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essentials corporate finance

Corporate Finance 4th Edition David Hillier - Solutions

11 Options and Corporate Decisions In many countries, governments have encouraged bank mergers to reduce their risk. Use option analysis to show why this may be bad news for the bank’s shareholders. Does this mean that you should not buy the shares of a newly merged bank? Explain.REGULAR
12 Option Pricing The Pirelli & C. SpA share price is €8.895. A call option with an exercise price of €9 sells for €0.35 and a put option with the same exercise price sells for €0.65. Does this make sense? Explain.
13 Two-state Option Pricing Model T-bills currently yield 2.1 per cent and the Man Group plc share price is £0.97. There is no possibility that the equity will be worth less than £0.50 per share in one year.(a) What is the value of a call option with a £0.97 exercise price? What is the intrinsic
14 Understanding Option Quotes Use the option quote information from Euronext Liffe shown here for Xstrata plc to answer the questions that follow. The equity is selling for £11.025.Calls Puts Settl. O.I.Day Vol. Last Bid Ask Strike Bid Ask Last Day Vol. O.I. Settl.463.00 − − − 431.50 490.00
15 Calculating Payoffs Use the option quote information on Unilever NV from Euronext below to answer the questions that follow. Assume that 100 shares make 1 contract.CODES AND CLASSIFICATION Code UN Market Euronext Amsterdam Vol. 6,251 09 Apr 2019 Exercise Type American Currency € O.I. 302,381
16 Two-state Option Pricing Model The share price of ABC plc will be either £2 or £1.5 at the end of the year. Call options are available with one year to expiration. UK government bond yields are currently at 3 per cent.(a) Suppose the current share price of ABC plc is £1.74. What is the value
17 Two-state Option Pricing Model The price of National Bank of Greece shares will be either €1.74 or€1.43 at the end of the year. Call options are available with one year to expiration. T-bills currently yield 7 per cent.(a) Suppose the current price of National Bank of Greece shares is
18 Put–Call Parity BP plc shares are currently selling for £4.29 per share. A put option with an exercise price of £4.40 sells for £0.25 and expires in three months. If the risk-free rate of interest is 2.6 per cent per year, compounded continuously, what is the price of a call option with the
19 Put–Call Parity Alcatel-Lucent has a put option and a call option with an exercise price of €1 and three months to expiration, sell for €0.28 and €0.11, respectively. If the risk-free rate is 2.5 per cent per year, compounded continuously, what is the current share price?
22 Black–Scholes and Asset Value In the previous problem, suppose you wanted the option to sell the mine to the buyer in one year. Assuming all the facts are the same, describe the transaction that would occur today. What is the price of the transaction today?
24 Black–Scholes Xstrata plc is currently priced at £10.52. A call option with an expiration of six months has an exercise price of £9.00. The risk-free rate is 3 per cent per year, compounded continuously, and the standard deviation of the equity’s return is infinitely large. What is the
25 Equity as an Option Shire plc has a zero coupon bond issue outstanding with £12 billion face value that matures in five years. The current market value of the firm’s assets is £20 billion. The standard deviation of the return on the firm’s assets is 23 per cent per year, and the annual
26 Equity as an Option and NPV Suppose Shire plc (see problem 25) is considering two mutually exclusive investments. Project A has an NPV of £700 million, and project B has an NPV of £1.2 billion. As the result of taking project A, the standard deviation of the return on the firm’s assets will
27 Mergers and Equity as an Option Suppose Shire plc (problem 25) decides to reorient its operations and, as a result, the return on assets now has a standard deviation of 30 per cent per year.(a) What is the value of Shire plc equity now? The value of debt?(b) What was the gain or loss for
28 Equity as an Option and NPV A company has a single zero coupon bond outstanding that matures in 10 years with a face value of £30 million. The current value of the company’s assets is £22 million, and the standard deviation of the return on the firm’s assets is 39 per cent per year. The
29 Two-state Option Pricing Model Ken is interested in buying a European call option written on Southeastern Airlines plc, a non-dividend-paying equity, with a strike price of £110 and one year until expiration. Currently, Southeastern’s equity sells for £100 per share. In one year Ken knows
30 Two-state Option Pricing Model Maverick Manufacturing plc must purchase gold in three months for use in its operations. Maverick’s management has estimated that if the price of gold were to rise above$875 per ounce, the firm would go bankrupt. The current price of gold is $850 per ounce. The
31 Black–Scholes and Collar Cost An investor is said to take a position in a ‘collar’ if she buys the asset, buys an out-of-the-money put option on the asset and sells an out-of-the-money call option on the asset.The two options should have the same time to expiration. Suppose Marie wishes to
32 Debt Valuation and Time to Maturity McLemore Industries has a zero coupon bond issue that matures in two years with a face value of £30,000. The current value of the company’s assets is £13,000, and the standard deviation of the return on assets is 60 per cent per year.(a) Assume the
3 The value of an option depends on five factors:(a) The price of the underlying asset(b) The exercise price(c) The expiration date(d) The variability of the underlying asset(e) The interest rate on risk-free bonds.
