Question 1 The exercise price on one of ORNE Corporation's call options is $35 and the price of the underlying stock is $34. The option will expire in 55 days. The option is currently selling for $0.25.
a. Calculate the option's exercise value?
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$
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Stock price
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34
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Strike price
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35
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Market price of option
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0.25
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Exercise value of option
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-1
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b. Calculate the value of the premium over and above the exercise value? What does this value represent?
c. Is this an out-of-the money option, at-the-money, or in-the-money? Why?
d. What will happen to the value of the option if the underlying stock price changes to $34.50? Why?
e. If Orne Corporation had issued a put option (instead of the call), would it have a greater or lesser value than the call option? Why?
Question 2. Pierre Imports is evaluating the proposed acquisition of new equipment at a cost of $90,000. In addition the equipment would require modifications at a cost of $10,000 plus shipping costs of $2,000. The equipment falls into the MACRS 3-year class, and will be sold after 3 years for $35,000. The equipment would require increased inventory of 6,000. The equipment is expected to save the company $35,000 per year in before-tax operating costs. The company's marginal tax rate is 30 percent and its cost of capital is 11 percent.
a. What is the cash outflow at Time 0?
b. What are the net operating cash flows in years 1, 2, and 3?
c. Calculate the non-operating terminal year cash flow.
d. Calculate net present value. Should the machine be purchased?
Question 3. A company has a target capital structure that consists of 40 percent debt and 60 percent equity. The company's capital budget for next year is $10 million. Axel expects net income of $8 million. The company's cost of capital is 12 percent.
a. How much will the company pay out in dividends if it follows a residual dividend policy?
b. What is the company's dividend payout ratio if it pays the dividends calculated above?
c. Is it likely the company will follow a residual dividend policy? Why or why not?
d. If the company decided to pay out $4.5 million in dividends, how much would it need to raise in equity outside the company?
e. Should the company go ahead with a project of average risk that generates a 10 percent rate of return? Why or why not?
Question 4. Shown below are exchange rates for several currencies.
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$ per 1 euro
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$ per 1 franc
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Peso per $1
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Spot rate
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1.33
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1.08
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12.8
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30-day forward rate
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1.31
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1.11
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13.1
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60-day forward rate
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1.29
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1.22
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13.9
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a. Is the euro appreciating or depreciating against the U.S. dollar? Explain.
b. Is the Swiss franc appreciating or depreciating against the U.S. dollar? Why?
c. Is the Mexican peso appreciating or depreciating against the U.S. dollar? Why?
d. Using cross-rates, based on the spot rate, how many francs will the euro buy, how many pesos will the franc buy, and how many euro will the peso buy?
e. A U.S. company purchases goods from several foreign companies with payment due in euros, francs, and pesos. Would the company be better off paying now or waiting for 60 days? Why?
Question 5. Kern Corporation entered into an agreement with its investment banker to sell 15 million shares of the company's stock with Kern netting $300 million from the offering. The expected price to the public was $25 per share.
The out-of-pocket expenses incurred by the investment banker were $5 million.
a. What profit or loss would the investment banker incur if the issue were sold to the public at an average price of $25 per share?
b. What profit or loss would the investment banker realize if the issue were sold to the public at an average price of $20 per share?
c. Is the agreement between the company and its investment banker an example of a negotiated or a best-efforts deal? Why? Which is riskier to the company? Why?
Question 6. Epoty Corporation is evaluating whether to lease or purchase needed equipment at a cost of $100,000. If the equipment is leased, the lease would not have to be capitalized. The company's balance sheet prior to the acquisition of the equipment is shown below.
a. Calculate the company's current debt ratio?
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Equipment cost
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$100,000
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Current Balance Sheet
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Current assets
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300,000
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Debt
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400,000
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Net Fixed assets
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600,000
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Equity
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500,000
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Total assets
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900,000
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Total claims
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900,000
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a. Current debt ratio
b. Calculate the company's debt ratio if it purchases the equipment with debt.
c. Calculate the company's debt ratio if it leases the equipment?
d. Will the company's ROA and ROE ratios be affected by its decision to lease or purchase? Why or why not?
e. What factors should the company consider in coming to its decision other than net advantage to leasing? Why?
Question 7. Calhoun Resorts is interested in developing a new facility in Toronto. The company estimates that the hotel would require an initial investment of $10 million. The company expects that the facility will produce positive cash flows of $3,000,000 a year at the end of each of the next 5 years. The project's cost of capital is 12%.
a. Calculate the expected net present value of the project.
b. A hotel tax may be imposed that would affect cash flows. In one year, the company expects to know whether the tax will be imposed. The company believes there is a 40% change that the tax will be imposed, in which case annual cash flows will be $2.5 million. If the tax is not imposed, annual cash flows will be $3.2 million . It is deciding whether to proceed with the facility today or to wait 1 year to find out whether the tax will be imposed. If it waits a year, the initial investment will remain at $10 million, and incoming cash flows will be delayed 1 year. Cost of capital will remain at 12%.
If the company waits one year, calculate the project's NPV in Year 1 with restrictions and without restrictions.
c. Identify 3 qualitative factors in addition to the value of the real option that the company should consider in making its decision.