Fundamentals of Corporate Finance 3e Test Bank
50.
When a company issues convertible bonds with a $1,000 par value that can be converted
to 20 shares of common stock, each bond includes:
A)
a put option with an exercise price of $200 per share.
B)
a call option with an exercise price of $50 per share.
C)
a put option with an exercise price of $20 per share.
D)
a call option with an exercise price of $20 per share
Ans:
B
51.
Consider a CEO who holds neither stock nor stock options in the company she runs. Her
payoff function regarding the firm’s performance is most likely to resemble:
A)
stockholders.
B)
lenders.
C)
owners of a call option on the firm.
D)
holders of a risk-free bond with coupon payments equal to her salary.
Ans:
B
Fundamentals of Corporate Finance 3e Test Bank
52.
When the value of the firm is above the face value of the debt:
A)
B)
C)
D)
Ans:
53.
Which of the following is a valid reason for managers selecting projects with negative
NPV?
The NPV analysis includes a valuable real option to expand the project if things
go well.
B)
some risky negative NPV projects.
C)
Managers’ payoff functions represent the payoffs of lenders. By taking negative
NPV projects, the managers can create value for lenders.
D)
Projects having negative NPV can have high internal rate of return.
B
Fundamentals of Corporate Finance 3e Test Bank
54.
As the manager of a sporting goods company, you are presented with a new golf
project. An inventor has recently patented the design for a new golf club that makes
playing golf much easier. Your company has made contact with the inventor, who is
willing to sell the exclusive rights to the technology, but if you don’t act fast he will sell
the rights to a rival company. You are not certain whether the new golf club will
become popular, but your analysts have completed a basic NPV analysis. Given the
available information, the project has a positive NPV. However, you know there are
several real options associated with the project, including the option to abandon the
project and the option to make follow-on investments. Which of the following
statements regarding the project is correct?
A)
Based on the NPV analysis, you should accept the project. The value of the
project may be worth more than the NPV analysis but not less.
B)
Based on the NPV analysis, you should accept the project. The NPV analysis
contains all the information about the value of the project.
C)
Based on the NPV analysis, you should reject the project. Without additional
information about the value of the real options, there is no way to make a
decision.
D)
Based on the NPV analysis, you should reject the project. The NPV analysis
contains all the information about the value of the project.
Ans:
A
Fundamentals of Corporate Finance 3e Test Bank
55.
Arctic Inc. has built a highly interactive operating system for mobile and other
electronic gadgets. The development cost to the company was high but the system was
inexpensive to sustain and market. The NPV of this project was negative. However, in
the coming years the company plans to launch mobile phones, portable audio and video
devices. The decision of launching the operating system for mobile and other devices is
an example of:
A)
option to defer investment.
B)
option to abandon a project.
C)
option to change operations.
D)
option to make follow-on investments.
Ans:
D
56.
The employment contracts for professional athletes often contain options for either the
player or the team. Consider one recent contract in Major League Baseball. The player’s
salary was guaranteed for the first couple of years. However, after several years, the
team had the option to cancel the contract if the player became injured. If we think of
each player as a project for the team, this option feature of the contract is best described
as:
A)
the option to defer investment.
B)
the option to make follow-on investments.
C)
the option to change operations.
D)
the option to abandon projects.
Fundamentals of Corporate Finance 3e Test Bank
57.
Adosonic Reality is considering the construction of a new development of
condominiums in downtown Austin, Texas. The site for the new development is
currently occupied by an office building owned by the city. The project’s profitability
will depend largely on the population increase in Austin over the next several years.
Rather than buy the site, Adosonic Reality has entered into an agreement with the city
to pay $200,000 for the right to purchase the site for $10 million two years from now.
The real option embedded in this contract is best described as:
A)
the option to defer investment.
B)
the option to make follow-on investments.
C)
the option to change operations.
D)
the option to abandon projects.
Ans:
A
58.
Consider a new firm that is working on the first generation of long-awaited consumer
jet packs. The project will take a tremendous amount of R&D expenditure. Even if the
development is successful, manufacturing the first generation of jet packs is likely to be
so expensive that only a selected few consumers will be able to afford them. The
projected sales of the first generation of jet packs almost certainly won’t cover the
development and manufacturing costs—the project has a negative NPV. Which of these
reasons would validate the firm’s decision to pursue the jet pack project?
A)
If development is unsuccessful, it can abandon the project before spending
money on manufacturing.
B)
If the project is successful, it may lead to a very profitable second project—a
cheaper jet pack that will be a positive-NPV project.
C)
Because it is a high-tech firm, the cash flows generated by a project are not
important to valuing the company.
D)
If development is successful, it allows managers to reach wide range of
consumers.
Ans:
B
Fundamentals of Corporate Finance 3e Test Bank
59.
A local city government has awarded a contract to sequentially build five new
elementary schools over the next 10 years. The price for each school has been spelled
out in the contract, but at the beginning of each year the city can cancel the order for
the remaining schools. The city government is concerned that if the population of the
town does not grow as expected it may not need all of the schools. What sort of
financial option does the option to cancel the order resemble?