5 Much of corporate financial theory can be presented in terms of options. In this chapter, we pointed out that:(a) Equity can be represented as a call option on the firm.(b) Shareholders enhance the value of their call by increasing the risk of their firm.
1 Executive Share Options Why do companies issue options to executives if they cost the company more than they are worth to the executive? Why not just give cash and split the difference? Wouldn’t that make both the company and the executive better off?
2 Real Options What are the two options that many businesses have? Why does a traditional NPV analysis tend to underestimate the value of an investment opportunity? Explain.
3 Valuing a Start-up Given that anything is possible in the future, why can’t an entrepreneur who is seeking funding choose assumptions that make a start-up look good when it isn’t? Is this more a danger with real option analysis than with normal capital budgeting analysis?
4 The Binomial Model Why is the binomial model more appropriate for real option analysis than Black–Scholes?
5 Executive Stock Options Do you think that executive stock options motivate executives to act in the best interests of the company? Explain.REGULAR
6 Stock Option Exercises and Share Prices The stock price of ABC plc is currently at £30, and the company has 2 million shares outstanding. The company’s CEO exercises 200,000 stock options with a strike price of £20. What will happen to the share price of ABC plc?
8 Real Options Your company owns a vacant plot in a suburban area. What is the advantage of waiting to develop the plot?
9 Real Options Ventiora SpA has a disused warehouse it is holding until land prices increase before selling to potential buyers. In option terminology, what type of option(s) does the company have on the warehouse?
10 Real Options and Capital Budgeting Most companies use traditional capital budgeting techniques, such as payback period and net present value. Why do you think this is the case? How would you justify the use of real option methodology to a reluctant chief executive?
12 Real Options How would the analysis of real options change if a company has competitors?
13 Employee Share Options Kevin Swinson is the finance director of Mountainbrook Trading plc.The board of directors has just granted Mr Swinson 30,000 at-the-money European call options on the company’s equity, which is currently trading at £30 per share. The equity pays no dividends. The
14 Employee Share Options Joseph-Benoit Suvee has just been named the new chief executive officer of BluBell Fitness NV. In addition to an annual salary of €400,000, his three-year contract states that his compensation will include 10,000 at-the-money European call options on the company’s
15 Binomial Model Gasworks AG has been approached to sell up to 5 million litres of gasoline in three months at a price of €1.85 per litre. Gasoline is currently selling on the wholesale market at €1.65 per litre and has a standard deviation of 46 per cent. If the risk-free rate is 6 per cent
16 Real Options Webber plc is an international conglomerate with a real estate division that owns the right to erect an office building on a parcel of land on the outskirts of Leeds over the next year. This building would cost £10.5 million to construct. Due to low demand for office space in the
17 Real Options Eurocargoair is a British private air courier firm that has been given the option to purchase three new small jets at the price of £3 million per plane. The purchase agreement is only valid for the next three months before the offer is removed from the table. The company is also in
18 Real Options Jet Black is an international conglomerate with a petroleum division and is currently competing in an auction to win the right to drill for crude oil on a large piece of land in one year. The current market price of crude oil is $55 per barrel, and the land is believed to contain
19 Real Options Sardano and Sons is a large, publicly held company that is considering leasing a warehouse.One of the company’s divisions specializes in manufacturing steel and this particular warehouse is the only facility in the area that suits the firm’s operations. The current price of
20 Real Options Mouillez Pour L’été SA (MPLE) manufactures filters for swimming pools. The company is deciding whether to implement a new technology in its pool filters. One year from now the company will know whether the new technology is accepted in the market. If the demand for the new
21 Binomial Model There is an American put option on an equity that expires in two months. The share price is €13.20, and the standard deviation of the share price returns is 35 per cent. The option has a strike price of €14.00 and the risk-free interest rate is a 3.5 per cent annual percentage
22 Real Options You are in discussions to purchase an option on an office building with a strike price of £47 million. The building is currently valued at £45 million. The option will allow you to purchase the building either six months from today or one year from today. Six months from today,
