What are the prices of a call option and a put option with the following characteristics?
Stock price = $64
Exercise price = $60
Risk-free rate = 2.7% per year, compounded continuously
Maturity = 4 months
Standard deviation = 62% per year
2. Draw the payoff picture at expiration for a long position in a call option that has a premium of $1.25 and a strike price of $30.
3. Draw the payoff picture for a short position in the call option given in Problem 2.
4. Draw the payoff picture at expiration for a long position in a put option that has a premium of $3.50 and a strike price of $80.
5. Draw the payoff picture for a short position in the put option given in Problem 4
Some videos you may find helpful.
Intro to Options
Option Quotes – Intrinsic Value and Time Value
Black Scholes Pt 1
Black Scholes Pt 2
Application to Corporate Finance
1. A company’s 6% coupon rate, semiannual payment, $1,000 par value bond that matures in 30 years sells at a price of $515.16. The company’s federal-plus-state tax rate is 25%. What is the firm’s after-tax component cost of debt for purposes of calculating the WACC? 2. The earnings, dividends, and stock price of Shelby Inc. are expected to grow at 7% per year in the future. Megan’s common stock sells for $23 per share, its last dividend was $2.00, and the company will pay a dividend of $2.14 at the end of the current year.a. Using the discounted cash flow approach, what is its cost of equity?b. If the firm’s beta is 1.6, the risk-free rate is 9%, and the expected return on the market is 13%, then what would be the firm’s cost of equity based on the CAPM approach?c. If the firm’s bonds earn a return of 12%, then what would be your estimate of rs using the own-bond-yield-plus-judgmental-risk-premium approach? (Hint: Use a 4% risk premium.)d. On the basis of the results of parts a—c, what would be your estimate of Shelby’s cost of equity?3. Suppose the Big Boat Company has this book value balance sheet:Current assets$30,000,000Current liabilities$20,000,000Notes payable 10,000,000Fixed assets 70,000,000Long-term debt 30,000,000Common stock (1 million shares 1,000,000Retained earnings 39,000,000Total assets$100,000,000Total liabilities and equity$100,000,000The notes payable are to banks, and the interest rate on this debt is 10%, the same as the rate on new bank loans. These bank loans are not used for seasonal financing but insteadare part of the company’s permanent capital structure. The long-term debt consists of 30,000 bonds, each with a par value of $1,000, an annual coupon interest rate of 6%,and a 20-year maturity. The going rate of interest on new long-term debt, r d, is 10%, and this is the present yield to maturity on the bonds. The common stock sells at a price of $60 per share. Calculate the firm’s market value capital structure.
4. The following table gives the current balance sheet for Travellers Inn Inc. (TII), a company that was formed by merging a number of regional motel chains.Travellers Inn (Millions of Dollars)Cash$ 10Accounts payable$ 10Accounts receivable 20Accruals 15Inventories 20Short-term debt 0 Current assets$ 50 Current liabilities$ 25Net fixed assets 50Long-term debt 30Preferred stock (50,000 shares) 5Common equity (3,800,000 shares$ 10Retained earnings 30 Total common equity$ 40Total liabilities and equity$ 100
The following facts also apply to TII.
(1) The long-term debt consists of 29,412 bonds, each having a 20-year maturity, semiannual payments, a coupon rate of 7.6%, and a face value of $1,000. Currently, these bonds provide investors with a yield to maturity of 11.8%. If new bonds were sold, they would have an 11.8% yield to maturity.(2) TII’s perpetual preferred stock has a $100 par value, pays a quarterly dividend per share of $2, and has a yield to investors of 10%. New perpetual preferred stock would have to provide the same yield to investors, and the company would incur a 3.85% flotation cost to sell it.(3) The company has 3.8 million shares of common stock outstanding, a price per share = P0 = $20, dividend per share = D0 = $1, and earnings per share = EPS0 = $5. The return on equity (ROE) is expected to be 10%.(4) The stock has a beta of 1.6%. The T-bond rate is 6%, and RPM is estimated to be 5%.(5) TII’s financial vice president recently polled some pension fund investment managers who hold TII’s securities regarding what minimum rate of return on TH’s common would make them willing to buy the common rather than TII bonds, given that the bonds yielded 11.8%. (6) TII is in the 25% federal-plus-state tax bracket.Assume that you were recently hired by TII as a financial analyst and that your boss,the treasurer, has asked you to estimate the company’s WACC under the assumptionthat no new equity will be issued. Your cost of capital should be appropriate for use in evaluation projects that are in the same risk class as the assets TII now operates. Based on your analysis, answer the following questions.a. What are the current market value weights for debt, preferred stock, and common stock? (Hint: Do your work in dollars, not millions of dollars. When you calculatethe market values of debt and preferred stock, be sure to round the market price perbond and the market price per share of preferred to the nearest penny.)b. What is the after-tax cost of debt?c. What is the cost of preferred stock?d. What is the required return on common stock using CAPM?e. Use the retention growth equation to estimate the expected growth rate. Then usethe expected growth rate and the dividend growth model to estimate the requiredreturn on common stock.f. Use the required return on stock from the CAPM model, and calculate the WACC.
8. Cost of Capital for Tesla
Let’s return to the case involving Tesla’s project for the Minivan. In Week 2, we estimated the cash flows, which is the first step in analyzing project. We now need to estimate Tesla’s cost of capital in order to continue our analysis of the project. Use the 10-year Treasury Bond rate as the risk free rate and assume that the market risk premium is 6.5% to find Tesla’s cost of equity. Assume that Tesla’s bonds are rated AAA and that Tesla’s corporate tax rate is 21%. Assume that Tesla’s bonds have no floatation costs, but the cost of issuing equity is 3.5%. Find Tesla’s weighted average cost of capital. Assume that the project will be financed with internal funds. You will need to find additional financial information from the Wall Street Journal and online at sites like http://finance.yahoo.com to complete your calculation. Use Tesla’s debt-to-equity ratio to compute the percentages of debt and equity.Do this analysis in the same spreadsheet where you computed the operating cash flows for the project. Put the work in a separate tab. Next week, when we tackle capital budgeting, we’ll use these cost of capital and cash flow estimates to determine if the project is desirable.
Some videos you may find helpful.Cost of EquityCost of Issuing New EquityCost of Debt and Preferred StockWeighted Average Cost of Capital