A)
Owning a call option on the value of the new schools
B)
Owning a put option on the value of the new schools
C)
Selling a call option on the value of the new schools
D)
Selling a put option on the value of the new schools
Ans:
A
60.
Purchasing a house is a somewhat complicated process. Typically, if the buyer’s offer is
accepted by the seller, the transaction will not be completed or “closed” for several
weeks. During this time the buyer may gather more information about the house or
research other houses in the area. Some home purchase contracts include an option fee.
The buyer may pay the seller a few hundred dollars for the right to walk away from the
contract prior to closing for any reason. This option fee is best described as:
A)
the option to defer investment.
B)
the option to make follow-on investments.
C)
the option to change operations.
D)
a put option on the house.
Fundamentals of Corporate Finance 3e Test Bank
61.
The management at Sevenglobe Motors considered the option to abandon when
building their new manufacturing plant. The design of the plant allows it to easily be
converted to manufacture other types of large machinery. If their new line of cars is
poorly received, their plant should be easy to sell to another manufacturing company. In
this example, the extra cost of building the plant in such a way that it can easily be
converted for other uses resembles:
A)
the premium of a put option on the plant.
B)
the premium of a call option on the plant.
C)
the strike price of a put option on the plant.
D)
the strike price of a call option on the plant.
Ans:
A
62.
Anonxy Foods has made the decision to invest in a new line of organic microwave
dinners. The new line of dinners is a negative-NPV project; paying its suppliers to
convert to organic practices will be expensive. However, the company will be in a good
position to expand into more profitable lines of food if consumer demand for organic
foods grows more than expected. The negative value of the organic dinner project most
closely resembles:
A)
the premium of a put option on future organic projects.
B)
the premium of a call option on future organic projects.
C)
the strike price of a put option on future organic projects.
D)
the strike price of a call option on future organic projects.
Ans:
B
Fundamentals of Corporate Finance 3e Test Bank
63.
Bifive Homes, Inc., is a developer of planned residential communities. It has entered
into an option contract with a land owner outside Austin, Texas. It will pay the land
owner $100,000 for the option to buy the land in two years at a price of $20 million.
During that time Bifive Homes will evaluate population and real estate trends in Austin.
Its plan is to buy the land if real estate prices in Austin increase enough that developing
the land would be worth more than the $20 million price. The $20 million purchase
price resembles:
A)
the premium price of a put option on the land.
B)
the premium price of a call option on the land.
C)
the strike price of a put option on the land.
D)
the strike price of a call option on the land.
Ans:
D
64.
The claim stockholders hold on cash flows in a company with outstanding debt is often
described as:
A)
a call option on the firm’s assets.
B)
a put option on the firm’s assets.
C)
an interest-free bond with the same value as the firm’s assets.
D)
a put option on the firm’s liabilities.
Ans:
A
Fundamentals of Corporate Finance 3e Test Bank
65.
Which of the following statements is an example of the agency cost of debt?
A)
ABC Co. shareholders pressure management to invest in very risky projects in
hopes that one of the investments might pay off. The company is highly
leveraged, so shareholders have little to lose.
B)
ABC Co. has no debt but very few investment opportunities. The board of
directors decides not to pay out a large special dividend. Lenders collect 100
percent of the face value of the debt.
C)
ABC Co. is financially sound. The company has a negative-NPV investment
opportunity. Investors refuse to invest the additional funds necessary to pursue
the project, as it has negative NPV.
D)
Investors are unsure of the value for ABC Co. ABC Co. decides to issue equity to
pay down debt. The market assumes that ABC Co.’s managers are issuing equity
because they think that the company’s stock is overvalued. As a result, the
company’s stock price falls when the equity issue is announced.
Ans:
A
66.
The claim lenders’ hold on cash flows in a company with outstanding risky debt is often
thought of as:
A)
holding a call option on the firm’s assets.
B)
holding a put option on the firm’s assets.
C)
selling a put option on the firm’s assets and holding a risk-free bond.
D)
selling a call option on the firm’s asset and holding a risk-free bond.
Fundamentals of Corporate Finance 3e Test Bank
67.
Adding stock options and bonuses for performance to the compensation of a manager is
intended to closer align the interest of the manager with:
A)
stockholders.
B)
lenders.
C)
employees.
D)
public.
Ans:
A
68.
What is the payoff for a call option with a strike price of $50 if the underlying stock
price at expiration is $85?
A)
$35
B)
$50
C)
$45
D)
$140
Ans:
A
(Call) Payoff = Stock price – Strike price
69.
What is the payoff for the owner of a call option with a strike price of $35 if the
underlying stock price at expiration is $30?
A)
$10
B)
$20
C)
$5
D)
$0
Ans:
D
Fundamentals of Corporate Finance 3e Test Bank
70.
What is the payoff for the owner of a put option with a strike price of $63 if the
underlying stock price at expiration is $43?
