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Questions and Answers of Corporate Finance

Consider the example of the valuation of the pharmaceutical R&D project described in the final section of the chapter. Under the assumptions stated, the DTA value is identical to the ROV value.
Discuss the relative merits of including risk adjustments in cash flow or in discount rates—especially for high-growth companies in emerging markets—and show how both approaches can be aligned.
To estimate the beta for a Brazilian telecommunications company, you have collected a sample of telecom peers in Latin America and Asia and peers in the United States and Europe. The median beta
Many emerging economies have restrictions on capital outflows to protect their growth and stability; for example, they may impose high taxes on repatriated profits by foreign companies. Where
What is the importance of purchasing power parity when you are trying to establish value for a company located in an emerging market?
Identify four risks associated with emerging markets that affect enterprise discounted cash flow (DCF) valuation. How should these risks be treated within the enterprise DCF model?
Describe the benefits of a scenarioDCFvaluation model. What factors should be considered when constructing scenario parameters?
You are computing the value of a firm headquartered in an emerging market. Identify the factors unique to an emerging market that need to be evaluated when estimating the cost of equity using the
Volatilities for individual stock and market indexes in emerging economies are typically higher than those for U.S. stocks and indexes. Should that mean that the cost of capital for investments in
Explain how the process of valuing a high-growth company differs from valuing an established company.
How does the total market for a new product differ from a company’s addressable market? Which market is more relevant for forecasting a company’s revenues?
For a company with a new product, how can you estimate its potential market share?
How do you estimate the potential margin and capital turnover for a young, high-growth company? Are the company’s current margin and capital turnover relevant?
Why do most young, high-growth companies have negative earnings?
Last year, GrowthCo traded at $20 per share. Over the past 12 months, the company’s share price rocketed to $60 per share. Does this mean the share price was misvalued last year?
Assuming investors had perfect foresight, how would the volatility of a cyclical company’s share price compare to the volatility of its profits?
Describe how analyst projections of cyclical company profits compare to actual performance. What are the possible reasons for the deviation?
Why should a scenario approach to valuation be used to value cyclical companies?
What are the potential reasons cyclical companies invest cyclically rather than countercyclically?
Why should you estimate the value of a bank by employing the equity cash flow method when throughout the text the enterprise DCF models have been stressed?
Identify the value drivers embedded in the equity cash flow model. How do the equity cash flow drivers differ from the drivers of the enterprise DCF models?
Why is maturity mismatch important for understanding a bank’s risk and analyzing its performance?
If a bank increases its maturity mismatch, what happens to its economic spread before taxes and its economic spread after taxes (i.e., including the tax penalty)?
If a bank attracts new equity to increase its Tier 1 capital ratio, what happens to its cost of equity and its intrinsic value if it invests the new equity capital in (1) deposits with the central
Consider a large banking group with businesses in retail banking, equity trading, and mergers and acquisitions (M&A) advisory. Discuss its potential for creating value based on the possible
In a bank valuation, the amount of current loan loss provision is not deducted from the DCF result. Why is it then important to analyze the adequacy of the bank’s current loan loss provisions?
In the economic spread analysis, a tax penalty is allocated to a bank’s interest spread on loans but no tax credit is allocated to the interest spread on deposits. Why does that not violate the
Heating degree-day and cooling degree-day futures contracts make payments based on whether the temperature is abnormally hot or cold. Explain why the following businesses might be interested in such
Short interest is a measure of the aggregate short positions on a stock. Check an online brokerage or other financial service for the short interest on several stocks of your choice. Can you guess
Suppose that you go to a bank and borrow $100. You promise to repay the loan in 90 days for $102. Explain this transaction using the terminology of short-sales.
Suppose your bank's loan officer tells you that if you take out a mortgage (i.e., you borrow money to buy a house), you will be permitted to borrow no more than 80% of the value of the house.
