Xiang Zhu, a client of FinCorp Inc., has phoned you with a question. She has been reading a finance textbook and cannot understand how to use the binomial option pricing model to value a call option. The underlying stock is currently trading for $100. There is a 30‐perent chance it will increase to $190 in one year, and a 70‐percent chance it will fall to $85 in the same period. The riskfree rate is 10 percent. There is a call option with a strike price of $170, which according to the binomial model should have a value of $4.329. Xiang is confused because she calculates that if there is a 30‐percent chance the call will be worth $20 and a 70‐percent chance it will be worth zero, the expected value should be $6. Why is it only worth $4.329? a. Demonstrate that if the call was trading for $6, there would be an arbitrage opportunity. b. Calculate the risk‐neutral probabilities. c. Calculate the expected present value of the call option using the risk‐neutral probabilities. d. Why can we value options as if the investors are risk neutral?
> Compare the payoff of a call option and the underlying security. Show that the price of a call option must always be less than the value of the underlying security.
> Describe four different types of public offerings.
> The cost (interest rate) of the loan Jackie needs for her business is 6 percent per year. Given that the company s net income will fall by less than the amount of interest paid (see Practice Problem 21), is Jackie correct to think that the after‐tax cost
> Jackie would like to borrow $125,000 to expand her small business, but needs to understand the impact of the 6-percent interest payments. Last year, her company did not pay any interest and had total earnings before tax of $143,500. The tax rate was 30 p
> Describe the basic stages of IPOs.
> Describe three major categories of exempt purchasers.
> Mr. Cabinet, your boss at FinCorp Inc., prefers to have his information presented visually. At his request, graph the payoffs (intrinsic values) and profits at expiration for the following option investments. a. long call, strike $65, cost today $10 b. s
> You are in the process of interviewing for a promotion at FinCorp Inc. and have to identify the type of security based on the payoff diagrams below. All options expire on January 15, 201x, and the underlying asset is the index. Match the series from the
> Explain how offering memorandums differ from prospectuses and how exempt markets differ from public markets.
> In late 2006, Canada Post began issuing “permanent” stamps. Purchased at the current first‐class letter rate these stamps may be used indefinitely even if the price of stamps increases. Arthur Ponzarelli (known to his friends as “Ponzi”) is always lookin
> Nash Business School is considering whether to lease or buy shuttle buses for students travelling between its two campuses. The buses cost $2 million, with a CCA rate of 20 percent. The lease payments are $450,000 per year for the next five years, with p
> Igor, the intern at FinCorp Inc., has just presented your boss, Mr. Cabinet, with his valuation of Kitchen Gadget Company (KGC). Igor has identified two other companies, Kitchen Widgets and Kitchen Thingies, in exactly the same line of business as KGC an
> White River Manufacturing Company has just signed several leases and has hired FinCorp Inc. to do the initial classification of the leases as operating or financial for accounting purposes. White River could have bought each asset for $1 million instead
> Financial statements for Canadian public corporations are available from corporate websites or from the System for Electronic Document Analysis and Retrieval (SEDAR) at www.sedar.com. a. Review a copy of Air Canada’s annual report for fiscal year end Dec
> A bond is currently trading at par, which is $1,000. If the bond pays an annual coupon rate of 10 percent, calculate the IRR of this bond.
> Using NPV, should you invest in a project where the initial cash outflow is $24,000 and the cash inflow in the first year is $1,600 and “grows” at a rate of 3 percent thereafter? Assume cost of capital is 10 percent.
> Using initial cost of I 0 , and annual cash inflows of R over N period, express R in terms of I 0 and N such that the payback period is equal to its life.
> Name one condition under which the discounted payback period will be equal to the payback period.
> You are interested in an investment where the initial investment is $118,000 and your required cost of capital is 12 percent. Cash inflows from this project are expected to be $11,400 at the end of the first year and are expected to grow at 4 percent a y
> Explain how real option valuation (ROV) is applied.