23 Overseas Oil Exploration Fan and Zhu (2010) propose a real options framework to value oil exploration projects in the presence of three sources of uncertainty: the overseas investment environment, the exchange rate and the oil price. Explain how the real options methodology can aid in investment
24 Downsizing and Shared Services With increased globalization, many firms have chosen to share services or facilities with another firm in different countries. An example is the joint venture by Fiat and Chrysler to share their manufacturing facilities in Europe and North America. Explain how the
25 Electrical Interconnectors In the electricity industry, interconnectors give the owner the option to transmit electricity to one of two locations. Show, using your own example, how real option analysis can be used to value an electrical interconnector.
26 Research and Development You have recently been employed as a finance consultant to a growing company, R&D Industries, which consistently develops successful products. After a meeting with the company’s management, you estimate that the company produces, on average, two new product proposals
1 Your firm is considering a bid for a financially distressed football firm that is in administration.The administrators have said you must pay an exclusivity fee of £500,000 to develop the bid further, show the seriousness of your bid and present your commitment to resolving the issue. There are
2 What are the benefits of real option methodology over traditional methods? Why, in your opinion, do many firms not use real options to value investments? Explain. (30 marks)
3 In real options analysis, why is the binomial model preferred to Black–Scholes? Explain your answer, using a quantitative example. (30 marks)
1 You are trying to value your options. What minimum value would you assign? What is the maximum value you would assign?As a new university graduate, you have taken a management position with Exotic Cuisines plc, a restaurant chain that went public just last year. The company’s restaurants
2 Suppose that, in three years, the company’s equity is trading at £60. At that time should you keep the options or exercise them immediately? What are some of the important determinants in making such a decision?As a new university graduate, you have taken a management position with Exotic
3 Your options, like most employee share options, are not transferable or tradable. Does this have a significant effect on the value of the options? Why?As a new university graduate, you have taken a management position with Exotic Cuisines plc, a restaurant chain that went public just last year.
4 Why do you suppose employee share options usually have a vesting provision? Why must they be exercised shortly after you depart the company even after they vest?As a new university graduate, you have taken a management position with Exotic Cuisines plc, a restaurant chain that went public just
5 As we have seen, much of the volatility in a company’s share price is due to systematic or market-wide risks. Such risks are beyond the control of a company and its employees. What are the implications for employee share options? In light of your answer, can you recommend an improvement over
5 Consider the cement example from Chapter 7. What are the real options that exist for the project? How would you incorporate these into your consultancy work? What would be the process you would follow to arrive at future decisions and what would be the main inputs into your analysis?
6 The important standard for executive share options is IFRS 2 Share-based Payment. Although not directly linked to real option analysis, there is an accounting standard for exploration and mining activities. This is IFRS 6 Exploration for and Evaluation of Mineral Resources. Visit the IASPlus
3 Convertible bonds and warrants are like call options. However, there are some important differences:(a) Warrants and convertible securities are issued by corporations. Call options are traded between individual investors.(i) Warrants are usually issued privately and are combined with a bond. In
4 Many arguments, both plausible and implausible, are given for issuing convertible bonds and bonds with warrants. One plausible rationale for such bonds has to do with risk. Convertibles and bonds with warrants are associated with risky companies. Lenders can do several things to protect
5 One puzzle particularly vexes financial researchers: convertible bonds may have call provisions.Companies appear to delay calling convertibles until the conversion value greatly exceeds the call price. From the shareholders’ standpoint, the optimal call policy would be to call the convertibles
1 Warrants What are warrants? Why are warrants sometime referred to as equity kickers? What does this mean?
2 Warrants and Options What is the primary difference between a warrant and a traded call option?Why is the dilution factor important in warrant pricing?