Pick a derivatives exchange such as CME Group, Eurex, or the Chicago Board Options Exchange. Go to that exchange's website and try to determine the following:a. What products the exchange
Consider the widget exchange. Suppose that each widget contract has a market value of $0 and a notional value of $100. There are three traders, A, B, and C. Over one day, the following trades occur:
Suppose the businesses in the previous problem use futures contracts to hedge their temperature-related risk. Who do you think might accept the opposite risk?
ABC stock has a bid price of $40.95 and an ask price of $41.05. Assume there is a $20 brokerage commission.a. What amount will you pay to buy 100 shares?b. What amount will you receive for
Repeat the previous problem supposing that the brokerage fee is quoted as 0.3% of the bid or ask price.Previous ProblemABC stock has a bid price of $40.95 and an ask price of $41.05. Assume there is
Suppose a security has a bid price of $100 and an ask price of $100.12. At what price can the market-maker purchase a security? At what price can a market-maker sell a security? What is the spread in
Suppose you short-sell 300 shares of XYZ stock at $30.19 with a commission charge of 0.5%. Supposing you pay commission charges for purchasing the security to cover the short-sale, how much profit
Suppose you desire to short-sell 400 shares of JKI stock, which has a bid price of$25.12 and an ask price of $25.31. You cover the short position 180 days later when the bid price is $22.87 and the
When you open a brokerage account, you typically sign an agreement giving the broker the right to lend your shares without notifying or compensating you. Why do brokers want you to sign this
Suppose a stock pays a quarterly dividend of $3. You plan to hold a short position in the stock across the dividend ex-date. What is your obligation on that date? If you are a taxable investor, what
Suppose XYZ stock has a price of $50 and pays no dividends. The effective annual interest rate is 10%. Draw payoff and profit diagrams for a long position in the stock. Verify that profit is 0 at a
For Figure 2.6, verify the following:a. The S&R index price at which the call option diagram intersects the x-axis is $1095.68.b. The S&R index price at which the call option and forward
For Figure 2.8, verify the following:a. The S&R index price at which the put option diagram intersects the x-axis is $924.32.b. The S&R index price at which the put option and forward
For each entry in Table 2.5, explain the circumstances in which the maximum gain or loss occurs.
Suppose the stock price is $40 and the effective annual interest rate is 8%.a. Draw on a single graph payoff and profit diagrams for the following options:(i) 35-strike call with a premium of
Suppose the stock price is $40 and the effective annual interest rate is 8%. Draw payoff and profit diagrams for the following options:a. 35-strike put with a premium of $1.53.b. 40-strike
The profit calculation in the chapter assumes that you borrow at a fixed interest rate to finance investments. An alternative way to borrow is to short-sell stock. What complications would arise in
A sold goods to B for 20000. B whose value added is 40000 sell half of its output to c and remaining to D. C sells all its output to D. D whoes value added is 30000 sell whole of its output to final
Using the same information as the previous question, draw payoff and profit diagrams for a short position in the stock. Verify that profit is 0 at a price in 1 year of $55.
What position is the opposite of a purchased call? The opposite of a purchased put?
a. Suppose you enter into a long 6-month forward position at a forward price of $50. What is the payoff in 6 months for prices of $40, $45, $50, $55, and $60?b. Suppose you buy a 6-month call option
a. Suppose you enter into a short 6-month forward position at a forward price of $50. What is the payoff in 6 months for prices of $40, $45, $50, $55, and $60?b. Suppose you buy a 6-month put option
A default-free zero-coupon bond costs $91 and will pay $100 at maturity in 1 year.What is the effective annual interest rate? What is the payoff diagram for the bond? The profit diagram?
Suppose XYZ stock pays no dividends and has a current price of $50. The forward price for delivery in 1 year is $55. Suppose the 1-year effective annual interest rate is 10%.a. Graph the payoff and
Suppose XYZ stock pays no dividends and has a current price of $50. The forward price for delivery in one year is $53. If there is no advantage to buying either the stock or the forward contract,
An off-market forward contract is a forward where either you have to pay a premium or you receive a premium for entering into the contract. (With a standard forward contract, the premium is zero.)
