# Chapter 24

Problems 1-22
Input boxes in tan Output boxes in yellow Given data in blue Calculations in red Answers in green
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Chapter 24
Question 1 Input Area:

T-bills Share price Price won't drop below a. Exercise price on a call b. Exercise price on a call c. Exercise price on a put

\$ \$ \$ \$ \$

5.6% 66 60 55 45 55

Output Area:

a. Call value Intrinsic value b. Call value Intrinsic value

\$ \$ \$ \$

13.92 11.00 23.39 21.00

c. Put value \$ There is no possiblity that the put will finish in the money. Intrinsic value = \$0.

Chapter 24
Question 2 Input Area: Calls Option RWJ 85 85 85 85 Strike Price 80 80 80 80 Expiration Mar Apr Jul Oct Volume 230 170 139 60 Last 2.80 6.00 8.05 10.20

Output Area:

a. The calls are b. The puts are

in the money. out of the money.

The intinsic value is The intrinsic value is

c. The Mar call and the Oct put are mispriced. The call is mispriced because it is selling for less than its intrinsic value. If the option expired today, the arbitrage would be to buy the call for exercise it and pay \$80 for a share of stock, and sell the stock for \$85. Riskless profit of \$2. The Oct put is mispriced because it sells for less than the July put. To take advantage of thi sell the July put for \$3.90 and buy the October put for \$3.65, for a cash inflow of \$0.25. The The exposure of the short position is completely covered by the long position in the October put, with a positive cash inflow today.

Puts Volume 160 127 43 11 Last 0.80 1.40 3.90 3.65

\$5.00 \$0.00

riced because it is selling for less age would be to buy the call for \$2.80, ck for \$85. Riskless profit of \$2.20. uly put. To take advantage of this, , for a cash inflow of \$0.25. The the long position in the October

Chapter 24
Question 3 Input Area: Calls Option Macrosoft 119 119 119 119 Strike Price 120 120 120 120 Expiration Feb Mar May Aug 10 120 134 126 10 109 10 108 132 Volume 85 61 22 3 Last 3.23 4.41 6.97 10.20

a. Contracts bought Feb call b. Share price Share price c. Contracts bought Share price d. Contracts sold Share price Share price

\$ \$ \$ \$ \$ \$

Output Area:

a. Price b. ST ST c. Initial cost Maximum gain Terminal value Net gain d. Option payoff Net profit Option payoff Net profit Break-even

\$ 3,230.00 \$ \$ 14,000 6,000

\$ 9,100 \$ 110,900 \$ 11,000 \$ 1,900 \$ \$ \$ \$ \$ (12.00) (2,900) 9,100 110.90

For terminal stock prices above net profit.

\$

110.90 , the writer of the put option makes

Puts Volume 40 22 11 3 Last 3.70 5.30 7.30 9.10

he writer of the put option makes a

Chapter 24
Question 4 Input Area:

Low stock price High stock price T-bills a. Current price Exercise price b. Exercise price

\$ \$ \$ \$ \$

62 86 5% 70 65 75

Output Area:

a. C0 b. C0

\$ \$

8.10 5.02

Chapter 24
Question 5 Input Area:

Low stock price High stock price T-bills a. Current price Exercise price b. Exercise price

\$ \$ \$ \$ \$

75 95 6% 85 65 70

Output Area:

a. C0 b. C0

\$ \$

23.68 17.81

Chapter 24
Question 6 Input Area:

Call option price Stock price Stock price Exercise price Risk-free rate

\$ \$ \$ \$

1,300 48 67 60 8%

Output Area:

C0 S0

\$ \$

13.00 79.73

Chapter 24
Question 7 Input Area:

Asset value Asset value in 1 yr Asset value in 1 yr Risk-free rate Debt FV

\$ \$ \$ \$

1,050 1,000 1,270 7% 1,000

Output Area:

a. E0 b. D0 Interest rate

\$ \$

115.42 934.58 7.00%

c. The value of the equity will increase. The debt requires a higher return, therefore the present value of the debt is less while the value of the firm does not change.

Chapter 24
Question 8 Input Area:

Debt face value a. Asset value Asset value in 1 yr Asset value in 1 yr Risk-free rate b. Asset value in 1 yr Asset value in 1 yr

\$ \$ \$ \$ \$ \$

1,000 1,140 920 1,430 6% 800 1,600

Output Area:

a. E0 D0

\$ \$

229.40 910.60

b. E0 \$ 288.96 The stockholders will prefer the new asset structure because their potential gain increases while their maximum potential loss remains unchanged.

Chapter 24
Question 9 Input Area:

Convertible debenture Conversion price Common stock price

\$ \$ \$

1,000 35 46

Output Area:

Conversion ratio Conversion value

\$

28.57 1,314.29

Chapter 24
Question 10 Input Area:

Conversion price Coupon rate Par value Nonconvertible debenture % Settlement date Maturity date Market price of stock

\$ \$

\$

55 5.2% 1,000 7% 01/01/08 01/01/38 41

Output Area:

a. Straight bond value \$ 775.50 Conversion ratio 18.18 Conversion value \$ 745.45 The minimum value for this bond is the maximum of the straight bond price or the conversion value, in this case \$ 775.50 b. The option embedded in the bond adds the extra value.