3 Warrants What are the advantages and disadvantages of issuing warrants?
4 Convertible Bonds What is a convertible bond? What are the key features of such a security?
6 Reasons for Buying Convertible Bonds Why might an investor buy a convertible security?
7 Conversion Policy Why will convertible bonds not be voluntarily converted to equity before expiration?When and why should a firm force conversion of convertibles?REGULAR
8 Warrants Explain the following limits on the prices of warrants:(a) If the share price is below the exercise price of the warrant, the lower bound on the price of a warrant is zero.(b) If the share price is above the exercise price of the warrant, the lower bound on the price of a warrant is the
9 Convertible Bonds and Equity Volatility Assume that Barclays plc has just issued a callable convertible bond. You are concerned that the share price of Barclays is going to become more volatile over the next year. Should you buy the bond? Explain.
10 Convertible Bond Value Using the same bond as in problem 9, assume that you believe interest rates are going to increase. What do you think will happen to the value of the bond? What if the bond was a putable convertible bond? Explain.
11 Dilution What is dilution, and why does it occur when warrants are exercised?
13 Warrants and Convertibles You are employed as a financial consultant to a company that has undergone severe financial distress over the last number of years. Lacking in internal financing resources, the company tells you that it must go to the market to obtain funds, and has suggested issuing a
14 Convertible Bonds and Financial Distress Read the paper ‘The Role of Convertible Bonds in Alleviating Contracting Costs’ in the Quarterly Review of Economics and Finance by Krishnaswami and Yaman (2008).What are the authors’ main findings? Does this surprise you? Explain.
15 Warrant Valuation A warrant with five months until expiration entitles its owner to buy 100 shares of the issuing firm’s equity for an exercise price of €23 per share. If the current market price of the equity is€10 per share, will the warrant be worthless?
16 Convertible Bonds Why do you think executives believe the risk synergy rationale for issuing convertibles and not the other explanations? Explain.
17 Conversion Price A convertible bond with a face value of €1,000 has a conversion ratio of 16.4. What is the conversion price?
18 Conversion Ratio A convertible bond with a face value of SKr10,000 has a conversion price of SKr356.What is the conversion ratio of the bond?
19 Conversion Value A convertible bond has a conversion ratio of 100. If the shares are currently priced at£9.20, what is the conversion value of the bond?
20 Conversion Premium Citic Securities recently issued bonds with a face value of 100,000 renminbi and conversion ratio of 420. If the share price at the bond issue was 124 renminbi, what was the conversion premium?
21 Convertible Bonds Hannon Home Products recently issued £43,000,000 worth of 8 per cent convertible debentures. Each convertible bond has a face value of £100,000. Each convertible bond can be converted into 2,425 shares of equity any time before maturity. The share price is £31.25, and the
22 Warrant Value A warrant gives its owner the right to purchase three shares of equity at an exercise price of 32 Swedish krona per share. The current market price of the equity is 39 Swedish krona. What is the minimum value of the warrant?
24 Convertible Bond Value Tvep plc issued convertible bonds with a conversion price of £20. The bonds are available for immediate conversion. The current price of the company’s equity is £18 per share.The current market price of the convertible bonds is £990. The convertible bonds’ straight
25 Convertible Bonds You own a callable, convertible bond with a conversion ratio of 500. The equity is currently selling for £22 per share. The issuer of the bond has announced a call at a call price of 105 on a face value of £100. What are your options here? What should you do?