Suppose that you buy the S&R index for $1000, buy a 1000-strike put, and borrow $980.39. Perform a payoff and profit calculation mimicking Table 3.1. Graph the resulting payoff and profit
Construct payoff and profit diagrams for the purchase of a 1050-strike S&R call and sale of a 950-strike S&R call. Verify that you obtain exactly the same profit diagram for the purchase of a
Suppose you invest in the S&R index for $1000, buy a 950-strike put, and sell a 1050 strike call. Draw a profit diagram for this position. What is the net option premium? If you wanted to
Suppose you invest in the S&R index for $1000, buy a 950-strike put, and sell a 1107 strike call. Draw a profit diagram for this position. How close is this to a zero-cost collar?
Draw profit diagrams for the following positions:a. 1050-strike S&R straddle.b. Written 950-strike S&R straddle.c. Simultaneous purchase of a 1050-strike straddle and sale of a 950-strike
Suppose you buy a 950-strike S&R call, sell a 1000-strike S&R call, sell a 950-strike S&R put, and buy a 1000-strike S&R put.a. Verify that there is no S&R price risk in this
Compute profit diagrams for the following ratio spreads:a. Buy 950-strike call, sell two 1050-strike calls.b. Buy two 950-strike calls, sell three 1050-strike calls.c. Consider buying n
In the previous problem we saw that a ratio spread can have zero initial premium. Can a bull spread or bear spread have zero initial premium? A butterfly spread? Why or why not?
Construct an asymmetric butterfly using the 950-, 1020-, and 1050-strike options.How many of each option do you hold? Draw a profit diagram for the position.
Verify that the butterfly spread in Figure 3.14 can be duplicated by the following transactions (use the option prices in Table 3.4):a. Buy 35 call, sell two 40 calls, buy 45 call.b. Buy 35 put, sell
Here is a quote from an investment website about an investment strategy using options:One strategy investors are applying to the XYZ options is using "synthetic stock."Asynthetic stock is created
Suppose that you short the S&R index for $1000 and sell a 1000-strike put. Construct a table mimicking Table 3.1 that summarizes the payoff and profit of this position. Verify that your table matches
Construct a spreadsheet for which you can input up to five strike prices and quantities of put and call options bought or sold at those strikes, and which will automatically construct the total
Suppose you buy theS&Rindex for $1000 and buy a 950-strike put. Construct payoff and profit diagrams for this position.Verify that you obtain the same payoff and profit diagram by investing
Suppose you short the S&R index for $1000 and buy a 950-strike call. Construct payoff and profit diagrams for this position. Verify that you obtain the same payoff and profit diagram by borrowing
Suppose you short the S&R index for $1000 and buy a 1050-strike call. Construct payoff and profit diagrams for this position. Verify that you obtain the same payoff and profit diagram by
Verify that you earn the same profit and payoff by (a) Buying the S&R index for $1000 and (b) Buying a 950-strike S&R call, selling a 950-strike S&R put, and lending $931.37.
Verify that you earn the same profit and payoff by (a) Shorting the S&R index for $1000 and (b) Selling a 1050-strike S&R call, buying a 1050-strike put, and borrowing $1029.41.
Suppose the premium on a 6-month S&R call is $109.20 and the premium on a put with the same strike price is $60.18. What is the strike price?
