Question: Gamma Airlines has an asset beta of

> Other things equal, which of these American options are you most likely to want to exercise early? a. A put option on a stock with a large dividend or a call on the same stock. b. A put option on a stock that is selling below exercise price or a call o

> a. Can the delta of a call option be greater than 1.0? Explain. b. Can it be less than zero? c. How does the delta of a call change if the stock price rises? d. How does it change if the risk of the stock increases?

> a. In Section 21-3 we calculated the risk (beta) of a six-month call option on Google stock with an exercise price of $530. Now repeat the exercise for a similar option with an exercise price of $450. Does the risk rise or fall as the exercise price is r

> Suppose you construct an option hedge by buying a levered position in delta shares of stock and selling one call option. As the share price changes, the option delta changes, and you will need to adjust your hedge. You can minimize the cost of adjustment

> The current price of United Carbon (UC) stock is $200. The standard deviation is 22.3% a year, and the interest rate is 21% a year. A one-year call option on UC has an exercise price of $180. a. Use the Black–Scholes model to value the

> The current price of the stock of Mont Tremblant Air is C$100. During each six-month period it will either rise by 11.1% or fall by 10% (equivalent to an annual standard deviation of 14.9%). The interest rate is 5% per six-month period. a. Calculate the

> Suppose that you have an option that allows you to sell Buffelhead stock (see Problem 12) in month 6 for $165 or to buy it in month 12 for $165. What is the value of this unusual option? Problem 12: Buffelhead’s stock price is $220 and could halve or dou

> Recalculate the value of the Buffelhead call option (see Problem 12), assuming that the option is American and that at the end of the first six months the company pays a dividend of $25. (Thus the price at the end of the year is either double or half the

> Suppose that you own an American put option on Bufflehead stock (see Problem 12) with an exercise price of $220. a. Would you ever want to exercise the put early? b. Calculate the value of the put. c. Now compare the value with that of an equivalent Eu

> Buffelhead’s stock price is $220 and could halve or double in each six month period (equivalent to a standard deviation of 98%). A one-year call option on Buffelhead has an exercise price of $165. The interest rate is 21% a year. a. What is the value of

> Look again at the bus lease described in Table 25.2.
a. What is the value of the lease if Greymare’s marginal tax rate is Tc = .20? b. What would the lease value be if, for tax purposes, the initial investment had to be written off in equal amounts ov

> Suppose that National Waferonics has before it a proposal for a four-year financial lease. The firm constructs a table like Table 25.2. The bottom line of its table shows the lease cash flows:
These flows reflect the cost of the machine, depreciation

> Look at Table 25.1.
How would the initial break-even operating lease rate change if rapid technological change in limo manufacturing reduces the costs of new limos by 5% per year?

> The price of Moria Mining stock is $100. During each of the next two six-month periods the price may either rise by 25% or fall by 20% (equivalent to a standard deviation of 31.5% a year). At month 6 the company will pay a dividend of $20. The interest r

> In Problem 8 we assumed identical lease rates for old and new desks. a. How does the initial break-even lease rate change if the expected inflation rate is 5% per year? Assume that the real cost of capital does not change. (Hint: Look at the discussion o

> Refer again to Problem 8. Suppose a blue-chip company requests a six year financial lease for a $3,000 desk. The company has just issued five-year notes at an interest rate of 6% per year. What is the break-even rate in this case? Assume administrative c

> Acme has branched out to rentals of office furniture to start-up companies. Consider a $3,000 desk. Desks last for six years and can be depreciated on a five-year MACRS schedule (see Table 6.4). What is the break-even operating lease rate for a new desk?

> How does a leveraged lease differ from an ordinary, long-term financial lease? List the key differences.

> What happens if a bankrupt lessee affirms the lease? What happens if the lease is rejected?