> Your truck has a market value of $60,000. You can sell it to your brother, who agreed to buy it now and pay $75,000 three years from now, or you can sell it to your cousin who agreed to pay you $65,000 at the end of the year. To whom should you sell the
> For the following decisions, indicate whether they are examples of a bottom‐up analysis or a top‐down analysis: a. Replacing the printing press at a newspaper b. A newspaper’s decision to sell all its
> What are the practical difficulties when attempting to apply the NPV evaluation process to foreign investments?
> For each pair of investment opportunities, indicate if they are more likely to be mutually exclusive or independent projects. Explain your choices. a. Cruise line: i. Build a cruise ship to carry 10,000 passengers ii. Build two ships each carrying 5,000
> What are independent projects? What are mutually exclusive projects?
> You have two mutually exclusive projects: Irrespective of the project, the discount rate is 10 percent. Calculate the payback and discounted payback periods for the projects. Which one will you consider? Year Cash Flow (A) Cash Flow (B) -160,000 -110
> Calculate the NPV and IRR of the following project and check whether they produce the same decision. After‐tax initial investment is $66,777; after‐tax cash flows at each of the following six year‐ends are $20,000. The year‐end cash flow at year 7 is $40
> SK Inc. has a project that requires a $60,000 after‐tax initial investment and produces these after‐tax cash flows at each year‐end: $20,000; $22,000; −$8,000; $38,050; $55,000; and $16,000. The appropriate domestic discount rate is 16.6 percent. The pro
> State the decision rules for NPV, IRR, PI, and the discounted payback period. List two possible consequences of using IRR.
> Which project(s) will be selected if the company uses the discounted payback period method in Practice Problem 34 and the discount rate is 12 percent?
> What is the difference between sensitivity analysis and scenario analysis?
> SK Inc. has two projects as follows: If SK set 2.6 years as a cut‐off period for screening projects, which projects will be selected, using the payback period method? Project Initial CF CF, CF, CF, CF, A -2,500 008 1,200 900 2,000 B
> If the NPV of a project is $5,360 and its after‐tax initial investment is $12,050, what is its PI? Should the firm accept the project? Does the PI yield the same decision as the NPV? (Assume all the cash flows except for the initial investment are inflow
> What is the crossover rate ( r ) given the following? Project A: C F0 $25,000; C F1 $6,600; C F2 $10,200; C F3 $19,800 P roject B: C F0 $20,000; C F1 $5,400; C F2 $7,800; C F3 $16,500
> Daria is evaluating two investments—investment 1 will produce cash flows for the next 5 years and has an NPV of $1,000. Investment 2 will produce cash flows for the next 15 years and has an NPV of $700. Based on this analysis, Daria recommends investment
> Elaine is evaluating two investments—investment 1 has a profitability index (PI) of 2.4 while investment 2 has a PI of 1.2. As these investments are mutually exclusive, Elaine is recommending investment 1. The chair of the board of BigCo has asked for yo
> Cutler Compacts will generate cash flows of $30,000 in year 1 and $65,000 in year 2. However, if it makes an immediate investment of $20,000, it can instead expect to have cash streams of $55,000 in total in year 1 and $63,000 in year 2. The appropriate
> The CEO of BigCo has just bought a fancy financial calculator and calculated the IRR and NPV of Project D from Table 1. He is utterly confused. His calculator is telling him that the IRR is 20.72 percent, but when he uses a cost of capital of 1 percent,
> You have conducted an analysis of BigCo and have found that the firm is made up of two different divisions: SatellitesRUs (a satellite launching service) and a bank. Projects A to G are all related to satellite‐launching technology. You
> Calculate the crossover rate for projects B and C from Table 1. Table 1 Annual Cash Flows (All Amounts in $Million) Project A Project B Project C Project D Project E Project F Project G Year 0 -1,200 -2,400 -8,500 -5,100 -5,600 -11,000 -3,200 Year 1
> The CFO of BigCo is concerned about the sensitivity of his decisions to the choice of discount rate. For projects A, C, and E, plot the NPV profiles on the same graph. Does the NPV ranking of the three projects remain the same for every possible discount
> Describe how CCA recapture and CCA terminal losses occur and their tax treatment.
