Question 5 a) A six-month call option on 100 shares of ABC Company is selling for...
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Question 5 a) A six-month call option on 100 shares of ABC Company is selling for $30. The strike price for the option is $4. The share is currently selling at $3.80 per share. (1) Ignoring brokerage fees, what price must the share achieve just to cover the expense of the option? (1 mark) (ii) If the share price rises to $4.75 at the time of expiration, what will the net profit on the option contract be? (2 mark) b) The Great Outdoors Company produces a single type of backpack that can be sold at a constant price of $200 per back-pack. Variable cost per backpack is $100, and fixed costs amount to $250,000 per year. The firm pays a tax rate of 30%. The company's assets, currently valued at $1,406,250, are financed by 40% debt and 60% equity, with the latter in the form of 1,000 ordinary shares (no preference shares issued). The firm pays annual interest of 8% on its debt financing. (i) Calculate the annual break-even volume of backpack sales. (1 mark) (ii) Calculate the firm's earnings before interest and taxes (EBIT) and earnings per share (EPS) at sales volumes of 3,000, 3,500 and 4,000 backpacks. (3 marks) (iii) Calculate the firm's degree of operating leverage (DOL), degree of financial leverage (DFL) and degree of total leverage (DTL) at a volume of sales of 3,000 backpacks. (0.53-1.5 marks) (iv) Explain the meaning of financial leverage. (1.5 marks) Question 5 a) A six-month call option on 100 shares of ABC Company is selling for $30. The strike price for the option is $4. The share is currently selling at $3.80 per share. (1) Ignoring brokerage fees, what price must the share achieve just to cover the expense of the option? (1 mark) (ii) If the share price rises to $4.75 at the time of expiration, what will the net profit on the option contract be? (2 mark) b) The Great Outdoors Company produces a single type of backpack that can be sold at a constant price of $200 per back-pack. Variable cost per backpack is $100, and fixed costs amount to $250,000 per year. The firm pays a tax rate of 30%. The company's assets, currently valued at $1,406,250, are financed by 40% debt and 60% equity, with the latter in the form of 1,000 ordinary shares (no preference shares issued). The firm pays annual interest of 8% on its debt financing. (i) Calculate the annual break-even volume of backpack sales. (1 mark) (ii) Calculate the firm's earnings before interest and taxes (EBIT) and earnings per share (EPS) at sales volumes of 3,000, 3,500 and 4,000 backpacks. (3 marks) (iii) Calculate the firm's degree of operating leverage (DOL), degree of financial leverage (DFL) and degree of total leverage (DTL) at a volume of sales of 3,000 backpacks. (0.53-1.5 marks) (iv) Explain the meaning of financial leverage. (1.5 marks)
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Related Book For
Principles Of Managerial Finance
ISBN: 9781292400648
16th Global Edition
Authors: Chad Zutter, Scott Smart
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