> Explain why the following statements are true: a. In a competitive leasing market, the annual operating lease payment equals the lessor’s equivalent annual cost. b. Operating leases are attractive to equipment users if the lease payment is less than the

> The following terms are often used to describe leases: a. Direct b. Full-service c. Operating d. Financial e. Rental f. Net g. Leveraged h. Sale and lease-back i. Full-payout Match one or more of these terms with each of the following statements: A. The

> Suppose that the Greymare lease gives the company the option to purchase the bus at the end of the lease period for $1. How would this affect the tax treatment of the lease? Recalculate its value to Greymare and the manufacturer. Could the lease payments

> Reconstruct Table 25.2 as a leveraged lease, assuming that the lessor borrows $80,000, 80% of the cost of the bus, nonrecourse at an interest rate of 11%. All lease payments are devoted to debt service (interest and principal) until the loan is paid off

> Magna Charter has been asked to operate a Beaver bush plane for a mining company exploring north and west of Fort Liard. Magna will have a firm one-year contract with the mining company and expects that the contract will be renewed for the five-year dura

> Suppose a stock price can go up by 15% or down by 13% over the next year. You own a one-year put on the stock. The interest rate is 10%, and the current stock price is $60. a. What exercise price leaves you indifferent between holding the put or exercis

> Look again at the valuation in Table 22.2 of the option to invest in the Mark II project. Consider a change in each of the following inputs. Would the change increase or decrease the value of the expansion option? a. Increased uncertainty (higher standa

> Some years ago the Australian firm Bond Corporation sold a share in some land that it owned near Rome for $110 million and as a result boosted its annual earnings by $74 million. A television program subsequently revealed that the buyer was given a put o

> Figure 20.14 shows some complicated position diagrams. Work out the combination of stocks, bonds, and options that produces each of these positions.

> Table 20.4 lists some prices of options on common stocks (prices are quoted to the nearest dollar). The interest rate is 10% a year. Can you spot any mispricing? What would you do to take advantage of it?

> In December 2014, a 13-month call on the stock of Amazon.com, with an exercise price of $305, sold for $42.50. The stock price was $305. The risk-free interest rate was 1%. How much would you be willing to pay for a put on Amazon stock with the same matu

> Is it more valuable to own an option to buy a portfolio of stocks or to own a portfolio of options to buy each of the individual stocks? Say briefly why.

> The common stock of Triangular File Company is selling at $90. A 26-week call option written on Triangular File’s stock is selling for $8. The call’s exercise price is $100. The risk-free interest rate is 10% per year. a. Suppose that puts on Triangular

> a. If you can’t sell a share short, you can achieve exactly the same final payoff by a combination of options and borrowing or lending. What is this combination? b. Now work out the mixture of stock and options that gives the same final payoff as investm

> Suppose that Mr. Colleoni borrows the present value of $100, buys a six month put option on stock Y with an exercise price of $150, and sells a six-month put option on Y with an exercise price of $50. a. Draw a position diagram showing the payoffs when t

> A European call and put option have the same maturity and both are at the money. The stock does not pay a dividend. Which option should sell for the higher price? Explain.

> FX Bank has succeeded in hiring ace foreign exchange trader Lucinda Cable. Her remuneration package reportedly includes an annual bonus of 20% of the profits that she generates in excess of $100 million. Does Ms. Cable have an option? Does it provide her

> “The buyer of the call and the seller of the put both hope that the stock price will rise. Therefore the two positions are identical.” Is the speaker correct? Illustrate with a position diagram.

> Discuss briefly the risks and payoffs of the following positions: a. Buy stock and a put option on the stock. b. Buy stock. c. Buy call. d. Buy stock and sell call option on the stock. e. Buy bond. f. Buy stock, buy put, and sell call. g. Sell put.

> Look again at Figure 20.13. It appears that the investor in panel (b) can’t lose and the investor in panel (a) can’t win. Is that correct? Explain.

