Deck 24: Options and Corporate Finance: Extensions and Applications

Question 1

What are the u,the up state multiplier,and d,the down state multiplier,if there are monthly intervals and the standard deviation is .38?

A) 1.1159; 0.8961
B) 0.0317; 31.5789
C) 0.0317; 0.9683
D) 0.2193; 0.7807

Answer 1

1.1159; 0.8961

Question 2

What is d₂?

A) 0.0121
B) 0.0252
C) 0.1732
D) 0.0452
E) 0.0525

Answer 2

0.1732

Question 3

If Mr.Maxim earned $500,000 in regular annual salary why might why might he prefer to have $1,500,000 in straight salary versus salary and options?

Answer 3

Mr.Maxim likely has a large portion of his wealth tied up in Digital Storage Devices.If he is in a very undiversified position and his pay-off is dependent on the firm stock doing well to make the options pay-off,he is exposed to a large amount of risk.If the stock price falls he will suffer a large decrease in wealth.Mr.Maxim must also wait the 3 year freeze-out period before exercising the options and while price may rise it can also fall drastically.

Question 4

If a project has optionality:

A) the shorter the available life of the project the less valuable the project is.
B) the longer the available life of the project the less valuable the project is.
C) the shorter the available life of the project the more valuable the project is.
D) available project life does not change optionality.

Question 5

Rejecting an investment today forever may not be a good choice because:

A) the size of the firm will decline.
B) there are always errors in the estimation of NPVs.
C) the option value is negative.
D) the company's foregoing the future rights or option to the investment.

Question 6

The NPV approach must be:

A) augmented by added analysis if there are a few embedded options.
B) augmented by added analysis if a decision has significant embedded options.
C) jettisoned if there are any embedded options.
D) computed carefully to identify the options.

Question 7

Which of the following is not part of the Black Scholes option pricing model?

A) Standard deviation
B) Time to maturity
C) Exercise price
D) Par value of the company's stock

Question 8

The call option on a dividend paying stock compared to a non-dividend paying stock is:

A) more valuable because of the extra dividend payment.
B) equal in value because cash dividends are paid on stock.
C) less valuable because cash dividends are paid on stock.
D) less valuable if the dividend paying stock is in-the-money while the non-dividend paying stock if out-of-the-money.

Question 9

Options are granted to top corporate executives because:

A) executives will make better business decision in line with benefiting the shareholders.
B) executive pay is at risk and linked to firm performance.
C) options are tax-efficient and taxed only when they are exercised.
D) All of the choices are correct.

Question 10

What is d₁?

A) .1842
B) .4102
C) .4583
D) 0.5196
E) .5412

Question 11

What is the value of a call option?

A) $3.14
B) $5.86
C) C)$4.26
D) $5.62
E) $6.16

Question 12

Calculate N(d₂).

A) 0.5688
B) 0.5278
C) 0.6085
D) 0.7085
E) 0.7142

Question 13

Calculate N(d₁).

A) 0.5054
B) 0.6508
C) 0.6983
D) 0.7047
E) 0.8096

Question 14

The risk-neutral probabilities for an asset,with a current value equal to the present value of future payoffs are:

A) given by the probability of each state occurring.
B) given by the value of the underlying asset under good news and the risk free rate.
C) given by the value of the underlying asset under good news and bad news.
D) given by the value of the underlying asset under good news, bad news, and the risk free rate.

Question 15

The volatility of interest rates affect the value of the project by:

A) increasing the value as volatility increase.
B) increasing the value as volatility decrease.
C) decreasing the value as volatility increase.
D) Interest rate volatility does not affect value.

Question 16

Executives cannot exercise their options for a fixed period of time,this is the:

A) investing period.
B) freeze-out period.
C) valuation period.
D) guaranteed growth period.
E) strike period.

Question 17

Corporations by rewarding executives with large option positions:

A) cause the executives to hold highly undiversified portfolios.
B) put the firm in a risky position to pay off the options.
C) cause the value of the stock to fall because the options are theft.
D) are really valueless because most options are never exercised.

Question 18

A financial manager who does not follow the general constraints of the NPV rule may:

A) accept a negative project for fear of losing an investment opportunity.
B) accept a marginally acceptable NPV project limiting the corporation's ability to choose a competing project.
C) option the project to another firm.
D) not take a positive NPV project even if the NPV is adequate reward to forego the option.

Question 19

The Alger Co.operates a bauxite mine.The mine can produce 800,000 tons a year.The mine is currently closed and will cost $12 million to open it.When should the mine be opened?

A) At a net bauxite price after extraction/production costs equal to $15.00 per ton before discounting and valuing extended options.
B) At a net bauxite price after extraction/production costs greater than $15.00 per ton before discounting and valuing extended options.
C) If the mineable bauxite is available then the mine should be open because the cash breakeven is less than $15.00 per ton.
D) If mineable bauxite exists at any price close to $15.00 per ton if bauxite prices are high volatile.

Question 20

What is the value of Mr.Maxim's options?

Question 21

Why would the company pay the executive in options as opposed to salary?

Question 22

The Nu-Tech Company has a new project available to it at a cost of $6 million.The project that they can sell 13,000 personal organizers at $172 in net cash flow for each of the next five years.Nu-Tech's discount rate is 15%.What is the NPV of the investment? The executives of Nu-Tech are concerned about the potential of future competition and a subsequent drop in sales and price.If after two year you can dispose of the asset for 1.0 million at what price would it make sense to abandon the project?

Question 23

The CEO of NuValue was granted 1,000,000 options.The stock price at the time of the granting of the options was $45 and the options are at the money.The risk free rate was 5% and the options expire in 5 years.The variance on the stock is .04.What is the value of the options contract? If he had negotiated a larger salary and only 10,000 options,what would be the value of the options contract?

Question 24

The CFO of NuValue was granted 1,000,000 options.The stock price at the time of the granting of the options was $20 and the options are at the money.The risk free rate was 4% and the options expire in 5 years.The variance on the stock is .05.What is the value of her options contract? If she had negotiated a larger salary and only 10,000 options,what would be the value of the options contract?