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intermediate financial management
Financial Management And Policy 12th Edition James C. Van Horne - Solutions
. Is this an optimal strategy?
a. With strict capital rationing, which of these investments should be undertaken?
8. The Lake Tahoe Ski Resort is studying a half-dozen capital improvement projects. It has allocated $1 million for capital budgeting purposes. The following proposals and associated profitability indexes have been determined.The projects themselves are independent of one another.
b. If the working capital requirement of $10,000 were required in addition to the cost of the equipment and this additional investment were needed over the life ofA& project, what would be the effect on net present value? (All other things are the same as in part a,)
a. If the required rate of return is still 15 percent, what is the net present value of the project? Is it acceptable?
7. In Problem 6, suppose 6 percent inflation in labor cost savings is expected over the last 4 years, so that savings in the first year are $20,000, savings in the second year are $21,200, and so forth.
b. If its required rate of return is 18 percent, what is the maximum price Insell should pay?
a. What expected annual cash flows would Insell realize from this acquisition?
4. Insell Corporation is considering the acquisition of Fourier-Fox, Inc., which is in a related line of business. Fourier-Fox presently has a cash flow of $2 million per year. With a merger, synergism would be expected to result in a growth rate of this cash flow of 15 percent per year for 10
(1) produce a new line of aluminum skillets, (2) expand its existing cooker line to include several new sizes
3. The Platte River Perfect Cooker Company is evaluating three investment situations:
b. What is the project's net present value if the required rate of return is 14 percent?
a. What are the incremental cash inflows over the 8 years and what is the incremental cash outflow at time O?
2. Carbide Chemical Company is considering the replacement of two old machines with a new, more efficient machine. The old machines could be sold for $70,000 in the secondary market. Their depreciated book value is $120,000 with a remaining useful and depreciable life of 8 years. Straight-line
c. What would be the case if the required rate of return were 10 percent?d. What is the project's payback period?
b. What is its internal rate of return?
a. If the required rate of return is 15 percent, what is the net present value of the project? Is it acceptable?
1. Briarcliff Stove Company is considering a new product line to supplement its range line. It is anticipated that the new product line will involve cash investments of $700,000 at time 0 and $1.0 million in year 1. After-tax cash inflows of$250,000 are expected in year 2, $300,000 in year 3,
5. Continual reevaluation of investment projects after their acceptance
4. Selection of projects based on an acceptance criterion
3. Evaluation of cash flows
2. Estimation of cash flows for the proposals
1. Generation of investment proposals
c. If the call has a market value of $5 and market price of the stock is $12 per share, what is the value of the put?
b. If the put has a market price of $1 and the call $4, what is the value of the stock per share?
a. If the put has a market price of $2 and stock is worth $9 per share, what is the value of the call?
1. A put and a call option each have an expiration date 6 months hence and an exercise price of $10. The interest rate for the 6-month period is 3 percent.
c. Suppose now that the original conditions hold, but we do not know the standard deviation. If the option price is $2, what is the implied standard deviation?
b. What would be the value if the current share price were $30? $35?How do these premiums over lower boundary theoretical values compare with that when share price is $25? Why the differences?
a. What is the value of the option according to the Black-Scholes formula?
9. A 6-month call option on the stock of Costello Equipment Company permits the holder to acquire one share at $30. Presently, share price is $25, and the ex-, - ) pected standard deviation of its continuously compounded return is .20. The short-term annual interest rate is 8 percent.
c. The standard deviation is .10 instead of .50.
b. The short-term interest rate is 8 percent instead of 6 percent.
a. The length of time to expiration is 1 year instead of 3 months.
8. For Zilcon Laboratories, Inc., in Problem 7, determine the value of the option with the following changes, holding all else constant, and explain why the change in the value of the option occurs.
b. If you believe in these numbers, what should you do?
7. Zilcon Laboratories, Inc., is a new high-technology company whose common stock sells for $23 per share. A call option exists on this stock with 3 months to expiration. It has an exercise price of $18 and sells for $5.30. You have made a careful study of the stock's volatility and conclude that a
6. In Problem 5, what will be the market price of the option at the beginning of the period if financial markets are efficient and rational? What would happen if the actual market price of the option were in excess of the price you compute?What would happen if it were less? . .
b. Show how the value of your position will be the same regardless of the stock price outcome.
a. How would you establish a perfectly hedged position, using the stock and the option?
5. Shinto Carbon Steel Company's stock price at the beginning of a 6-month period is $40 per share. At the end of the period, there is a 50 percent chance that the stock will increase in value to $50 and a 50 percent chance that it will fall in value to $38 per share. An option on the stock can be
c. Reconcile your answers to parts a and b.
b. What is the expected value of option price for the two options at expiration, assuming the options are held to this time?
a. What is the expected value of market price per share 6 months hence for the two companies?