Chapter 24
Question 11 Input Area:

Settlement date Maturity date Coupon rate Coupons per year Par value Conversion price Market price of stock Nonconvertible coupon rate

\$ \$ \$

01/01/08 01/01/38 7% 2 1,000 45 39 9%

Output Area:

a. Straight bond value \$ 793.62 Conversion ratio 22.22 Conversion value \$ 866.67 The minimum value for this bond is the maximum of the straight bond price or the conversion value, in this case \$ 866.67 b. Conversion premium 15.38%

Chapter 24
Question 12 Input Area:

Detachable warrants Face value Settlement date Maturity date Coupon Yield

\$

\$

25 1,000 01/01/08 01/01/23 45 7%

Output Area:

Coupon rate Bond value component Warrant component Price of one warrant

\$ \$ \$

4.50% 772.30 227.70 9.11

Chapter 24
Question 13 Input Area:

New machine cash flow Price Pirce decline/year Lowest price Technology life Required return

\$ \$ \$ \$

320,000 1,800,000 120,000 1,200,000 10 12%

Output Area:

Purchase in year: 0 1 2 3 4 5 6

\$ \$ \$ \$ \$ \$ \$

NPV 8,071.37 22,357.08 23,632.59 14,521.81 (2,764.29) (26,369.24) (115,536.32)

You should purchase when the NPV is the highest, which is \$ 23,632.59

Chapter 24
Question 14 Input Area:

Units sold per year Net cash flow per unit Life time Annual operating cash flow Initial investment Discount rate Abandonment value

\$ \$ \$ \$

7,500 68 10 510,000 2,300,000 14% 1,500,000

Output Area:

a. NPV

\$

360,218.98 4,460

b. Q Abandon the project if Q < 4,460 because NPV(abandonment) > NPV(project CF's)

c. The abandonment value is the market value of the project. If you continue with the project in one year, you forego this cash that could have been used for something else.

Chapter 24
Question 15 Input Area:

Units per year if successful Units per year if unsuccessful Net cash flow per unit Successful operating cash flow Initial operating cash flow Initial investment Life time Discount rate Abandonment value

\$ \$ \$ \$

\$

9,500 4,000 68 646,000 510,000 2,300,000 10 14% 1,500,000

Output Area:

a. Success: PV future CF's

\$3,195,356.21

Failure: (Calculation assumes that if the project is unsuccessful it will be abandoned.) From #14, Q < 4,460 so you will abandon, PV = \$ 1,500,000 Year 1 expected value \$ 2,857,678.10 NPV \$ 206,735.18 b. No abandonment, PV future CF's \$1,345,413.14 Gain from option to abandonment \$ 154,586.86 Option is 50% likely to occur: Value = \$ 67,801.25

Chapter 24
Question 16 Input Area:

Units per year if successful Units per year if unsuccessful Net cash flow per unit Annual operating cash flow Initial operating cash flow Initial investment Life time Discount rate Abandonment value Projected sales after expansion

\$ \$ \$ \$

\$

9,500 4,000 68 646,000 510,000 2,300,000 10 14% 1,500,000 19,000

Output Area:

Success: PV future CF's \$6,390,712.41 Failure: (Calculation assumes that if the project is unsuccessful it will be abandoned.) From #14, Q < 4,460 abandon the project, PV = \$ 1,500,000 Year 1 expected value \$ 4,455,356.21 NPV \$ 1,608,207.20 Gain from option to expand, PV future CF's \$3,195,356.21 Option is 50% likely to happen \$ 1,597,678.10 Present value of option CF's \$ 1,401,472.02

Chapter 24
Question 17 Input Area:

Stock price today Risk-free Low price in one year High price in one year a. Exercise price

\$ \$ \$ \$

65 5% 75 85 75

Output Area:

a. C0 \$ The option isn't worth anything.

-

b. The stock price is too low for the option to finish in the money. The minimum return on the stock required to get the option in the money is 15.38% which is much higher than the risk-free rate of interest.

Chapter 24
Question 18 Input Area:

A Offering price of bond Bond value Conversion value \$ \$ \$ 800 800 1,000 \$ \$ \$

B 1,000 950 900

Output Area:

B is the more typical; A presents an arbitrage opportunity. Buy the bond for \$800 and immediately convert it into stock that can be sold for \$1,000. A riskless \$200 profit result.

