as initially hoped, possibly leaving them with a negative npv. Think of it this way, if the management believed the npv was positive it would not have made economic sense to exercise an option to delay as you lose TVM by delaying the cash flows. Since the real option to delay was excercised, this tells us that management believed NPV was either negative or too uncertain to be determined. Either way, the title “NPV Project Clarity” is looking increasingly ironic as this thread is now approaching 5 pages. And if anyone is wondering why I’m fighting so tenaciously for this one, I screwed up on the NPV q with 250k investment change as well as pretty much every other easy question that came up. I need this one slouiscar, and I believe you have plenty of cushion to spare so throw me a friggin bone here man, this q’s all I got left.
Black Swan Wrote: ------------------------------------------------------- I need this one > slouiscar, and I believe you have plenty of > cushion to spare so throw me a friggin bone here > man, this q’s all I got left. Me too…and slouiscar’s can is made of charmin his cushion is so big.
it’s settled then. right or wrong, cfai institute, we think no/yes is how this question should be graded. slouis can set the top 1% with this one wrong… it’ll help the MPS, everyone’s a winner. i f’d the NPV q also swan and put 250k, literally left ALL ELSE VERY CONSTANT. too constant it seems. oh well. just let us have this one. we need this one.
fine. -1 fo me then. “Right, people you have to tell me these things, okay? I’ve been frozen for thirty years, okay? Throw me a frickin’ bone here! I’m the boss! Need the info.”
LOL thats exactly what I had in my head when I said that, I need to rewardh those movies, dr. Evils rants are freaking hillarious.
over05, I am with you: it should be y/y. I took a semester long class on real options as few more people who took L2 with me this year: we agreed that Y/Y is the answer (in real world). Though, CFAI might not want to complicate things and use as n/y as answer…
papasita, thanks man…who said the truth is usually in the hands of minorities:-)… My thoughts about CFA is always that it teaches you HOW to do things but rarely tell you WHY…one example is the temporal and all current methods in FSA…the text is HORRIBLE. How many people are still confused about this? How many people EVER think the economic and logic reasons behind these methods, how many people TRULY understand the diff between these methods?..same thing with CF, derivatives… I coined a wold “CFAI finance” vs. finance. People who pass CFA tests are good at CFAI finance…CFAI does well in many things but fail in many things also.
I’m pretty sure everyone on this forum can agree on why you shouldn’t value sunk cost and if you guys need the why explained, maybe you should take your real option class again.
papasita Wrote: ------------------------------------------------------- > over05, I am with you: it should be y/y. I took a > semester long class on real options as few more > people who took L2 with me this year: we agreed > that Y/Y is the answer (in real world). Though, > CFAI might not want to complicate things and use > as n/y as answer… Can you tell me how is sunk cost related to real options?
kabhii, Black Swan There is no reason to diminish each other. With that said we might have understood/read the question differently. It my opinion, it was not a sunk cost, it was initial negative outflow(time 0), at the end of the period x, you have real option to delay and then to expand the project with possibility of more negative cash flows and then positives (or changing sign). Real options heavily uses in energy sector. Consider you bought oil reserves in the ground, you have to explore, drill for test results first (initial outflow)…then you have option to expand the drilling if results are good (or bad), at the same time NPV in both cases will be based on projected oil prices and some other variables (few more real option). Anyway, all cost are considered as cash flows, including original outflow. I remember the case about tech company that had to invest in unsuccessful, negative NPV project with G2 something. Sunk cost? NO. It was considered initial outflow for learning and testing the market (+ real option), sort of step up to G3. So, at time zero you will have to take all cash flows into consideration And by the way, I got a job offer b/c of knowledge of real options. Nevertheless, my answer could be wrong…I know too much in this area:) for CFAI test> I wish we had a whole vignette on real options:) As other poster already mentioned, CFAI did a great job by asking “easy to understand” questions… Peace!
kabhii Wrote: ------------------------------------------------------- > papasita Wrote: > -------------------------------------------------- > ----- > > over05, I am with you: it should be y/y. I took > a > > semester long class on real options as few more > > people who took L2 with me this year: we agreed > > that Y/Y is the answer (in real world). Though, > > CFAI might not want to complicate things and > use > > as n/y as answer… > > Can you tell me how is sunk cost related to real kabii, I was refering to them saying the r&d should be considered as it is a sunk cost, the real option being considered is of course yes, see my other posts. > options?