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2023-2 Assignment2

The document provides instructions for a corporate finance assignment with 6 questions. Question 1 has 3 parts asking to calculate ex-right stock price, right value, and subscription price given different rights entitlement ratios. Question 2 asks to draw payoff diagrams for two investment strategies. Question 3 asks to calculate a put option premium using a replication approach. Question 4 asks to price an American call option using a binomial tree. Question 5 asks to calculate a firm's equity value using a binomial approach. Question 6 asks to estimate the value of warrants given stock price and volatility information.

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24 views

2023-2 Assignment2

The document provides instructions for a corporate finance assignment with 6 questions. Question 1 has 3 parts asking to calculate ex-right stock price, right value, and subscription price given different rights entitlement ratios. Question 2 asks to draw payoff diagrams for two investment strategies. Question 3 asks to calculate a put option premium using a replication approach. Question 4 asks to price an American call option using a binomial tree. Question 5 asks to calculate a firm's equity value using a binomial approach. Question 6 asks to estimate the value of warrants given stock price and volatility information.

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BUSS384

Corporate Finance

Assignment 2

(Due by Dec. 13, 2023)


Please solve the following questions. Please make sure that you write down the names of all of
your group members. The assignment is due at the beginning of class on the due date. Please
show all the intermediate steps and calculations when solving the problems and state your
assumptions (if any). Please type your answers.

1. XYZ Corp.’s stock is currently selling at $13 per share. There are 1 million shares
outstanding. The firm is planning to raise $2million to finance a new project. What is
the ex-right stock price, the value of a right, and the appropriate subscription prices, if

(a) Two shares of outstanding stock are entitled to purchase one additional share of
the new issue.
(b) Four shares of outstanding stock are entitled to purchase one additional share of
the new issue.
(c) How does the stockholders’ wealth change from a to b?

2. Draw the expiration date payoff diagrams for the following investment strategies: (You can
draw by hand.)

(a) Buy a put option with a strike price of $30, sell a put option with a strike price of $80
and borrow the present value of $50 at the risk-free rate.
(b) Buy a call option with a strike price of $100, sell a call option with a strike price of
$150 and buy a share of stock.

3. ABC Corp’s stock is currently trading at $51. Over the next year, the stock can either
increase by 10% with 60% probability or it can decrease by 10% with 40% probability.
Using the “portfolio replication approach”, compute the current put option premium on
ABC Corp’s stock assuming the following: the exercise price on the put option is $53 and it
expires in one year. T-bills yield 7%.

4. Consider a 3-month American call option on a non-dividend-paying stock when the stock
price is $100, the strike price is $95, the risk-free interest rate is 8% per annum, and the
volatility is 30% per annum. Suppose that we divide the life of the option into three intervals
of length 1 month for the purposes of constructing a binomial tree. Determine the price of this
call option today using “binomial approach”.
5. ABC Corp. is considering an investment project over the next period. It has an equal chance
of success and failure. If it succeeds, the firm’s assets will have a market value of $40
million, and if it fails, the market value will drop to $10 million. The current market value of
the firm’s asset is $25 million. Also, the firm currently has bonds outstanding with $15
million of promised payment to bondholders at their maturity, which is the end of the period.
What is the firm’s equity value? Assume that the risk-free rate over the next period is 10%.
(Hint: Use the “binomial approach”)

6. ABC Corp. has 4 million shares of common stock outstanding. The company has
500,000 warrants being traded in the market. Each warrant has the right to buy one
share of common stock at $20 per share. The warrant will expire one year from
today. ABC Corp. stock is selling for $22 per share and the volatility of the return on
stock is 0.005. The risk-free rate is 5 percent. Estimate the warrant value.

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