Task1. Scanlin, Inc. is considering a project which will result in initial after-tax cash savings of $1.73 million at the end of first year, and these savings will grow at rate of 3 percent per year indefinitely. The firm has target debt–equity ratio of 0.85, a cost of equity of 11.3 percent, and after-tax cost of debt of 4.1 percent. The cost-saving proposal is somewhat riskier than the usual project the firm undertakes; management uses the subjective approach and applies adjustment factor of 2 percent to the cost of capital for such risky projects.
Question1. What is the maximum initial cost company would be willing to pay for project?
Task2. The current price of non-dividend paying stock is $30. Over the next six months it is anticipated to increase to $36 or fall to $26. Suppose the risk-free rate is zero.
Question1. What long position in the stock is necessary to hedge long put option if the strike price is $32? Give the number of shares purchased as percentage of the number of options purchased option.
Question2. What is the value of put option?
Question3. What is the risk neutral probability of stock price moving up?