The exercise price on one of ORNE Corporation's call options

The exercise price on one of ORNE Corporation's call options is $25 and the price of the underlying stock is $29. The option will expire in 35 days and is currently selling at $5.50.

a. Calculate the option's exercise value? What is the significance of this value?

b. Why is an investor willing to pay more than the exercise value for the option?

c. If the price of the underlying stock changes to $33 per share, will the market value of the option increase, decrease, or remain the same? Why

d. If Orne Corporation had issued a put option (instead of the call), would its value increase, decrease, or remain the same if the price of the underlying stock increased? Why?

Pierre Imports is evaluating the proposed acquisition of new equipment at a cost of $900,000. In addition the equipment would require modifications at a cost of $10,000 plus shipping costs of $20,000. The equipment falls into the MACRS 3-year class, and will be sold after 3 years for $35,000. The equipment would require increased net working capital of 60,000. The equipment is expected to save the company $35,000 per year in before-tax operating costs. The company's marginal tax rate is 35 % and its cost of capital is 11%.

a. What is the cash outflow at Time 0?

b. Calculate net operating cash flows in years 1, 2, and 3?

MACRS 3 year class 0.3333 0.4445 0.1481 0.0741

c. Calculate the non-operating terminal year cash flow.

d. Calculate net present value. Should the machine be purchased?