26 Warrant Value General Modems has five-year warrants that currently trade in the open market. Each warrant gives its owner the right to purchase one share of equity for an exercise price of £35.(a) Suppose the equity is currently trading for £33 per share. What is the lower limit on the price
27 Convertible Bonds Trichet SA has just issued a 30-year callable, convertible bond with a coupon rate of 7 per cent annual coupon payments. The bond has a conversion price of €125. The company’s equity is selling for €32 per share. The owner of the bond will be forced to convert if the
28 Convertible Bonds Rob Stevens is the chief executive officer of Isner Construction plc and owns 500,000 shares. The company currently has 4 million shares and convertible bonds with a face value of£20 million outstanding. The convertible bonds have a conversion price of £20, and the equity is
30 Warrants The capital structure of Ricketti Enterprises plc consists of 10 million shares of equity and 1 million warrants. Each warrant gives its owner the right to purchase one share of equity for an exercise price of £15. The current share price is £17, and each warrant is worth £3. What is
31 Convertible Calculations You have been hired to value a new 25-year callable, convertible bond.The bond has a 6.80 per cent coupon rate, payable annually. The conversion price is £150, and the equity currently sells for £44.75. The stock price is expected to grow at 12 per cent per year. The
32 Warrant Value Superior Clamps AB has a capital structure consisting of 4 million shares of equity and 500,000 warrants. Each warrant gives its owner the right to purchase one share of newly issued equity for an exercise price of €20. The warrants are European and will expire one year from
33 Warrant Value Omega Airlines’ capital structure consists of 1.5 million shares of equity and zero coupon bonds with a face value of $10 million that mature in six months. The firm just announced that it will issue warrants with an exercise price of $95 and six months until expiration to raise
1 You have been hired to value a new 10-year callable, convertible bond. The bond has a 5.6 per cent coupon rate, payable annually. The conversion price is £150, and the equity currently sells for £44.75. The share price is expected to grow at 8 per cent per year. The bond is callable at £1,100
2 Your firm has 3 million shares of equity and 100,000 warrants. Each warrant gives its owner the right to purchase one share of newly issued equity for an exercise price of €15. The warrants are European and will expire one year from today. The market value of the company’s assets is €60
3 Review the reasons given for why firms issue convertible bonds. Which one do you think is the most valid?Explain. (40 marks)
1 Why do you think Kartner is suggesting a conversion price of €25? Given that the company is not publicly traded, does it even make sense to talk about a conversion price?Kartner Meister was recently hired by S&S Air AB to assist the company with its short-term financial planning and to evaluate
2 What is the floor value of the S&S Air convertible bond?Kartner Meister was recently hired by S&S Air AB to assist the company with its short-term financial planning and to evaluate the company’s performance. Kartner graduated from university five years ago with a finance degree. He has been
3 What is the conversion ratio of the bond?Kartner Meister was recently hired by S&S Air AB to assist the company with its short-term financial planning and to evaluate the company’s performance. Kartner graduated from university five years ago with a finance degree. He has been employed in the
4 What is the conversion premium of the bond?Kartner Meister was recently hired by S&S Air AB to assist the company with its short-term financial planning and to evaluate the company’s performance. Kartner graduated from university five years ago with a finance degree. He has been employed in the
5 What is the value of the option?Kartner Meister was recently hired by S&S Air AB to assist the company with its short-term financial planning and to evaluate the company’s performance. Kartner graduated from university five years ago with a finance degree. He has been employed in the finance
6 Is there anything wrong with Hans’s argument that it is cheaper to issue a bond with a convertible feature because the required coupon is lower?Kartner Meister was recently hired by S&S Air AB to assist the company with its short-term financial planning and to evaluate the company’s
7 Is there anything wrong with Stephan’s argument that a convertible bond is a bad idea because it allows new shareholders to participate in gains made by the company?Kartner Meister was recently hired by S&S Air AB to assist the company with its short-term financial planning and to evaluate the
8 How can you reconcile the arguments made by Hans and Stephan?Kartner Meister was recently hired by S&S Air AB to assist the company with its short-term financial planning and to evaluate the company’s performance. Kartner graduated from university five years ago with a finance degree. He has
9 During the debate, a question comes up concerning whether the bonds should have an ordinary(not make-whole) call feature. Kartner confuses everybody by stating, ‘The call feature lets S&S Air force conversion, thereby minimizing the problem Stephan has identified.’ What is he talking about?Is
10 Download the financial accounts of 10 companies and look for any issues of warrants or convertibles.You may find examples of bonds that have conversion options or warrant-like properties. Are convertibles an important part of your firms’ capital structures? Write a brief report on the use of

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