> Suppose you buy a one-year European call option on Wombat stock with an exercise price of $100 and sell a one-year European put option with the same exercise price. The current stock price is $100, and the interest rate is 10%. a. Draw a position diagram

> There is another strategy involving calls and borrowing or lending that gives the same payoffs as the strategy described in Problem 3. What is the alternative strategy? Problem#3: Suppose that you hold a share of stock and a put option on that share. Wh

> What is put–call parity and why does it hold? Could you apply the parity formula to a call and put with different exercise prices?

> Suppose that you hold a share of stock and a put option on that share. What is the payoff when the option expires if (a) the stock price is below the exercise price? (b) the stock price is above the exercise price?

> You’ve just completed a month-long study of energy markets and conclude that energy prices will be much more volatile in the next year than historically. Assuming you’re right, what types of option strategies should you undertake? (Note: You can buy or s

> Three six-month call options are traded on Hogswill stock:
How would you make money by trading in Hogswill options?

> Which one of the following statements is correct? a. Value of put + present value of exercise price = value of call + share price b. Value of put + share price = value of call + present value of exercise price c. Value of put – share price = present valu

> It is possible to buy three-month call options and three-month puts on stock Q. Both options have an exercise price of $60 and both are worth $10. If the interest rate is 5% a year, what is the stock price? (Hint: Use put–call parity.)

> Pintail’s stock price is currently $200. A one-year American call option has an exercise price of $50 and is priced at $75. How would you take advantage of this great opportunity? Now suppose the option is a European call. What would you do?

> Complete the following passage: A ______ option gives its owner the opportunity to buy a stock at a specified price that is generally called the _____ price. A ____ option gives its owner the opportunity to sell stock at a specified price. Options that c

> Omega Corporation has 10 million shares outstanding, now trading at $55 per share. The firm has estimated the expected rate of return to shareholders at about 12%. It has also issued $200 million of long-term bonds at an interest rate of 7%. It pays tax

> Look back at Problem 19. Suppose now that Archimedes repurchases debt and issues equity so that D/V = .3. The reduced borrowing causes rD to fall to 11%. How do the other variables change?

> Consider the following three tickets: Ticket A pays $10 if is elected as president, ticket B pays $10 if is elected, and ticket C pays $10 if neither is elected. (Fill in the blanks yourself.) Could the three tickets sell for less than the present value

> Archimedes Levers is financed by a mixture of debt and equity. You have the following information about its cost of capital:
Can you fill in the blanks?

> Imagine a firm that is expected to produce a level stream of operating profits. As leverage is increased, what happens to a. The ratio of the market value of the equity to income after interest? b. The ratio of the market value of the firm to income befo

> Each of the following statements is false or at least misleading. Explain why in each case. a. “A capital investment opportunity offering a 10% DCF rate of return is an attractive project if it can be 100% debt-financed at an 8% interest rate.” b. “The m

> Indicate what’s wrong with the following arguments: a. “As the firm borrows more and debt becomes risky, both stockholders and bondholders demand higher rates of return. Thus by reducing the debt ratio we can reduce both the cost of debt and the cost of

> Executive Cheese has issued debt with a market value of $100 million and has outstanding 15 million shares with a market price of $10 a share. It now announces that it intends to issue a further $60 million of debt and to use the proceeds to buy back com

> Executive Chalk is financed solely by common stock and has outstanding 25 million shares with a market price of $10 a share. It now announces that it intends to issue $160 million of debt and to use the proceeds to buy back common stock. a. How is the ma

> Suppose all plant and division managers were paid only a fixed salary—no other incentives or bonuses. a. Describe the agency problems that would appear in capital investment decisions. b. How would tying the managers’ compensation to EVA alleviate these

> Here is a limerick: There once was a man named Carruthers, Who kept cows with miraculous udders. He said, “Isn’t this neat? They give cream from one teat, And skim milk from each of the others!” What is the analogy between Mr. Carruthers’s cows and firms

> Companies A and B differ only in their capital structure. A is financed 30% debt and 70% equity; B is financed 10% debt and 90% equity. The debt of both companies is risk-free. a. Rosencrantz owns 1% of the common stock of A. What other investment packag

> Refer to Section 17-1. Suppose that Ms. Macbeth’s investment bankers have informed her that since the new issue of debt is risky, debtholders will demand a return of 12.5%, which is 2.5% above the risk-free interest rate. a. What are rA and rE? b. Suppos

> True or false? a. MM’s propositions assume perfect financial markets, with no distorting taxes or other imperfections. b. MM’s proposition 1 says that corporate borrowing increases earnings per share but reduces the price–earnings ratio. c. MM’s proposit

> Suppose that Macbeth Spot Removers issues only $2,500 of debt and uses the proceeds to repurchase 250 shares. a. Rework Table 17.2 to show how earnings per share and share return now vary with operating income. b. If the beta of Macbeth’s assets is .8 an

> The common stock and debt of Northern Sludge are valued at $50 million and $30 million, respectively. Investors currently require a 16% return on the common stock and an 8% return on the debt. If Northern Sludge issues an additional $10 million of common

> Spam Corp. is financed entirely by common stock and has a beta of 1.0. The firm is expected to generate a level, perpetual stream of earnings and dividends. The stock has a price–earnings ratio of 8 and a cost of equity of 12.5%. The company’s stock is s

> Ms. Kraft owns 50,000 shares of the common stock of Copperhead Corporation with a market value of $2 per share, or $100,000 overall. The company is currently financed as follows: Market Value Common stock (8 million shares)......................

> Suppose that new security designs could be patented.13 The patent holder could restrict use of the new design or charge other firms royalties for using it. What effect would such patents have on MM’s capital-structure irrelevance theory?

> MM insisted that payout policy should be analyzed holding debt and investment policy constant. Why? Explain.

> Compare typical compensation and incentive arrangements for (a) top management, for example, the CEO or CFO, and (b) plant or division managers. What are the chief differences? Can you explain them?

> What is meant by “the information content of dividends”? Explain.

> Which of the following U.S. investors have tax reasons to prefer companies that pay out cash by repurchases instead of cash dividends? Which should not care? a. A pension fund b. An individual investor in the top income-tax bracket c. A corporation d

> Mr. Milquetoast admires Warren Buffet and believes that Berkshire Hathaway is a good investment. He wants to invest $100,000, but hesitates because Berkshire Hathaway has never paid a dividend. He needs to generate $5,000 per year in cash for living expe

> Suppose that there are just three types of investors with the following tax rates: The remaining stock is held by the institutions. All three groups simply seek to maximize their after-tax income. These investors can choose from three types of stock offe

> Consider the following two statements: “Dividend policy is irrelevant,” and “Stock price is the present value of expected future dividends.” (See Chapter 4.) They sound contradictory. This question is designed to show that they are fully consistent. The

> The middle-of-the-road party holds that dividend policy doesn’t matter because the supply of high-, medium-, and low-payout stocks has already adjusted to satisfy investors’ demands. Investors who like generous dividends hold stocks that give them all th

> “Many companies use stock repurchases to increase earnings per share. For example, suppose that a company is in the following position: Net profit………………………………………..……$10 million Number of shares before repurchase…………..1 million Earnings per share……………….……

> Generous dividend payouts and high price–earnings multiples are correlated positively. Does this imply that paying out cash as dividends instead of repurchases increases share price?

> Comment briefly on each of the following statements: a. “Unlike American firms, which are always being pressured by their shareholders to increase dividends, Japanese companies pay out a much smaller proportion of earnings and so enjoy a lower cost of c

> An article on stock repurchase in the Los Angeles Times noted: “An increasing number of companies are finding that the best investment they can make these days is in themselves.” Discuss this view. How is the desirability of repurchase affected by compan

> How in practice do managers of public firms meet short-run earnings targets? By creative accounting?

