Chapter 8: Problems 1, 3, 7
Chapter 26: Problem 2
Note:
· All quantitative work must be done in Excel; Word is not acceptable.
Chapter 8
8-1 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?
8-3 Assume that you have been given the following information on Purcell Industries: Current stock price $15 Strike price of option $15Time to maturity of option 6 months Risk-free rate 6%Variance of stock return 0.12d XXXXXXXXXXN(d 1 ) 0.59675d XXXXXXXXXXN(d XXXXXXXXXX
8-7. 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 tha thas a strike price of $14 and that expires in 6 months. ( Hint: Use daily compounding.)
Chapter 26: Problem 2
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 thee nd 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 that if it waits 2 years then the project would cost$9 million. Moreover, if 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?