> Using projects A to F in Table 1, construct BigCo’s investment opportunity schedule. If BigCo has $9,000 (millions) available for investment, which projects should it undertake (assume all projects are independent)? Justify your recommendations to the CE
> a. If the firm is not capital constrained and the projects in Table 1 are mutually exclusive, which project should the firm undertake using the following criteria? i. NPV ii. IRR iii. Payback period iv. Discounted payback period v. Profitability index b.
> a. If the firm is not capital constrained and the projects in Table 1 are independent, which projects should the firm undertake using the following criteria? i. NPV ii. IRR iii. Payback period iv. Discounted payback period b. Are any of your recommendati
> Assume that BigCo’s cost of capital for all the projects is 10 percent. Calculate the NPV, IRR, payback period, discounted payback, and profitability index for each project in Table 1 . The firm requires a payback period of 2 years and
> Name some unique risks that may arise when evaluating FDI.
> What is so different about evaluating FDI compared to domestic projects?
> Explain how the purchase method gives rise to goodwill.
> In the next period, the economy can be in either state 1 or state 2, with a probability of 50 percent. You may trade any combination, including fractions of shares, of the following three securities: a. Are these securities correctly priced? If not, why
> You have just been appointed manager of the equity portfolio of a large pension plan. The portfolio has a current value of $100 billion and is well diversified; consequently, it has a beta close to one. The trustees of the pension plan are very risk aver
> A firm plans to either purchase or lease a machine that costs $300,000 and is subject to a 20‐percent CCA rate, using the declining balance method. The required lease payments are $35,000 at the beginning of each of four years. The lessor has agreed to p
> The current price of a stock is $107. You expect the price of the stock to be in the range of $105 to $115 in the next period. The call option with an exercise price of $115 is $1.30; the put option with an exercise price of $105 is $1.00. Both options e
> Mr. Kent, one of your clients, has been reading his daughter ’ s finance textbook and has a question about options. He says: “If I buy a call option, I have the right to buy the asset at the strike price. If I buy a put option, I have the right to sell t
> Complete the following table. At expiration Value Рayoff Value of In/Out (intrinsic Profit Long Call of or Strike option undertying of the value) short put price today asset money of option (loss) or 0.05 A Long Put 90 B Long Call 90 2 A -0.05 B -1 S
> LargeCo has a capital budget of $100 million to invest in projects. It has evaluated six independent projects and the results of the analysis are summarized in the following table. a. If the company was not capital constrained, which projects should it u
> Summarize all the cash flows that cannot be used in the capital budgeting process and explain the reasons.
> Briefly describe the main factors that affect a call option’s value, and how they affect the value.
> An investor has observed that BathGate Company, a shareholder wealth–maximizing company, has just made an investment that appears to have a negative NPV. The investor is very puzzled about why a company would undertake a negative NPV project. Assume that
> Firms A and B are competing for a project. The potential client has provided the following information on a hypothetical project: initial cost is $500,000; building renovation is $600,000; and the building cannot be rented due to the project (currently t
> State the drawbacks of the payback period and discounted payback period.
> Bert has just been hired by your company as a summer co‐op student and has been assigned to assist you. Bert is puzzled about why your company is calculating IRR and payback periods for investment projects. According to Bert’s finance textbook, NPV gives
> A firm plans to either lease a piece of equipment or purchase it. The upfront purchase price is $900,000, and it is depreciated at $90,000 per year for tax purposes. The equipment could be sold in nine years for $90,000. If the firm leases the equipment
> How does the existence of asymmetric information lead to market inefficiencies?