> Hors d’Age Cheeseworks has been paying a regular cash dividend of $4 per share each year for over a decade. The company is paying out all its earnings as dividends and is not expected to grow. There are 100,000 shares outstanding selling for $80 per shar

> Respond to the following comment: “It’s all very well saying that I can sell shares to cover cash needs, but that may mean selling at the bottom of the market. If the company pays a regular cash dividend, investors avoid that risk.”

> Here are key financial data for House of Herring, Inc.: Earnings per share for 2018 …………..….. $5.50 Number of shares outstanding…….40 million Target payout ratio……………………………..50% Planned dividend per share………………..$2.75 Stock price, year-end 2018…………….…..$

> House of Haddock has 5,000 shares outstanding and the stock price is $140. The company is expected to pay a dividend of $20 per share next year and thereafter the dividend is expected to grow indefinitely by 5% a year. The President, George Mullet, now m

> Look back one last time at Problem 17. How would you value Little Oil if it paid out $500,000 in cash dividends year in and year out, with no expected growth or decline? Remaining free cash flow will be used to repurchase shares. Assume that Little Oil’s

> We stated in Section 16-3 that MM’s proof of dividend irrelevance assumes that new shares are sold at a fair price. Look back at Problem 17. Assume that new shares are issued in year 1 at $10 a share. Show who gains and who loses. Is dividend policy stil

> Little Oil has outstanding one million shares with a total market value of $20 million. The firm is expected to pay $1 million of dividends next year, and thereafter the amount paid out is expected to grow by 5% a year in perpetuity. Thus the expected di

> Does the good news conveyed by the announcement of a dividend increase mean that a firm can increase its stock price in the long run simply by paying cash dividends? Explain.

> Investors and financial managers focus more on changes in cash dividends than on the level of cash dividends. Why?

> Half shell Seafood is still generating good profits, but growth is slowing down. How should its CFO decide when to start up a program of paying out cash to stockholders? What questions should the CFO ask?

> Fill in the blanks: “A project’s economic income for a given year equals the project’s _____ less its _____ depreciation. New projects may take several years to reach full profitability. In these cases book income is _____ than economic income early in t

> Some types of investors prefer dividend-paying stocks because dividends provide a regular, convenient source of income. Does demand from these investors necessarily lift the prices of dividend-paying stocks relative to stocks of companies that pay no div

> Surf & Turf Hotels is a mature business, although it pays no cash dividends. Next year’s earnings are forecasted at $56 million. There are 10 million outstanding shares. The company has traditionally paid out 50% of earnings by repurchases and reinvested

> Go back to the first Rational Demiconductor balance sheet one more time. Assume that Rational does not win the lawsuit (see Problem 5) and is left with only $1 million in surplus cash. Nevertheless Rational decides to pay a cash dividend of $2Â&nbs

> Go back to the first Rational Demiconductor balance sheet. Now assume that Rational wins a lawsuit and is paid $1 million in cash. Its market capitalization rises by that amount. It decides to pay out $2 per share instead of $1 per share. Explain what ha

> Look again at Problem 3. Assume instead that the CFO announces a stock repurchase of $4 per share instead of a cash dividend. a. What happens to the stock price when the repurchase is announced? Would you expect the price to increase to $90? Explain bri

> Seashore Salt Co. has surplus cash. Its CFO decides to pay back $4 per share to investors by initiating a regular dividend of $1 per quarter or $4 per year. The stock price jumps to $90 when the pay-out is announced. a. Why does the stock price increase

> Here are several “facts” about typical corporate dividend policies. Which are true and which false? a. Companies decide each year’s dividend by looking at their capital expenditure requirements and then distributing whatever cash is left over. b. Manag

> In 2014, Entergy paid a regular quarterly dividend of $.83 per share. a. Match each of the following dates. (A1) Friday, July 25 (B1) Record date (A2) Monday, August 11 (B2) Payment date (A3) Tuesday, August 12 (B3) Ex-dividend date (A4) Thursday, Augus