Finc 5880 week 5 mid-term examination 36096

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?

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b. Calculate the value of the premium over and above the exercise value? What does
this value represent?

c. Is this an out-of-the money option, at-the-money, or in-the-money? Why?

d. What will happen to the value of the option if the underlying stock price changes to $34.50?
Why?

e. If this were a put option, would it have a greater or lesser value than the call option? Why?

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 5

 c. Calculate the terminal year cash flow.

 d. Calculate NPV. Should the machinery be purchased? Why or why not?

Question 3. (15 points) A company estimates the following free cash flows (FCFs) during the next 3 years, after which FCF
is expected to grow at a constant 6% rate. The company’s cost of capital is 12%. the company has $3 million in marketable
securities, $50 million in debt, and 10 million shares of stock.

Year
Free cash flow ($ millions)

1
-5

2
15

3
30

a. Calculate the company’s horizon, value?

b. Calculate the company’s current value of operations.

c. Calculate the value of one share of share?

d. The stock is selling for $32.50. Is it appropriately priced in the market? Explain.

Page 3 of 4

05/18/2013

Mid-Term Examination
FINC 5880
Week 5
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?
Equipment cost
Current assets
Net Fixed assets
Total assets

$10,000
Current Balance Sheet
$50,000
Debt
40,000
Equity
$90,000
Total claims

$35,000
55,000
$90,000

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?

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