A)
$126
B)
$43
C)
$20
D)
$63
Ans:
C
Payoff for the owner of a put option = Strike price – Stock price = $63 – $43 = $20
71.
You own a put option on Phosfranc Inc. stock with a strike price of $50. The current
stock price is $50. In which of the following cases your benefit will increase?
A)
If the stock price goes up
B)
If the stock price goes down
C)
If the stock price stays the same
D)
Benefit is indifferent to the changes in the stock price.
Ans:
B
Fundamentals of Corporate Finance 3e Test Bank
72.
You have sold a call option on Ausia Co. stock with a strike price of $50. You do not
intend to make any other transactions before the options expiration date. The current
stock price is $30. Which of the following statements best describes your hopes for the
stock?
A)
You want the stock price to fall below $30.
B)
You want the stock price to rise above $50.
C)
You are indifferent, as long as the stock price stays under $50.
D)
It doesn’t matter; you are indifferent to changes in the stock price.
Ans:
C
73.
What is the payoff for a put option with a strike price of $22 if the price of the
underlying stock at expiration is $19?
A)
$1
B)
$3
C)
$20
D)
$22
Ans:
B
Payoff for the owner of a put option = Strike price – Stock price = $22 – $19 = $3
Fundamentals of Corporate Finance 3e Test Bank
74.
Consider a call option with a strike price of $20, which expires in one year. The risk-
free rate of interest is 5 percent. The underlying stock price is $30. Without arbitrage,
which of the following is a possible price for the call option? (Round intermediate
computations to two decimal places.)
A)
$0
B)
$8
C)
$15
D)
$1
Ans:
C
Fundamentals of Corporate Finance 3e Test Bank
75.
Consider a call option with a strike price of $10, which expires in one year. The risk-
free rate of interest is 10 percent. The current underlying stock price is $30. Without
arbitrage, which of the following is a possible price for the call option? (Round
intermediate computations to two decimal places.)
A)
$0
B)
$19.50
C)
$21.00
D)
$19.00
Ans:
C
Fundamentals of Corporate Finance 3e Test Bank
76.
Consider a put option with a strike price of $40, which expires in one year. The risk-
free rate of interest is 8 percent. The current underlying stock price is $20. Without
arbitrage, which of the following is a possible price for the put option? (Round
intermediate computations to two decimal places.)
A)
$0.50
B)
$16.20
C)
$25.00
D)
$10.20
Ans:
C
Fundamentals of Corporate Finance 3e Test Bank
77.
Pitchgent, Inc., stock is currently trading at $22 per share. There are two types of
options available on the stock. Call options with a strike price of $16, which expire next
month, are currently trading at $7.00. Put options with a strike price of $16 which
expire next month are currently trading at $1.10. Larry invests $132 in common stock.
Keaty invests $132 in the call options. Marek invests $132 in the put options. At the
end of one month, the price of Pitchgent, Inc., is $25. Who made the most money off of
their investment?
A)
Larry
B)
Keaty
C)
Marek
D)
Larry and Keaty tied
Ans:
B
Fundamentals of Corporate Finance 3e Test Bank
78.
Tunerecord Unit Co. stock is currently trading at $24. There are two types of options
available on the stock. Call options with a strike price of $24, which expire next year,
are currently trading at $9.6. Put options with a strike price of $24, which expire next
year, are currently trading for $2.4. Berniss invests $144 in common stock. Jewel
invests $144 in the call options. Reynardo invests $144 in the put options. At the end of
one year the price of Tunerecord Unit stock is $21.6. Who made the least losses off of
their investment?
A)
Berniss
B)
Jewel
C)
Reynardo
D)
Berniss and Jewel tied
Ans:
C
Fundamentals of Corporate Finance 3e Test Bank
79.
Assume that the stock of Alitor Craft, Inc,. is currently trading for $19 and will either
rise to $21 or fall to $15 in one year. The risk-free rate for one year is 12 percent. What
is the value of a call option with a strike price of $16? (Do not round intermediate
computations. Round final answer to two decimal places.)
A)
$4.67
B)
$2.33
C)
$1.04
D)
$6.83
Ans:
A
Fundamentals of Corporate Finance 3e Test Bank
80.
Assume that the stock of Tencheck, Inc., is currently trading for $45 and will either rise
to $57 or fall to $19 in one year. The risk-free rate for one year is 9 percent. What is the
value of a call option with a strike price of $47? (Do not round intermediate
computations. Round final answer to two decimal places.)
A)
$3.40
B)
$6.84
C)
$8.84
D)
$7.25
Ans:
D
Fundamentals of Corporate Finance 3e Test Bank
81.
XYZ, Inc., stock is currently trading for $47 and will either rise to $49 or fall to $44 in
one year. The risk-free rate for one year is 6 percent. You own a call option with a
strike price of $32, which expires in one year. What is the value of your call option?
(Do not round intermediate computations. Round final answer to two decimal places.)
A)
$0
B)
$5.27
C)
$10.05
D)
$16.81
Ans:
D
The value of the option is the value of the replicating portfolio: