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CHAPTER 24
OPTIONS AND CORPORATE FINANCE
Answers to Concepts Review and Critical Thinking Questions
1. A call option confers the right, without the obligation, to buy an asset at a given price on or before a
10. The reason they don’t show up is that the U.S. government uses cash accounting; i.e., only actual cash
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12. The option to expand reflects our ability to increase production if the new product sells more than we
Solutions to Questions and Problems
NOTE: All end of chapter problems were solved using a spreadsheet. Many problems require multiple
steps. Due to space and readability constraints, when these intermediate steps are included in this solutions
manual, rounding may appear to have occurred. However, the final answer for each problem is found
without rounding during any step in the problem.
Basic
1. a. The value of the call is the stock price minus the present value of the exercise price, so:
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c. The Mar call and the Oct put are mispriced. The call is mispriced because it is selling for less
3. a. Each contract is for 100 shares, so the total cost is:
The maximum gain on the put option would occur if the stock price goes to $0. We also need to
subtract the initial cost, so:
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4. a. Using the equation presented in the text to prevent arbitrage, we find the value of the call is:
6. Each option contract is for 100 shares of stock, so the price of a call on one share is:
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b. The current value of debt is the value of the firm’s assets minus the value of the equity, so:
8. a. Using the no arbitrage valuation model, we can use the current market value of the firm as the
stock price, and the par value of the bond as the strike price to value the equity. Doing so, we get:
9. The conversion ratio is the par value divided by the conversion price, so:
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10. a. The minimum bond price is the greater of the straight bond value or the conversion price. The
straight bond value is:
11. a. The minimum bond price is the greater of the straight bond value or the conversion value. The
straight bond value is:
b. The conversion premium is the difference between the current stock price and conversion price,
divided by the current stock price, so:
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12. The value of the bond without warrants is:
13. If we purchase the machine today, the NPV is the cost plus the present value of the increased cash
flows, so:
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Intermediate
14. a. The base-case NPV is:
15. a. If the project is a success, present value of the future cash flows will be:
b. If we couldn’t abandon the project, the present value of the future cash flows when the quantity
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16. If the project is a success, present value of the future cash flows will be:
17. a. The value of the call is the maximum of the stock price minus the present value of the exercise
price, or zero, so:
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19. a. The conversion ratio is given at 19. The conversion price is the par value divided by the
conversion ratio, so:
b. The straight bond value is:
c. We simply need to set the straight bond value equal to the conversion ratio times the stock price,
and solve for the stock price, so:
20. a. The NPV of the project is the sum of the present value of the cash flows generated by the project.
The cash inflows from this project are an annuity, so the NPV is:
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b. The company should abandon the project if the PV of the revised cash flows for the next seven
Challenge
21. The straight bond value today is:
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22. We will use the bottom-up approach to calculate the operating cash flow. Assuming we operate the
project for all four years, the cash flows are:
Year
0
1
2
3
4
b. The cash flows if we abandon the project after one year are:
Year
0
1
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So, the taxes on the salvage value will be:
If we abandon the project after two years, the cash flows are:
Year
0
1
2
The book value of the equipment is:
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The NPV if we abandon the project after two years is:
If we abandon the project after three years, the cash flows are:
Year
0
1
2
3
The book value of the equipment is:
