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Hello
I have a doubt in one of the questions that I came across in the Pearson VUE practice exam for P2.
L is considering investing in a machine that has a expected useful life of 3 years. The machine will reduce L’s production overheads but the amount of annual savings cannot be determined with certainty at the project appraisal stage.
The annual savings will be $10000, $20000, or $30000 each of which is regarded as equally likely. The saving generated in the first year will continue for the second and third years. The machine will cost $35000 to buy and will have zero scrap value. L requires a 10% return on its capital investments.
In order to encourage L’s board to buy the machine the vendor has offered to take the machine back at the end of year 1 and to refund $20000 of the initial investment if it does so. What is the value of the abandonment option offered by the vendor?Could you please let me know as to how to solve this question?
Hi,
Thanks for your question.I have found the scenario discussed on CIMA P2 practice paper but I need to confirm whether valuation of real options is beyond the scope of the P2 syllabus.
According to information issued by CIMA students need to be able to discuss the consequences of long term projects and this includes an understanding of real options ( to follow on , to delay or to abandon). It does not mention calculation of these which is why Kaplan recommended text nor Open Tuition notes cover this method.
I will get confirmation from CIMA as to whether this method is required knowledge for P2 and come back to you.Kindest Regards
Cath
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