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Exam 24: Options and Corporate Finance

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Question 41

Multiple Choice

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We are examining a new project. We expect to sell 9,000 units per year at $45 net cash flow apiece for the next 20 years. In other words, the annual operating cash flow is projected to be $45 *9,000 = $405,000. The relevant discount rate is 14 percent, and the initial investment required is $1,730,000. After the first year, the project can be dismantled and sold for $1,350,000. If expected sales are revised based on the first year's performance, it would make sense to abandon the investment if the sales are less than which of the following number of units?

A) 4,580 units
B) 4,620 units
C) 4,750 units
D) 4,810 units
E) 5,020 units

F) B) and E)
G) B) and C)

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Question 42

Multiple Choice

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Suzie is the controller of The Price Rite Company. She has been granted to the right to buy 1,000 shares of her employer's stock at $25 a share anytime within the next three years. Which one of the following has Suzie been granted?

A) employee stock option
B) company bonus option
C) employee grant
D) employee exercise option
E) company benefits option

F) A) and B)
G) C) and D)

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Question 43

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We are examining a new project. We expect to sell 8,000 units per year at $80 net cash flow apiece for the next 15 years. In other words, the annual operating cash flow is projected to be $80 *8,000 = $640,000. The relevant discount rate is 16 percent, and the initial investment required is $2,740,000. The project can be dismantled after the first year and sold for $2,130,000. Suppose you think it is likely that expected sales will be revised upward to 9,600 units if the first year is a success and revised downward to 3,000 units if the first year is not a success. Suppose the scale of the project can be doubled in one year in the sense that twice as many units can be produced and sold. Naturally, expansion would be desirable only if the project is a success. This implies that if the project is a success, projected sales after expansion will be 19,200. Assume that success and failure are equally likely. Note that abandonment is still an option if the project is a failure. What is the value of the option to expand?

Patience is reviewing a project with projected sales of 4,200 units a year, a cash flow of $28 a unit, and a four-year project life. Assume all operating cash flows occur on the last day of each year. The initial cost of the project is $247,000. The relevant discount rate is 13 percent. Patience has the option to abandon the project after two years at which time she feels she could sell the project's assets for $110,000. At what level of annual sales, starting in year 3, should she be willing to abandon this project?

Mark owns both a March $20 put and a March $20 call on Alpha stock. Which one of the following statements correctly relates to Mark's position? Ignore taxes and transaction costs.

Which one of the following considers all of the options implicit in a project?

Electronic Importers has a pure discount bond with a face value of $25,000 that matures in one year. The risk-free rate of return is 3.8 percent. The assets of the business are expected to be worth either $23,000 or $35,000 in one year. Currently, these assets are worth $27,500. What is the current value of the bond?

Which one of the following describes the intrinsic value of a put option?

You own a convertible bond with a face value of $1,000 and a market value of $1,034. The bond can be converted into 14 shares of stock. What is the conversion price?

You own one call option with an exercise price of $40 on S'more Good stock. The stock is currently selling for $41 a share but is expected to sell for either $37 or $43 a share in one year. The risk-free rate of return is 4.25 percent and the inflation rate is 3.6 percent. What is the current call option price if the option expires one year from now?

What is the final day on which an option can be exercised called?

You purchased six call option contracts on ABC stock with a strike price of $32.50 when the option was quoted at $1.80. The option expires today when the value of ABC stock is $34.60. Ignoring trading costs and taxes, what is the net profit or loss on this investment?

The price of Time Squared Corp. stock will be either $80 or $95 at the end of the year. Call options are available with one year to expiration. T-bills currently yield 6 percent and the current price of Time Squared Corp. stock is $85. What is the value of a call option if the exercise price is $75 per share?

Which of the following will decrease the value of a call option? I. a decrease in the exercise price II. a decrease in the value of the underlying security III. an increase in the risk-free rate IV. an increase in the time to expiration

KT Enterprises has expanded its operations into a new field, which is the production of everyday dinnerware. If this project goes well, the firm has the option to expand its production into fine china. What type of option is this?

A $20 put option on Wildwood stock expires today. The current price of the stock is $18.50. Which one of the following best describes this option?

You own eight call option contracts on Swift Water Tours stock with a strike price of $15. When you purchased the shares the option price was $0.30 and the stock price was $15.25. What is the total intrinsic value of these options if the stock is currently selling for $16.08 a share?

This morning, you purchased a call option on Schoolhouse Supply Co. stock that expires in one year. The exercise price is $40. The current price of the stock is $43.40 and the risk-free rate of return is 3.6 percent. Assume the option will finish in the money. What is the current value of the call option?

What are the basic similarities and basic differences between warrants and call options?

Lucinda owns a convertible bond that matures in six years. The bond has a 9 percent coupon and pays interest annually. The face value of the bond is $1,000 and the conversion price is $22. Similar bonds have a market return of 8.75 percent. The current price of the stock is $21.60 per share. What is the conversion value of this bond?