> Castle Company manufactures expensive watch cases that are sold as souvenirs. Three of its sales departments are retail sales, wholesale sales, and outlet sales. The retail sales department is a profit centre. The wholesale sales department is a cost cen
> Z-Bar Pastures is a 160-hectare farm on the outskirts of Swift Current, Saskatchewan, specializing in the boarding of brood mares and their foals. A recent economic downturn in the thoroughbred industry has led to a decline in breeding activities, and it
> Prasad & Green Inc. manufactures ergonomic devices for computer users. Some of its more popular products are glare screens (for computer monitors), keyboard stands with wrist rests, and laptop stands that allow air to circulate. Over the past five years,
> Sports Fanatic Company is a retail sporting goods store that uses accrual accounting for its records. Information on Sports Fanatic's operations is as follows: 1. The store has budgeted sales at $220,000 for January and $200,000 for February. 2. It expec
> Solid State sells electronic products. The controller is responsible for preparing the master budget and has accumulated the information below for the months of January, February, and March. Balances at January 1 are expected to be as follows: The budg
> Howe Ltd. is trying to decide whether it is going to need to take a loan in coming January to buy a new microcomputer system. The microcomputer will cost $8,800. The president, Joan Howe, has collected the following information about her operations as at
> Peters Corporation operates on a calendar-year basis. It begins the annual budgeting process in late August when the president sets targets for the total dollar sales and net income before taxes for the next year. The sales target is given first to the m
> You are excited because your employer has offered you a promotion, with an increased salary. But it will mean you must relocate to Vancouver and you are concerned because you have heard a lot about the high cost of housing in that city. Your employer wil
> Impro Company operates in a province where corporate taxes and workers' compensation insurance rates have recently doubled. Impro’s president has just assigned you the task of preparing an economic analysis and making a recommendation about whether or no
> Tony Skateboards is considering building a new plant. Mahmoud Al- Saigh, the company’s marketing manager, is an enthusiastic supporter of the new plant. Alyssa Minh, the company’s chief financial officer, is not so sure that the plant is a good idea. Cur
> Wayans Company produces and sells automobile batteries, including the heavy-duty HD-240. The 2020 sales budget is as follows: Prepare quarterly production budgets. Quarter ……………………………………………… Units of HD-240 1 ………………………………………………………………………. 6,000 2 …………………
> Ms. Cookie Corporation is a company specializing in selling cookies for fundraising activities. One year ago, the company purchased a special cookie-cutting machine. However, to have more efficient operations, Ms. Cookie is considering the purchase of a
> Lapides Ltd. is a small company that is currently analyzing capital expenditure proposals for the purchase of equipment. The capital budget is limited to $250,000, which Lapides believes is the maximum capital it can raise. The financial adviser is prepa
> The owners of Les Tigres de Trois-Rivières hockey club are considering a deal with an older, established club whereby they can acquire the services of Pierre Luc, a very high scorer and great gate attraction, in exchange for Robert McCain (currently paid
> The City of Craston has recently turned its attention to the apparent problem of a shortage of public transportation. In the past few years, more and more complaints have surfaced regarding inadequate bus services or difficulties in obtaining taxi servic
> Migami Company is considering the purchase of a new machine. The invoice price of the machine is $122,000, freight charges are estimated to be $3,000, and installation costs are expected to be $5,000. The salvage value of the new equipment is expected to
> Morgan Company is considering a capital investment of $210,000 in additional productive facilities. The new machinery is expected to have a useful life of five years with no salvage value. Depreciation is by the straight-line method. During the life of t
> Dryden Service Centre just purchased an automobile hoist for $18,600. The hoist has a five-year life and an estimated salvage value of $1,400. Installation costs and freight charges were $3,900 and $900, respectively. Dryden uses straight-line depreciati
