1. Knightly Co's stock price is currently $10 per share. Knightly's warrants have a price of $7
per warrant. Each warrant enables the holder to purchase three shares of Knightly's common
stock for $8 per share. What is the speculative premium on the warrant?

2. Let us suppose that an investor buys a 100-share call option for $250. The call option has an
exercise price of $60. The underlying price per share of the stock at expiration is $66. What
then is the amount of profit or loss, ignoring brokerage fees?

Use the following information for the next three problems.

Floppy Company has an issue of convertible bonds with a $1,000 par value. Floppy's bonds
have a 10 percent coupon rate. They have a 10-year maturity, and are convertible into 100
shares of common stock. The yield to maturity on bonds of similar risk is 11 percent and the
market price of the firm's common stock is currently $9.00. Based on this information,
3. What is the conversion value of Floppy's bond if it is selling at $970.

4. What is its pure bond value?

5. What is its conversion premium?

6. Frosty, Inc. presently has an outstanding 5 percent, $1,000 convertible bond. The bond can
be converted into 25 shares of common stock and it is callable at $1,050. Right now, the
current market price of the firm's stock is $41 per share. The bond holder will_______.
A) allow the call to be exercised
B) convert the bond into stock
C) sell the bond on the secondary market
D) do nothing and wait until the stock price goes up further

7. Kelsey Tanaka is an investor who buys a 100-share put option for $150. It has an exercise
price of $38 and the underlying price per share of the stock at expiration is $39. What is
Kelsey's amount of profit or loss, ignoring brokerage fees?

8. Tyrone Company wants to purchase a property that costs $150,000. The full amount needed
to finance the purchase can be borrowed at 12% interest. The terms of the loan require equal
end-of-year payments for the next 6 years. Determine the total annual loan payment.

 

 

Use the following information for the next two problems:
Top management of Markel Company is considering whether to lease or purchase an aircraft
to transport them around the country. They are in the 40 percent tax bracket and their after-
tax cost of debt is 7 percent. The estimated after-tax cash flows for the lease and purchase
alternatives are given below. (The Year 5 purchase cash flow is positive since they rent out
the aircraft for part of that year.)

End of Year Lease
(cash flows are all
negative)
Purchase
Yrs 1-4 cash flows
are negative; Year 5
is positive.
1. (40,000) (68,454)
2. (40,000) (59,110)
3. (40,000) (63,596)
4. (40,000) (66,633)
5. (40,000) 30,056

9. Given the above cash outflows, calculate the present value of the after-tax cash flows of the
lease alternative using the after-tax cost of debt.

10. Given the above cash outflows:
a) Calculate the present value of the after-tax cash flows of the purchase alternative using the
after-tax cost of debt. (Hint: if you are confused about using NPV for this problem, you can
calculate the PV of each cash flow and add them together. Keep in mind that there are
outflows and inflows.)
b) Which alternative do you choose?

 

11.

Floopy Co has decided to purchase new equipment. They are in the 38% tax bracket.
The desired equipment costs $77,000 and it can be financed entirely with a 12% loan which
requires annual end-of-year payments of $32,059 for 3 years. The firm will depreciate the
equipment under MACRS using a 3-year recovery period (depreciation is 33% in year 1, 45% in
year 2 and 15% in year 3). The firm will pay $2,000 per year for a maintenance contract.
Calculate the present value of the cash outflows for the purchase alternative.
A template is on the next page for those who want to work this problem.