QUESTION 4

(a) You are employed by ABC Inc. as a consultant to evaluate their investment options and make recommendations. The company is currently evaluating investing in t-shirt manufacturing plant (Project T) which will cost $250,000 to construct. Revenues are expected to be $100,000 for the next 3 years. At the end of the 3 years, the company will have the option to increase its size to supply a major clothing company. The probability of getting contract is 10% with an NPV of $700,000 however there is a 90% probability that the next best alternative will result in a NPV of negative $500,000.

Assuming a 15% discount rate, calculate the Expected Net Present Value at time zero (0) of Project T and advise if it make sense to proceed with the project?[7 Marks]

(b) You have recently noticed that the value of a National Commercial Bank ("NCB") stock 180-day Call Option with an Exercise Price of $140 was calculated to be $9.50 by an Analyst at Mayberry. You are however, interested in the value of a 90 day Put Option on NCB stock. If the Risk Free Rate is 10.0% p.a and you believe that the price of the NCB stock can either go to $168 or $119, what is the current value of the 180-day Put Option on this stock? [7 Marks]

(c) The common stock of Navara Limited serves as underlying asset for the following derivative securities:

i) Long Forward contract with a contract price of $50

ii) Long European style call option with and exercise price of $50 and an option price of $5.

iii) Long European style put option with and exercise price of $50 and an option price of $3.

Assuming that all the derivatives expiry on the same day, what is the payoff/profit for each of the derivatives at the below closing prices?[6 marks]

Price at expiry Forward Call Put

$25 ? ? ?

$50 ? ? ?

$65 ? ? ?