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FINC 5880 Week 5 Midterm Exam




Question;Question 1. (10 points) The exercise price on one of ORNE Corporation's call options is $35 and the price of the underlying stock is $34. The option will expire in 55 days. The option is currently selling for $0.25.a. Calculate the option's exercise value?The call option is out ofmoney option. It does not have negative value hence its excercise value is 0 options excercise value =options excercise value =call Options wont be excercised hence its value will be 0b. Calculate the value of the premium over and above the exercise value? What does this value represent?Question 2. (15 points) The Reuth Company is evaluating the proposed acquisition of a new machine. The machine's base price is $600,000 plus shipping costs of $20,000. The machine falls into the MACRS 3-year class (use factors.33,.45,.15,.07), and it would be sold after 5 years for $10,000. The machine would require an increase in net working capital of $25,000. The machine would have no effect on revenues, but it is expected to save the firm $200,000 per year for 5 years in before-tax operating costs.. Campbell's marginal tax rate is 35 percent and its cost of capital is 13 percent.a. Calculate the cash outflow at time zero.b. Calculate the net operating cash flows for Years 1 through 5c. Calculate the terminal year cash flow.d. Calculate NPV. Should the machinery be purchased? Why or why not?Question 6. (15 points) Epoty Corporation is evaluating whether to lease or purchase needed equipment at a cost of $10,000. If the equipment is leased, the lease would not have to be capitalized. The company's balance sheet prior to the acquisition of the equipment is as follows. a. Calculate the company's current debt ratio?b. Calculate the company's debt ratio if it purchases the equipment.c. Calculate the company's debt ratio if it leases the equipment?d. Will the company's ROA and ROE ratios be affected by its decision to lease or purchase? Why or why not?e. What factors should the company consider in coming to its decision other than net advantage to leasing? Why?Question 7. (15 points) Pierre Imports recently issued two types of bonds. The first issue consisted of 10-year straight debt with a 10 percent annual coupon. The second issue consisted of 10-year bonds with a 9 percent annual coupon and attached warrants. Both issues sold at their $1,000 par values. The company's stock is currently selling for $24.50 per share.a. Calculate the implied value of the warrants attached to each bond.b. Discuss the advantages to the investor of purchasing bonds with warrants instead of straight bonds?c. Discuss 2-3 advantages to the company of issuing a bond with warrants instead of straight bonds? d. What will happen to the value of the bond with warrants if the company's stock price increases? Why?e. What will likely happen to the value of the straight bond if the company's stock price increases?Why?


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