1) Which of the following statements is CORRECT?

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a.An option’s value is determined by its exercise value, which is the market price of the stock less its striking price. Thus, an option can’t sell for more than its exercise value.

b.The market value of an option depends in part on the option’s time to maturity and also on the variability of the underlying stock’s price.

c.As the stock’s price rises, the time value portion of an option on a stock increases because the difference between the price of the stock and the fixed strike price increases.

d.The potential loss on an option decreases as the option sells at higher and higher prices because the profit margin gets bigger.

e.Issuing options provides companies with a low cost method of raising capital.

2)The current price of a stock is $50, the annual risk-free rate is 6%, and a 1-year call option with a strike price of $55 sells for $7.20. What is the value of a put option, assuming the same strike price and expiration date as for the call option?






3) An option that gives the holder the right to sell a stock at a specified price at some future time is

a.a naked option.

b.a covered option.

c.a put option.

d.a call option. out-of-the-money option.

4) Careco Company and Audaco Inc are identical in size and capital structure. However, the riskiness of their assets and cash flows are somewhat different, resulting in Careco having a WACC of 10% and Audaco a WACC of 12%. Careco is considering Project X, which has an IRR of 10.5% and is of the same risk as a typical Careco project. Audaco is considering Project Y, which has an IRR of 11.5% and is of the same risk as a typical Audaco project.

Now assume that the two companies merge and form a new company, Careco/Audaco Inc. Moreover, the new company’s market risk is an average of the pre-merger companies’ market risks, and the merger has no impact on either the cash flows or the risks of Projects X and Y. Which of the following statements is CORRECT?

a.After the merger, Careco/Audaco should select Project Y but reject Project X. If the firm does this, its corporate WACC will fall to 10.5%.

b.After the merger, Careco/Audaco would have a corporate WACC of 11%. Therefore, it should reject Project X but accept Project Y.

c.If the firm evaluates these projects and all other projects at the new overall corporate WACC, it will probably become riskier over time.

d.Careco/Audaco’s WACC, as a result of the merger, would be 10%.

e.If evaluated using the correct post-merger WACC, Project X would have a negative NPV

5) Which of the following statements is CORRECT?

a.The WACC that should be used in capital budgeting is the firm’s marginal, after-tax cost of capital.

b.The after-tax cost of debt usually exceeds the after-tax cost of equity.

c.The WACC is calculated using before-tax costs for all components.

d.For a given firm, the after-tax cost of debt is always more expensive than the after-tax cost of non-convertible preferred stock.

e.Retained earnings that were generated in the past and are reported on the firm’s balance sheet are available to finance the firm’s capital budget during the coming year.

6) Avery Corporation’s target capital structure is 35% debt, 10% preferred, and 55% common equity. The interest rate on new debt is 6.50%, the yield on the preferred is 6.00%, the cost of common from reinvested earnings is 11.25%, and the tax rate is 40%. The firm will not be issuing any new common stock. What is Avery’s WACC?






7) Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows.

a.A project’s NPV is generally found by compounding the cash inflows at the cost of capital to find the terminal value (TV), then discounting the TV at the IRR to find its PV.

b.The NPVs of relatively risky projects should be found using relatively low costs of capital.

c.If a project’s NPV is greater than zero, then its IRR must be less than the cost of capital.

d.If a project’s NPV is greater than zero, then its IRR must be less than zero.

e.The higher the cost of capital used to calculate the NPV, the lower the calculated NPV will be.

8) Suzanne’s Cleaners is considering a project that has the following cash flow data. What is the project’s payback?

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