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Mace and Thomas Buildings Inc. has decided to go public by selling $10,000,000 of new common stock. Its investment bankers agreed to take a smaller fee now (7% of gross proceeds versus their normal 12%) in exchange for a 1?year option to purchase an additional 300,000 shares at $5.00 per share. The investment bankers expect to exercise the option and purchase the 300,000 shares in exactly one year, when the stock price is forecasted to be $4.50 per share. However, there is a chance that the stock price will actually be $10.00 per share one year from now. If the $10 price occurs, what would the present value of the entire underwriting compensation be?

Assume that the investment banker's required return on such arrangements is 18%, and ignore taxes.

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Jamar Ferry
Jamar FerryLv2
28 Sep 2019

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Related questions

Which of the following is correct?

NPV will be higher if sunk costs are included in a project's cash flows
A good example of a sunk cost is a situation where a company builds a restaurant and that results in lower sales by another of its restaurants.
A good example of a sunk cost is a situation where a company builds a restaurant and closes another of its restaurants.
A good example of a sunk cost is a situation where a company evaluated a site for a new restaurant last year, expensed the cost on its income statement, and now builds the restaurant

none of the above

2.

TUNDRA Corporation's stock sells for $50 per share. A call option on the stock has a strike price of $55. A put option on the stock also has a strike price of $55. Which of the following is correct?

The call option is in-the-money
The put option is in-the-money
Both the call option and the put option are out-of-the money
The call option has a value of $5

none of the above

3.

A firm plans to purchase equipment for $1.5 million. It will cost 200,000 to modify it for use in the firm's facility. The equipment is in the 3-year MACRS class. Calculate depreciation expense for Year 3.

222,150
$251,770
$566,667
$500,000

none of the above

4.

A proposed project is much riskier than average. The best way to account for its added risk is:

Ignoring it because project risk cannot be measured accurately.
Decreasing the discount rate to account for the higher risk
Increasing the discount rate to account for the higher risk
Reducing the NPV by 5% to account for the higher risk

none of the above

5.

A company needs to decide whether to invest in a project now or wait a year until better information is available. The project has a positive expected NPV, but it could be negative if cash flows are less than expected. No competitors are likely to invest in a similar project if the company decides to wait. Which of the following best describes the issues the company is facing in making its decision?

The more uncertainty about the future cash flows, the more reason to go ahead with the project today.
NPV should be even higher by waiting a year, since it is positive today.
The project should be adopted now to lock in the expected positive NPV.
Waiting would probably reduce the project's risk.

none of the above

6.

A stock is currently selling for $25. A 6-month call option on the stock has a strike price of $30 and sells for $0.50. Calculate the exercise value of the option?

$0.00
$4.50
$5.00
$24.50

none of the above

7.

Which of the following is not a real option?

The option to switch the type of vehicle manufactured in a plant
The option to expand into a foreign country
The option to buy shares of stock if its price goes up.
The option to abandon a project.

none of the above

8.

The current price of a stock is $22, and at the end of one year its price will be either $27 or $17. The annual risk-free rate is 6.0%, based on daily compounding. A 1-year call option on the stock, with an exercise price of $22, is available. Based on the binominal model, what is the option's value?

$2.99
$2.70
$2.43
$3.29

$3.62

9.

A company purchases equipment for $5 million, incurs shipping costs of $30,000 and installation costs of $50,000. It also requires additional net working capital of $100,000. What is the depreciable base?

$5,000,000
$5,180,000
$5,080,000
$5,030,000

none of the above

10.

Which of the following is an example of a real option?

An option to buy stock at a specified price for a specified period of time
An option to sell stock at a specified price for a specified period of time
An option to invest in a project today or to wait a year.
An option to buy either an American or European option
none of the above

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