3. Julia Malone is considering writing a 30-day option on Video Sonics Corporation, which is currently trading at $60 per share. The exercise price will also be$60 per share, and the premium received on the option will be $3.75. At what common stock prices will she make money, at what price will
2. The X-Gamma Company and the X-Theta Company have actively traded options on their stocks with the same exercise price, $30. The current market prices of the two stocks are the same, $27 per share, yet the current market price of the X-Gamma option is $2.25, and that of the X-Theta option is
b. What is the appropriate hedge ratio, and how does it work?
a. On the basis of this information, what is the proper value of the option using the Black-Scholes option pricing model? (The calculations can be made with a reasonably sophisticated calculator or with an ordinary calculator and various tables.)
3. A call option enables the holder to acquire one share of stock at $45 a share for each option held. The option has 6 months until its expiration. The market price of the stock is currently $40 a share, and the expected standard deviation of its continuously compounded return over the near future
c. What is the expected value of option price at the end of the period?
b. Under each of the two possibilities, what will be the value of your hedged position?
a. If you wished to establish a perfectly hedged position, what would you do on the basis of the facts just presented?
2. Prudencio Jiiinez Company's share price is now $60. Six months from now, it will be either $75 with probability .70 or $50 with probability .30. A call option exists on the stock that can be exercised only at the end of 6 months at an exercise price of $65.
c. Presently, what is the theoretical value of the option? Why does it have a positive value?
b. What is the expected value of option price at expiration, assuming that the option is held to this time? Why does it differ from the option value determined in part a?
1. Loco Baking Company's common stock has a present market price per share of$28. A 6-month call option has been written on the stock with an exercise price of $30. Presently the option has a market value of $3. At the end of 6 months, you estimate the market price of the stock to be $24 per share
B. MCELROY"S, orting Out Risks Using Known APT Factors," Financial Analysts Journal, 44(March-April 1988), 29-42.BRENNAN, MICHAEL J., TARUNC HORDMa,n d AVANDIDHAR SURRAHMANY"AAMlte, rnative Factor Specifications, Security Characteristics, and the Cross-Section of Expected Stock Returns,"Journal of
b. Portfolio expected return with one-third invested in Montana Leather Company and two-thirds in Bozeman Enterprises:The return may be higher or lower because we cannot reduce unsystematic risk to zero with so small a portfolio.BERRY, MICHAEL A,, EDWINB URMEISTERa,n d MARJORIE
3. (E)R,, = .06 + .09(.5) - .03(.4) + .04(1.2) = 14.1%(E)R,, = .06 + .09(.7) - .03(.8) + .04(.2) = 10.7%a. Portfolio expected return where the two investments are equally weighted:
2. The expected return for Hendershott Hinge stock using a factor model is
b. The dividend yield for Rubinstein Robotics Corporation is $1.28/$32 = 4.00%.The equation implies that dividend income is not as attractive as capital gains. Therefore, a higher return is required for the high-dividendpaying stock. In this case, dividend yield is less than the risk-free rate, so
9. How does the arbitrage pricing theory (APT) differ from the capital asset pricing model (CAPM)? What are the similarities of the two models?100 Part I Foundations of Finance 1.a. R, = .08 + 1.25(.15 - .08) = 16.75%
8. The expected return for Sawyer Coding Company's stock is described by the Roll-Ross model. Sawyer's reaction coefficients are as follows:b, = 1.4,b, = 2.0,b, = .7,b, = 1.2, andb, = .8. Using the lambda estimates of Chen, Roll, and Ross, what is the expected monthly return for this security?
b. As an arbitrager, what would you do and for how long?
a. (1) Which securities are overpriced in the sense of the required return being more than the expected return? (2) Which are underpriced?
7. Based on their present share prices and expected future dividends, Bosco Enterprises, Target Markets, Inc., and Selby Glass Company have expected returns of 16 percent, 14 percent, and 20 percent, respectively. The risk-free rate presently is 7 percent. Required returns on investment are
6. Security returns are generated by factors according to the following formula:Assume R, = 5 percent, F, = 6 percent, F, = 7 percent, and F, = 8 percent. Assume also the following for two securities, X and Y:b,, = .10 bly = .SOb, = 1.20 b,, = .20b, = .90 b,, = .40 What actual return would you
b. Now suppose that we wish to solve for the expected return. If the riskfree rate is 8 percent, A, = 4 percent, A, = 2 percent, and A, = 6 percent, what is the stock's expected return?
a. Suppose that the n term for the stock is 14 percent and that for the period the unanticipated change in factor l is 5 percent, factor 2 minus 2 percent, and factor 3 minus 10 percent. If the error term is zero, what would be the stock's actual return for the period?