Construct payoff and profit diagrams for the purchase of a 950-strike S&R call and sale of a 1000-strike S&R call.Verify that you obtain exactly the same profit diagram for the purchase of a
If XYZ does nothing to manage copper price risk, what is its profit 1 year from now, per pound of copper? If on the other hand XYZ sells forward its expected copper production, what is its estimated
Compute estimated profit in 1 year if Telco sells collars with the following strikes:a. $0.95 for the put and $1.00 for the call.b. $0.975 for the put and $1.025 for the call.c. $0.95 for the put and
Compute estimated profit in 1 year if Telco buys paylater calls as follows (the net premium may not be exactly zero):a. Sell one 0.975-strike call and buy two 1.034-strike calls.b. Sell two
Suppose that Wirco does nothing to manage the risk of copper price changes. What is its profit 1 year from now, per pound of copper? Suppose that Wirco buys copper forward at $1. What is its profit 1
What happens to the variability of Wirco's profit if Wirco undertakes any strategy (buying calls, selling puts, collars, etc.) to lock in the price of copper next year? You can use your answer to the
Golddiggers has zero net income if it sells gold for a price of $380. However, by shorting a forward contract it is possible to guarantee a profit of $40/oz. suppose a manager decides not to hedge
Consider the example in Table 4.6. Suppose that losses are fully tax-deductible. What is the expected after-tax profit in this case?€¢XYZ mines copper, with fixed costs of $0.50/lb and variable
Suppose that firms face a 40% income tax rate on all profits. In particular, losses receive full credit. Firm A has a 50% probability of a $1000 profit and a 50% probability of a $600 loss each year.
Suppose that firms face a 40% income tax rate on positive profits and that net losses receive no credit. (Thus, if profits are positive, after-tax income is (1ˆ’ 0.4)Ã— profit,
Consider the example of Auric.a. Suppose that Auric insures against a price increase by purchasing a 440-strike call. Verify by drawing a profit diagram that simultaneously selling a 400 strike put
Suppose that LMN Investment Bank wishes to sell Auric a zero-cost collar of width 30 without explicit premium (i.e., there will be no cash payment from Auric to LMN). Also suppose that on every
Suppose the 1-year copper forward price were $0.80 instead of $1. If XYZ were to sell forward its expected copper production, what is its estimated profit 1 year from now? Should XYZ produce copper?
Use the same assumptions as in the preceding problem, without the bid-ask spread.Suppose that we want to construct a paylater strategy using a ratio spread. Instead of buying a 440-strike call, Auric
Using the information in Table 4.11, verify that a regression of revenue on price gives a regression slope coefficient of about 100,000.€¢XYZ mines copper, with fixed costs of $0.50/lb and
Using the information in Table 4.9 about Scenario C:a. Compute Ïƒtotal revenue when correlation between price and quantity is positive.b. What is the correlation between price and revenue?€¢XYZ
Using the information in Table 4.9 about Scenario C:a. Using your answer to the previous question, use equation (4.7) to compute the variance-minimizing hedge ratio.b. Run a regression of revenue on
Using the information in Table 4.9 about Scenario C:a. What is the expected quantity of production?b. Suppose you short the expected quantity of corn. What is the standard deviation of hedged
Suppose that price and quantity are positively correlated as in this table:There is a 50% chance of either price. The futures price is $2.50. Demonstrate the effect of hedging if we do the
Compute estimated profit in 1 year if XYZ buys a put option with a strike of $0.95, $1.00, or $1.05. Draw a graph of profit in each case.€¢XYZ mines copper, with fixed costs of $0.50/lb and
Compute estimated profit in 1 year if XYZ sells a call option with a strike of $0.95, $1.00, or $1.05. Draw a graph of profit in each case.€¢XYZ mines copper, with fixed costs of $0.50/lb and
Compute estimated profit in 1 year if XYZ buys collars with the following strikes:a. $0.95 for the put and $1.00 for the call.b. $0.975 for the put and $1.025 for the call.c. $1.05 for the put and
Compute estimated profit in 1 year if XYZ buys paylater puts as follows (the net premium may not be exactly zero):a. Sell one 1.025-strike put and buy two 0.975-strike puts.b. Sell two 1.034-strike
If Telco does nothing to manage copper price risk, what is its profit 1 year from now, per pound of copper that it buys? If it hedges the price of wire by buying copper forward, what is its estimated

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