Chapter 24
Question 19 Input Area:

Face value Current price Conversion ratio Coupon rate Nonconvertible yield Settlement date Maturity date Stock price

\$ \$

\$

1,000 960 22 6% 9% 01/01/08 01/01/28 35

Output Area:

a. Conversion ratio Conversion price Conversion premium b. Straight bond value Conversion value c. Stock price

\$

22.00 45.45 29.87% 723.98 770.00 32.91

\$ \$ \$

d. There are actually two option values to consider with a convertible bond. The conversion option value, defined as the market value less the floor value, and the speculative option value, defined as the floor value less the straight bond value. When the conversion is less than the straight-bond value, the speculative option is worth zero. Conversion value \$ 190.00 Speculative option value \$ 46.02 Total option value \$ 236.02

Chapter 24
Question 20 Input area:

Annual OCF Project life Discount rate Initial investment Aftertax salvage value in Year 1

\$

\$ \$

18,000,000 8 14% 75,000,000 30,000,000

Output area:

a. NPV b. Minimum cash flow

\$ \$

8,499,550.09 6,995,771.32

Chapter 24
Question 21 Input Area:

Face value Settlement date Maturity date Coupon Conversion price Current price Growth rate Callable value Price when called Required return

\$

\$ \$ \$ \$

1,000 01/01/05 01/01/30 5.4% 150 41.40 11% 1,200 1,300 9%

Output Area:

Straight bond value \$ 646.39 Conversion value \$ 276.00 # of years 14.85 The bond will be called in 13.13 14.85 years, years, forcing conversion. Bond value \$ 794.68

Chapter 24
Question 22 Input Area:

Initial investment Net working capital Pretax revenue Pretax operating costs # of years Tax rate Discount rate Year 1 Year 2 Year 3 Year 4

\$ \$ \$ \$

12,000,000 900,000 9,100,000 3,700,000 4 38% 13% Salvage value \$ 8,200,000 \$ 6,100,000 \$ 4,700,000 \$ -

Output Area:

Assuming the project lasts four years, the NPV is calculated as follows: Year 0 1 Sales \$ 9,100,000 Operating costs 3,700,000 Depreciation 3,000,000 EBT \$ 2,400,000 Tax 912,000 Net income \$ 1,488,000 +Depreciation 3,000,000 Operating CF \$ 4,488,000 Change in NWC Capital spending Total cash flow Net present value Abandoned after one year: Year \$ \$ \$ (900,000) (12,000,000) (12,900,000) 0 0 4,488,000

\$

\$ 1,001,414.16

0

1

Sales Operating costs Depreciation EBT Tax Net income +Depreciation Operating CF Change in NWC Capital spending Total cash flow Book value of equipment Taxes on sale Salvage value Net present value \$ \$ \$ \$ \$ \$ \$ (900,000) (12,000,000) (12,900,000) 9,000,000 304,000 8,504,000 (606,194.69)

\$

\$ \$ \$ \$ \$ \$

9,100,000 3,700,000 3,000,000 2,400,000 912,000 1,488,000 3,000,000 4,488,000 900,000 8,504,000 13,892,000

Abandoned after two years: Year Sales Operating costs Depreciation EBT Tax Net income +Depreciation Operating CF Change in NWC Capital spending Total cash flow Book value of equipment Taxes on sale Salvage value Net present value \$ \$ \$ \$ \$ \$ \$

0 \$

\$ \$ \$ (900,000) (12,000,000) (12,900,000) 6,000,000 (38,000) 6,062,000 38,710.94

1 9,100,000 3,700,000 3,000,000 2,400,000 912,000 1,488,000 3,000,000 4,488,000 0 0 4,488,000

\$

Abandoned after three years: Year

0

1

Sales Operating costs Depreciation EBT Tax Net income +Depreciation Operating CF Change in NWC Capital spending Total cash flow Book value of equipment Taxes on sale Salvage value Net present value \$ \$ \$ \$ \$ \$ (900,000) (12,000,000) (12,900,000) 3,000,000 (646,000) 4,054,000

\$

\$ \$ \$

9,100,000 3,700,000 3,000,000 2,400,000 912,000 1,488,000 3,000,000 4,488,000 0 0 4,488,000

\$

\$ 1,130,223.36

ted as follows: \$ 2 9,100,000 3,700,000 3,000,000 2,400,000 912,000 1,488,000 3,000,000 4,488,000 \$ 3 9,100,000 3,700,000 3,000,000 2,400,000 912,000 1,488,000 3,000,000 4,488,000 \$ 4 9,100,000 3,700,000 3,000,000 2,400,000 912,000 1,488,000 3,000,000 4,488,000 900,000 0 5,388,000

\$ \$ \$

\$ \$ \$

\$ \$ \$

\$

0 0 4,488,000 \$

0 \$ 0 4,488,000 \$

\$

\$ \$ \$ \$ \$ \$

2 9,100,000 3,700,000 3,000,000 2,400,000 912,000 1,488,000 3,000,000 4,488,000 900,000 6,062,000 11,450,000

2

3

\$

\$ \$ \$

9,100,000 3,700,000 3,000,000 2,400,000 912,000 1,488,000 3,000,000 4,488,000

\$

\$ \$ \$

9,100,000 3,700,000 3,000,000 2,400,000 912,000 1,488,000 3,000,000 4,488,000 900,000 4,054,000 9,442,000

\$

0 \$ 0 \$ 4,488,000 \$

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