5. Leeny Kelly Company's stock is related to the following factors with respect to actual return:Chapter 4 Multivariable and Factor Valuation 99
4. Fullerton-Bristol, Inc., has a beta of .90, a market price per share of $27.20, and earnings per share of $3.40. The risk-free rate is 6 percent, the price/eamings ratio for the market portfolio is 12 times, and Fullerton-Bristol is in the sixth decile with respect to market capitalization (10
b. Cooper Chemical Company has a beta of 1.12 and is in the ninth decile with respect to size. What is the expected return of this company's stock? Why does it differ from that of Tobias Tire Company?
a. Tobias Tire Company has a beta of 1.10 and is in the second decile with respect to market capitalization size. What is its expected return?
3. Suppose the expected return for a stock were a function of beta and size according to the following formula:fS = Rf + .08(!3,) - .002 (size decile)where size is the decile in which security j falls with respect to total market capitalization, 10 being the largest. The risk-free rate is presently
b. In words, what would happen if negative instead of positive covariance occurred?
a. What is the stock's expected return?
2. Norway Fiord Boat Company has a beta of 1.40. The risk-free rate is presently 8 percent, and the inflation extension to the CAPM, Eq. (4-4), holds. The b coefficient in the equation is .075, and the i coefficient is .03. The inflation covariance/variance ratio for the company is .25.
b. What would happen if the b coefficient were .08 and the d coefficient were .25? Under what circumstances would this occur?
a. What is the expected return for the company's stock if the equation holds?
1. Perez Paint Company pays a dividend of $3 per share and share price is $40.Presently the risk-free rate is 5 percent and the expected return on the market portfolio is 12 percent. The company's beta is 30. The b coefficient in Eq. (4-2)is .07 and the d coefficient is .lo.
What would be the expected return on your portfolio if you were to invest (a)equally in the two securities? (b) one-third in Montana Leather Company and two-thirds in Bozeman Enterprises?98 Part I Foundations of Finance
3. Suppose a three-factor APT model holds and the risk-free rate is 6 percent.There are two stocks in which you have a particular interest: Montana Leather Company and Bozeman Enterprises. The market-price lambdas and reaction coefficients for the two stocks are as follows:Factor h b,, b,,
2. The return on Hendershott Hinge Company's stock is related to factors 1 and 2 as follows:where .6 and 1.3 are sensitivity, or reaction, coefficients associated with each of the factors as defined in the chapter. If the risk-free rate is 7 percent, the A, risk premium is 6 percent, and A, is 3
c. The price/earnings ratio for the market portfolio is 11, the p coefficient in Eq. (4-5) is -.006, and the b coefficient is ,075. What is the stock's expected return if that equation holds?
b. If dividends increase the required return on stocks with the result that the t coefficient in Eq. (4-2) is .10 while the b coefficient is ,075, what is the stock's expected return if we assume the equation holds?
a. What is the expected return using the CAPM without extension?
1. Rubinstein Robotics Corporation has a beta of 1.25. The risk-free rate is 8 percent and the expected return on the market portfolio is 15 percent. Share price is $32, earnings per share $2.56, and dividends per share $1.28.
b. If the risk-free rate is 8 percent and the expected retum on the market portfolio is 14 percent, what will be the portfolio's expected return?
. If you invest 20 percent of your funds in each of the first four securities, and 10 percent in each of the last two, what is the beta of your
11. Corliss Services, Inc., provides maintenance services to commercial buildings.Presently, the beta on its stock is 1.08. The risk-free rate is now 10 percent; the expected return for the market portfolio is 15 percent. Corliss is expected to pay a $2 per share dividend at the end of the year and
b. Assume now that you are able to borrow and lend at a risk-free rate of 6 percent. Which portfolio is preferred? Would you borrow or lend at the risk-free rate to achieve a desired position? What is the effect of borrowing and lending on the expected retum and on the standard deviation?
a. Assume that you can invest in only one of these portfolios; that is, it is not possible to mix portfolios. Plot the risk-return trade-off. Which portfolio do you prefer?
c. If the correlation coefficient were .70, what would happen to the diversification effect and to the minimum variance portfolio?
b. (1) Approximately what is the minimum variance portfolio? (2) What is the efficient set?
a. What portfolio expected returns and standard deviations arise from investing varying proportions of your funds in these two stocks? Vary your proportions in increments of .lo, going from 1.00 in Sierra Nevada Electric and 0 in Dot Thermal Controls to .90 and .lo, to .80 and .20, and so forth.
3. Dot Thermal Controls Company's common stock has an expected return of 20 percent and a standard deviation of 22 percent. Sierra Nevada Electric Company's stock has an expected retum of 12 percent and a standard deviation of 11 percent. The correlation coefficient between returns for the two
What is the expected return and standard deviation of a portfolio composed of equal investments in each?
3. The common stocks of Blatz Company and Stratz, Inc., have expected returns of 15 percent and 20 percent, respectively, while the standard deviations are 20 percent and 40 percent. The expected correlation coefficient between the two stocks is .36. What is the expected value of return and
b. What is the stock's present market price per share, assuming this required return?
a. What is the stock's required rate of return according to the CAPM?
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