Previous Question 6 Bookmark this page Homework due Mar 24, 2021 11:00 EDT Question 6 (Part A) 0.0/2.0 points (graded) High Energy Company (HEC) is currently 100% equity financed. Its only asset is a license to buy an oil field where it can extract 5 million barrels of oil this year (Year O). The license expires after this year. The acquisition cost is $450 million. For simplicity, assume that extraction cost is zero. The extraction time is Year 0. That is, if HEC decides to purchase the oil field and extract oil now (Year O), it can sell the oil next year in the market (Year 1). The oil price is now $100/barrel and can be $115/barrel or $90/barrel next year with equal probability. Assume no convenience yield or storage costs. The risk-free interest rate is 1%. HEC's tax rate is 10%. Assume all costs are incurred at the start of Year 0 and all sales are made at the start of Year 1. 2 points and 2 attempts learning.edx.org/course/course-v1:MITX+15.415.2x+2T2020/block-v1:MITX+15.415.2x+2T2020+type @sequential+block@ffd9c797f47c40dbaacd... = 2 points and 2 attempts (a) If HEC extracts oil today, what are the after-tax cash flows in Years 0 and 1, respectively? (Note: Negative cash flows do not generate tax credits if net cash flows in that period are negative.) (i) Year o million dollars (ii) Year 1, if oil price increases to $115/barrel million dollars (iii) Year 1, if oil price decreases to $90/barrel. million dollars 4:4 @ffd9c797447 1 point and 2 attempts (b) What are the state prices for oil price going up or down, respectively. (i) up (ii) down C40dbac Question 6 (Part C) 0.0/2.0 points (graded) 2 points and 2 attempts (c) Assume that HEC finances the acquisition cost with equity (i.e., by issuing new equity). (i) What is the NPV of the acquisition license? million dollars (ii) What is the current market value of HEC in this case? million dollars Please round your answers to at least two digits. >> (d) Suppose that HEC finances the acquisition with debt. If HEC defaults, the full amount of after-tax cash flow is paid to debtholders. The default is triggered when HEC cannot pay back both the principal amount and interest to debtholders. (i) What should the promised yield on the bond be? % (ii) What is the present value of the tax shield from debt financing? million dollars (iii) What is the current market value of HEC in the case described in Part D, above? million dollars Question 6 (Part E) 1 point possible (graded) 1 point and 2 attempt (e) Suppose that in the case of debt financing as described in Part D, when HEC defaults it incurs additional costs of $9 million. These costs reduce the value of existing assets. For simplicity, assume that defaults costs do not affect the promised yield on debt computed in Part D. What is the market value of the firm if it finances the acquisition with debt? million dollars Please round your answers to at least two digits. e.g., if the answer is 1977, submit 1.12. 1.1 will be marked as incorrect! 1.1176 will be accepted. Make sure you provide the type of answer required. Pay special attention to units specified in the trailing text after the blanks. (e.g., %) ubaaca.. * Question 6 (Part F) 0.0/1.0 point (graded) 1 point and 1 attempt (f) Suppose that oil forwards with 1-year maturity are traded in the market. If HEC uses the forwards to hedge the oil price risk, what should it do? Sell forward Buy forward Please, don't discuss the problem before the deadline. Save Submit You have used 0 of 1 attempt 147 C40dbaacd... Question 6 (Part 6) 0.0/1.0 point (graded) 1 point and 2 attempts (g) What is the 1-year oil forward price assuming no storage cost? per barrel (h) Suppose that HEC uses 1-year oil forwards to perfectly hedge oil price risk. (i) What is the total after-tax cash flow next year when the oil price goes up/down? Year 1 if oil price increases to $115/barrel million dollars Year 1 if oil price decreases to $90/barrel million dollars (ii) What is the current market value of HEC with debt financing and forward oil price hedging? million dollars Previous Question 6 Bookmark this page Homework due Mar 24, 2021 11:00 EDT Question 6 (Part A) 0.0/2.0 points (graded) High Energy Company (HEC) is currently 100% equity financed. Its only asset is a license to buy an oil field where it can extract 5 million barrels of oil this year (Year O). The license expires after this year. The acquisition cost is $450 million. For simplicity, assume that extraction cost is zero. The extraction time is Year 0. That is, if HEC decides to purchase the oil field and extract oil now (Year O), it can sell the oil next year in the market (Year 1). The oil price is now $100/barrel and can be $115/barrel or $90/barrel next year with equal probability. Assume no convenience yield or storage costs. The risk-free interest rate is 1%. HEC's tax rate is 10%. Assume all costs are incurred at the start of Year 0 and all sales are made at the start of Year 1. 2 points and 2 attempts learning.edx.org/course/course-v1:MITX+15.415.2x+2T2020/block-v1:MITX+15.415.2x+2T2020+type @sequential+block@ffd9c797f47c40dbaacd... = 2 points and 2 attempts (a) If HEC extracts oil today, what are the after-tax cash flows in Years 0 and 1, respectively? (Note: Negative cash flows do not generate tax credits if net cash flows in that period are negative.) (i) Year o million dollars (ii) Year 1, if oil price increases to $115/barrel million dollars (iii) Year 1, if oil price decreases to $90/barrel. million dollars 4:4 @ffd9c797447 1 point and 2 attempts (b) What are the state prices for oil price going up or down, respectively. (i) up (ii) down C40dbac Question 6 (Part C) 0.0/2.0 points (graded) 2 points and 2 attempts (c) Assume that HEC finances the acquisition cost with equity (i.e., by issuing new equity). (i) What is the NPV of the acquisition license? million dollars (ii) What is the current market value of HEC in this case? million dollars Please round your answers to at least two digits. >> (d) Suppose that HEC finances the acquisition with debt. If HEC defaults, the full amount of after-tax cash flow is paid to debtholders. The default is triggered when HEC cannot pay back both the principal amount and interest to debtholders. (i) What should the promised yield on the bond be? % (ii) What is the present value of the tax shield from debt financing? million dollars (iii) What is the current market value of HEC in the case described in Part D, above? million dollars Question 6 (Part E) 1 point possible (graded) 1 point and 2 attempt (e) Suppose that in the case of debt financing as described in Part D, when HEC defaults it incurs additional costs of $9 million. These costs reduce the value of existing assets. For simplicity, assume that defaults costs do not affect the promised yield on debt computed in Part D. What is the market value of the firm if it finances the acquisition with debt? million dollars Please round your answers to at least two digits. e.g., if the answer is 1977, submit 1.12. 1.1 will be marked as incorrect! 1.1176 will be accepted. Make sure you provide the type of answer required. Pay special attention to units specified in the trailing text after the blanks. (e.g., %) ubaaca.. * Question 6 (Part F) 0.0/1.0 point (graded) 1 point and 1 attempt (f) Suppose that oil forwards with 1-year maturity are traded in the market. If HEC uses the forwards to hedge the oil price risk, what should it do? Sell forward Buy forward Please, don't discuss the problem before the deadline. Save Submit You have used 0 of 1 attempt 147 C40dbaacd... Question 6 (Part 6) 0.0/1.0 point (graded) 1 point and 2 attempts (g) What is the 1-year oil forward price assuming no storage cost? per barrel (h) Suppose that HEC uses 1-year oil forwards to perfectly hedge oil price risk. (i) What is the total after-tax cash flow next year when the oil price goes up/down? Year 1 if oil price increases to $115/barrel million dollars Year 1 if oil price decreases to $90/barrel million dollars (ii) What is the current market value of HEC with debt financing and forward oil price hedging? million dollars