Question 1. (10
points) 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?
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 time and exercise
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. (15 points) 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. |
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| d. Calculate net present value. Should the machine be purchased? |
ve?
Question
3. (15 points) 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. (15 points) Shown below are exchange
rates for several currencies.
|
$ per 1 euro |
$ per 1 franc |
Peso per $1 |
| Spot rate |
1.33 |
1.08 |
12.8 |
| 30-day forward rate |
1.31 |
1.11 |
13.1 |
| 60-day forward rate |
1.29 |
1.22 |
13.9 |
a. Is the euro appreciating or depreciating
against the U.S. dollar? Explain.
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 pesobuy?
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. (15 points) 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. (15 points) 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?
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?
Question
7. (15 points) 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 for 5 years. If the
tax is not imposed, annual cash flows will be $3.2 million for 5 years . 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. What would you recommend to the company?
c.
Apart from real options, discuss 3 qualitative factors that the company
should consider when making its
decision on accepting the new
project.
Solution: FINC5880 midterm exam