Aem 4570 Week 1
Problem Set #3
AEM 4570: Advanced Corporate Finance
All questions are in “Principals of Corporate Finance” by Brealey, Myers, and
Allen(10 ed.). Due date is Thursday March 12 by 5pm. Drop box will be in front of
Gail Keenan’s office.
Chapter #19: Financing and Valuation Problems: #7, 8, 17, 19
Chapter #20: Understanding Options Problems: #10, 16, 18, 19
Chapter #21: Valuing Options Problems: #1, 5, 6, 12
Chapter #19: Financing and Valuation
7. a. 12%, of course. b. rE = .12 + (.12 - .075)(30/70) = .139, WACC = .075(1 - .35)(.30) + .139(.70) = .112, or 11.2%.
8. a. Base-case NPV = -1,000 + 1200/1.20 = 0 b. PV tax shield = (.35 X .1 X .3(1000))/1.1 = 9.55. APV = 0 + 9.55 = $9.55 17. …show more content…
No. The true probability of a price rise is -almost certainly higher than the risk neutral probability, but it does not help to value the option.
6. a. Call value = $3.44. b. Put value = call value + PV(exercise price) - stock price = …show more content…
a. The possible prices of Buffelhead stock and the associated call option values (shown in parentheses) are:
Let p equal the probability of a rise in the stock price. Then, if investors are risk-neutral: p (1.00) + (1 – p) × (–0.50) = 0.10 p = 0.4
If the stock price in month 6 is $110, then the option will not be exercised so that it will be worth:
[(0.4 × $55) + (0.6 × $0)]/1.10 = $20
Similarly, if the stock price is $440 in month 6, then, if it is exercised, it will be worth ($440 - $165) = $275. If the option is not exercised, it will be worth:
[(0.4 × $715) + (0.6 × $55)]/1.10 = $290
Therefore, the call option will not be exercised, so that its value today is:
[(0.4 × $290) + (0.6 × $20)]/1.10 = $116.36
b. (i) If the price rises to $440:
(ii) If the price falls to $110:
c. The option delta is 1.0 when the call is certain to be exercised and is zero when it is certain not to be exercised. If the call is certain to be exercised, it is equivalent to buying the stock with a partly deferred payment. So a one-dollar change in the stock price must be matched by a one-dollar change in the option price. At the other extreme, when
1.0
880 220
715 55
Delta =
−
−
=
0.33
220 55
55 0
Delta =
AEM 4570: Advanced Corporate Finance
All questions are in “Principals of Corporate Finance” by Brealey, Myers, and
Allen(10 ed.). Due date is Thursday March 12 by 5pm. Drop box will be in front of
Gail Keenan’s office.
Chapter #19: Financing and Valuation Problems: #7, 8, 17, 19
Chapter #20: Understanding Options Problems: #10, 16, 18, 19
Chapter #21: Valuing Options Problems: #1, 5, 6, 12
Chapter #19: Financing and Valuation
7. a. 12%, of course. b. rE = .12 + (.12 - .075)(30/70) = .139, WACC = .075(1 - .35)(.30) + .139(.70) = .112, or 11.2%.
8. a. Base-case NPV = -1,000 + 1200/1.20 = 0 b. PV tax shield = (.35 X .1 X .3(1000))/1.1 = 9.55. APV = 0 + 9.55 = $9.55 17. …show more content…
No. The true probability of a price rise is -almost certainly higher than the risk neutral probability, but it does not help to value the option.
6. a. Call value = $3.44. b. Put value = call value + PV(exercise price) - stock price = …show more content…
a. The possible prices of Buffelhead stock and the associated call option values (shown in parentheses) are:
Let p equal the probability of a rise in the stock price. Then, if investors are risk-neutral: p (1.00) + (1 – p) × (–0.50) = 0.10 p = 0.4
If the stock price in month 6 is $110, then the option will not be exercised so that it will be worth:
[(0.4 × $55) + (0.6 × $0)]/1.10 = $20
Similarly, if the stock price is $440 in month 6, then, if it is exercised, it will be worth ($440 - $165) = $275. If the option is not exercised, it will be worth:
[(0.4 × $715) + (0.6 × $55)]/1.10 = $290
Therefore, the call option will not be exercised, so that its value today is:
[(0.4 × $290) + (0.6 × $20)]/1.10 = $116.36
b. (i) If the price rises to $440:
(ii) If the price falls to $110:
c. The option delta is 1.0 when the call is certain to be exercised and is zero when it is certain not to be exercised. If the call is certain to be exercised, it is equivalent to buying the stock with a partly deferred payment. So a one-dollar change in the stock price must be matched by a one-dollar change in the option price. At the other extreme, when
1.0
880 220
715 55
Delta =
−
−
=
0.33
220 55
55 0
Delta =