1) A call option on the stock of Bedrock Boulders has a market price of $7. The stock sells for $30 a share, and the option has a strike price of $25 a share. What is the exercise value of the call option? What is the option's time value?

3) Assume that you have been given the following information on Purcell Industries:

Current stock price = $15 Strike price of option = $15

Time to maturity of option = 6 months Risk-free rate = 6%

Variance of stock return = 0.12

d1 = 0.24495 N(d1) = 0.59675

d2 = 0.00000 N(d2) = 0.50000

7) The current price of a stock is $15. In 6 months, the price will be either $18 or $13. The annual risk-free rate is 6%. Find the price of a call option on the stock that has a strike price of $14 and that expires in 6 months. (Hint: Use daily compounding.)

3) The Karns Oil Company is deciding whether to drill for oil on a tract of land the company owns. The company estimates the project would cost $8 million today. Karns estimates that, once drilled, the oil will generate positive net cash flows of $4 million a year at the end of each of the next 4 years. Although the company is fairly confident about its cash flow forecast, in 2 years it will have more information about the local geology and about the price of oil. Karns estimates if it waits 2 years then the project would cost $9 million. Moreover, it it waits 2 years, then there is a 90% chance that the net cash flows would be $4.2 million a year for 4 years and a 10% chance that they would be $2.2 million a year for 4 years. Assume all cash flows are discounted at 10%.

a. If the company chooses to drill today, what is the project's net present value?

b. Using decision-tree analysis, does it make sense to wait 2 years before deciding whether to drill?