Deck 24: Options and Corporate Finance: Extensions and Applications

Question 1

Corporations by rewarding executives with large option positions:

A) cause the executives to hold highly undiversified portfolios.
B) put the firm in a risky position to pay off the options.
C) cause the value of the stock to fall because the options are theft.
D) are really valueless because most options are never exercised.

Answer 1

cause the executives to hold highly undiversified portfolios.

Question 2

What is d₁?

A) .1842
B) .4102
C) .4583
D) .4909
E) .5412

Answer 2

.4909

Question 3

Calculate N(d₂).

A) .5130
B) .5578
C) .6085
D) .7085
E) .7142

Answer 3

.5130

Question 4

What is d₂?

A) .0121
B) .0252
C) .0326
D) .0452
E) .0525

Question 5

Which of the following is not part of the Black Scholes option pricing model?

A) Standard deviation
B) Time to maturity
C) Exercise price
D) Par value of the company's stock

Question 6

The volatility of interest rates affect the value of the project by:

A) increasing the value as volatility increase.
B) increasing the value as volatility decrease.
C) decreasing the value as volatility increase.
D) interest rate volatility does not affect value.

Question 7

Options are granted to top corporate executives because:

A) executives will make better business decision in line with benefiting the shareholders.
B) Executive pay is at risk and linked to firm performance.
C) options are tax-efficient and taxed only when they are exercised.
D) all of the above.

Question 8

The risk-neutral probabilities for an asset, with a current value equal to the present value of future payoffs are:

A) given by the probability of each state occurring.
B) given by the value of the underlying asset under good news and the risk free rate.
C) given by the value of the underlying asset under good news and bad news.
D) given by the value of the underlying asset under good news, bad news, and the risk free rate.

Question 9

What are the u, the up state multiplier, and d, the down state multiplier, if there are monthly intervals and the standard deviation is .38?

A) 1.1159; .8961
B) .0317; 31.5789
C) .0317; .9683
D) .2193; .7807

Question 10

What is the value of a call option?

A) $4.14
B) $4.86
C) $5.13
D) $5.62
E) $6.16

Question 11

The Nu-Tech Company has a new project available to it at a cost of $6 million. The project that they can sell 13,000 personal organizers at $172 in net cash flow for each of the next five years. Nu-Tech's discount rate is 15%. What is the NPV of the investment? The executives of Nu-Tech are concerned about the potential of future competition and a subsequent drop in sales and price. If after two year you can dispose of the asset for 1.0 million at what price would it make sense to abandon the project?

Question 12

Executives can not exercise their options for a fixed period of time, this is the:

A) investing period.
B) freeze-out period.
C) valuation period.
D) guaranteed growth period.
E) strike period

Question 13

Walter Maxim, the CEO of Digital Storage Devices has been granted options on 300,000 shares. The stock is currently trading at $27 a share and the options are at the money. The volatility of the stock has been about .15 on an annual basis over the last several years. The option mature in 5 years, become exercisable in 3 years, and the risk free rate is 4%.
If Mr. Maxim earned $500,000 in regular annual salary why might why might he prefer to have $1,500,000 in straight salary versus salary and options?

Question 14

The Alger Co. operates a bauxite mine. The mine can produce 800,000 tons a year. The mine is currently closed and will cost $12 million to open it. When should the mine be opened?

A) At a net bauxite price after extraction/production costs equal to $15.00 per ton before discounting and valuing extended options.
B) At a net bauxite price after extraction/production costs greater than $15.00 per ton before discounting and valuing extended options.
C) If the mineable bauxite is available then the mine should be open because the cash breakeven is less than $15.00 per ton.
D) If mineable bauxite exists at any price close to $15.00 per ton if bauxite prices are high volatile.

Question 15

Rejecting an investment today forever may not be a good choice because:

A) the size of the firm will decline.
B) there are always errors in the estimation of NPVs.
C) the option value is negative.
D) the company's foregoing the future rights or option to the investment.

Question 16

Walter Maxim, the CEO of Digital Storage Devices has been granted options on 300,000 shares. The stock is currently trading at $27 a share and the options are at the money. The volatility of the stock has been about .15 on an annual basis over the last several years. The option mature in 5 years, become exercisable in 3 years, and the risk free rate is 4%.
What is the value of Mr. Maxim's options?

Question 17

The NPV approach must be:

A) augmented by added analysis if there are a few imbedded options.
B) augmented by added analysis if a decision has significant imbedded options.
C) jettisoned if there are any embedded options.
D) computed carefully to identify the options.

Question 18

The call option on a dividend paying stock compared to a non-dividend paying stock is:

A) more valuable because of the extra dividend payment.
B) equal in value because cash dividends are paid on stock only.
C) less valuable because cash dividends are paid on stock only.
D) less valuable if the dividend paying stock is in-the-money while the non-dividend paying stock if out-of-the-money.

Question 19

Calculate N(d₁).

A) .5054
B) .6508
C) .6882
D) .7047
E) .8096

Question 20

A financial manager who does not follow the general constraints of the NPV rule may:

A) accept a negative project for fear of losing an investment opportunity.
B) Accept a marginally acceptable NPV project limiting the corporation's ability to choose a competing project.
C) Option the project to another firm.
D) Not take a positive NPV project even if the NPV is adequate reward to forego the option.

Question 21

Why would the company pay the executive in options as opposed to salary?