Complete the sentences in the appropriate form of the appropriate adjective in the box, depending on the context
answer the questions with the word box and you have to have the word in the correct spot
Fin 325 Fall2020 Assignment 4
Release date: Nov11, 2020 Due date: Nov18, 2020 @ 11:59pm
Please finish this assignment in groups. The maximum number of students in each group is
The final submitted copy should contain the group number in Canvas (if any), the name and
student ID of each group member.
The assignment must be finished and submitted through Canvas in an Excel format. No other
format will be accepted. Please organize your answer in an easy-to-read way.
1. Rocky Mountain Inc. is all-equity-financed. The expected rate of return on the
company’s shares is 14.75%.
A. What is the opportunity cost of capital for an average-risk Rocky Mountain investment?
B. Suppose the company issues debt, repurchases shares, and moves to a 38% debt-tovalue ratio (D/V = 0.38). What will be the company’s weighted-average cost of capital at
the new capital structure? The borrowing rate is 9.25% and the tax rate is 21%.
2. Urban Solar (US) has the opportunity to invest $2.15 million now (t = 0) and expects aftertax cash flow of $1,500,000 in t = 1 and $1,800,000 in t = 2. The project will last for two years
only. The opportunity cost of capital is 15% with all-equity financing, the borrowing rate is
7%, and US will borrow $1.8 million against the project. This debt must be repaid in two
equal installments of $900,000 each. Assume the tax rate is 21%.
A. Calculate the base case NPV of this project.
B. What is the interest tax shield each year?
C. Calculate the project’s APV.
D. If the firm incurs issue costs of $150,000 to raise the $1.8 million of required equity, what will
be the APV?
3. TreeOlivia’s stock price is $180 and could halve or double in each six-month period. The
interest rate is 12% a year.
A. What is the value of a six-month call option on TreeOlivia with an exercise price of
B. What is the option delta for the six-month call with an exercise of $120?
C. The payoffs of the six-month call option can be replicated by buying shares of stock
and borrowing. What amount should be invested in stock and what amount must be
borrowed? Assume the exercise price is $120.
D. What is the value of the one-year call option on TreeOlivia with an exercise of
$150? (Hint: use the two-step binominal tree)
E. What is the value of the one-year put option on TreeOlivia with an exercise of $150?
4. The following information is given:
I. Time to expiration 1 year.
II. Standard deviation 40% per year.
III. Exercise price $72.
IV. Stock price $72.
V. Risk free rate 4% a year.
A. Use the Black–Scholes formula to find the value of the call option.
B. What is the value of the put option with the same exercise price and time to expiration?
C. What is the value of the call option if time to expiration is 3 years?
D. What is the value of the call option if the standard deviation is 20%?
E. What is the value of the call option if the exercise price is $90?
F. What is the value of the call option if the current stock price is $50?
G. What is the value of the call option if the risk-free rate is 8%?
5. Tescac’s assets are worth $290. It has $175 of zero-coupon debt outstanding that is due to
be repaid at the end of two years. The risk-free interest rate is 5%, and the standard deviation
of the returns on Tescac’s assets is 40% per year.
A. What is the value of the put option owned by shareholders?
B. What is the value of the company’s debt?
C. What is the value of the company’s equity?
6. You own a bond with an annual coupon rate of 5% maturing in two years and priced at 85%.
Suppose that there is a 23% chance that at maturity the bond will default and you will receive
only 45% of the promised payment. Assume a face value of $1,000.
A. What is the bond’s promised yield to maturity?
B. What is its expected yield (i.e., the possible yields weighted by their probabilities)?
7. The owner of a pro-football team expects the team to be worth either $270 million next year
or $120 million, depending on whether or not she gets the city to build a new stadium. There is
a 60 percent chance she will get a new stadium. There is a buyer willing to pay $180 million for
the team right now. However, the buyer will keep his offer open—until the stadium issue is
resolved—if offered some form of compensation. If the interest rate is 6 percent, how much
should she be willing to pay the potential buyer for a one-year option to sell the team (round
to the nearest $1 million)?
8. Suppose Carol’s stock price is currently $20. If the standard deviation of the continuously
compounded returns (σ) on a stock is 60 percent per year. The monthly risk-free rate is 1
percent. Using one-step binomial tree, what is the current value of a six-month call option with
an exercise price of $15?
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