> Mane Event is considering opening a new hair salon in Lethbridge, Alberta. The cost of building a new salon is $300,000. A new salon will normally generate annual revenues of $70,000, with annual expenses (including depreciation) of $41,500. At the end o
> Summer Company is considering three capital expenditure projects. Relevant data for the projects are as follows: Determine the internal rate of return. Annual income is constant over the life of the project. Each project is expected to have zero salvag
> Kendra Corporation is involved in the business of injection moulding of plastics. It is considering the purchase of a new computer-aided design and manufacturing machine for $430,000. The company believes that with this new machine it will improve produc
> Roche and Young, CPAs, are preparing their service revenue (sales) budget for 2020. Their practice is divided into three departments: auditing, tax, and consulting. Billable hours for each department, by quarter, are as follows: Prepare a sales budget fo
> TLC Corp. is considering purchasing one of two new diagnostic machines. Either machine would make it possible for the company to bid on jobs that it currently is not equipped to do. Estimates for each machine are as follows: // Instructions Calculate t
> Jack’s Custom Manufacturing Company is considering three new projects. Each one requires an equipment investment of $25,000, will last for three years, and will produce the following net annual cash flows: The equipmentâ€&#
> Dobbs Corporation is considering purchasing a new delivery truck. The truck has many advantages over the company’s current truck (not the least of which is that it runs). The new truck would cost $56,000. Because of the increased capacity, reduced mainte
> Riuto Company accumulated the following standard cost data concerning product I-Tal. Materials per unit: 2 kg at $5 per kilogram Labour per unit: 0.2 hours at $14 per hour Manufacturing overhead: Predetermined rate is 125% of direct labour cost Instruct
> The standard cost of product 999 includes two units of direct materials at $6.00 per unit. During August, the company bought 29,000 units of materials at $6.20 and used those materials to produce 15,000 units. Calculate standard cost. Instructions Calcu
> The service division of Retro Industries reported the following results for 2020. Calculate ROI and expected return on investments. Sales ……………………………….. $500,000 Variable costs ……………………. 300,000 Controllable fixed costs …….. $ 75,000 Average operating a
> The Atlantic division operates as a profit centre. It reports the following for the year. Prepare a responsibility report. Instructions Prepare a responsibility report for the Atlantic division at December 31, 2020. Budgeted Actual Sales $2,000,000
> Chickasaw Company expects to produce 50,000 units of product XLA during the current year. Budgeted variable manufacturing costs per unit are direct materials $7, direct labour $12, and overhead $18. Annual budgeted fixed manufacturing overhead costs are
> In Moore Company's flexible budget graph, the fixed cost line and the total budgeted cost line intersect the vertical axis at $90,000. The total budgeted cost line is $330,000 at an activity level of 60,000 direct labour hours. Calculate total budgeted c
> Wade Company expects to produce 5,500 units of product IOA during the current year. Budgeted variable manufacturing costs per unit are direct materials $7, direct labour $13, and overhead $18. Monthly budgeted fixed manufacturing overhead costs are $8,00
> Point Claire Company had the following results during the most recent year: sales $500,000; residual income $5,000; investment turnover 2.5; and a required rate of return of 15%. Calculate amounts related to ROI. Instructions a. Calculate the total asse
> Zeller Company estimates that 2020 sales will be $40,000 in quarter 1, $48,000 in quarter 2, and $58,000 in quarter 3. Cost of goods sold is 50% of sales. Management desires to have ending finished goods inventory equal to 10% of the next quarter's expec
> Venetian Company management wants to maintain a minimum monthly cash balance of $20,000. At the beginning of April, the cash balance is $22,000, expected cash receipts for March are $245,000, and cash disbursements are expected to be $256,000. Determine
> Oak Creek Company is preparing its budgeted income statement for 2020. Relevant data pertaining to its sales, production, and direct materials budgets are found in D10.12. Calculate budgeted total unit cost and prepare budgeted income statement. In addit
