Assignment
1. What is a financial option? What is the single most important characteristic of an option?
2. Consider Triple Play's call option with a $25 strike price. The following table contains historical values for this option at different stock prices:
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Stock Price
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Call Option Price
|
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$25
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$3.00
|
|
30
|
7.50
|
|
35
|
12.00
|
|
40
|
16.50
|
|
45
|
21.00
|
|
50
|
25.50
|
a) Create a table which shows (1) stock price, (2) strike price, (3) exercise value, (4) option price, and (5) the time value.
b) What happens to the option's time value as the stock price rises? Why?
3. Quinlan Enterprises stock trades for $52.50 per share. It is expected to pay a $2.50 dividend at year end (D1 = $2.50), and the dividend is expected to grow at a constant rate of 5.50% a year. The before-tax cost of debt is 7.50%, and the tax rate is 25%. The target capital structure consists of 45% debt and 55% common equity.
a) What is the company's WACC if all the equity used is from reinvested earnings?
b) What four common mistakes in estimating the WACC should be avoided?
4. Carolina Company is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and are not repeatable.
WACC: 7.75%
Year 0 1 2 3 4
CFS -$1,050 $675 $650
CFL -$1,050 $360 $360 $360 $360
a) If the decision is made by choosing the project with the higher IRR, how much value will be forgone?
b) What is the underlying cause of ranking conflicts between NPV and IRR?
5. a) Distinguish among beta (or market) risk, within-firm (or corporate) risk, and stand-alone risk for a project being considered for inclusion in a firm's capital budget.
b) In theory, market risk should be the only "relevant" risk. However, companies focus as much on stand-alone risk as on market risk. What are the reasons for the focus on stand-alone risk?
6. Century Roofing is thinking of opening a new warehouse, and the key data are shown below. The company owns the building that would be used, and it could sell it for $100,000 after taxes if it decides not to open the new warehouse. The equipment for the project would be depreciated by the straight-line method over the project's 3-year life, after which it would be worth nothing and thus it would have a zero salvage value. No new working capital would be required, and revenues and other operating costs would be constant over the project's 3-year life. What is the project's NPV? (Hint: Cash flows are constant in Years 1-3.)
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Project cost of capital (r)
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10.0%
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Opportunity cost
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$100,000
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Net equipment cost (depreciable basis)
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$65,000
|
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Straight-line deprec. rate for equipment
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33.333%
|
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Sales revenues, each year
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$123,000
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Operating costs (excl. deprec.), each year
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$25,000
|
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Tax rate
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25%
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Format your assignment according to the following formatting requirements:
1. The answer should be typed, double spaced, using Times New Roman font (size 12), with one-inch margins on all sides.
2. The response also includes a cover page containing the title of the assignment, the student's name, the course title, and the date. The cover page is not included in the required page length.
3. Also include a reference page. The Citations and references should follow APA format. The reference page is not included in the required page length.