5B, ch 17-4c and Fall 94, #28

Shenaz_Keshwani@mercer.com
Mon, 19 Apr 1999 17:55:58 -0500

Richard:

Thank you for your all your tips in the past. Here is the question I
had asked about earlier this morning.



First problem: chapter 17 Quiz # 4c

Company C is financed entirely by common stock and has a beta of 1.0.
The stock has a P/E multiple of 10 and is priced to offer a 10%
expected return. The company decides to repurchase half the common
stock and substitute an equal value of debt. Assume that the debt
yields a risk free 5%

(After some calculations we find that the rate of return on the common
stock after refinancing is 15% and Beta of equity after refinancing is
2.0)


C) Assume that the operating profit of firm C is expected to remain
constant. Give:

i) The percentage increase in earnings per share
ii) The new price-earnings multiple.


Second Problem Fall 94 #28.

Fall 94 # 28 is from Chapter 20. It has to do w the position diagrams
and I tried to create them by using the drawing tools in excel.
However when I attach the file the drawing is not coming through. I
could fax you the problem and perhaps you may be able to shed some
light.

Basically, I am having trouble combining the different position
diagrams into one diagram. For example how would I represent the
following:

borrowing the present value of 100 at the risk free rate, buying two
shares of stock, and selling one call with an exercise price of $100

lending the PV of 100 at the risk free rate, selling a call with an
exercise price of 100 and buying a call with excercice price of $200.


______________________________ Reply Separator _________________________________
Subject: RE: 5B, Fall 94, #28
Author: "Goldfarb; Richard" <Goldfarb@WESTPORT.MSMAIL.AIGFPC.COM> at uucp
Date: 4/19/99 2:26 PM

While I await the full question from you, here's what I think will clear
things up for you.

In all questions like this, there is rarely any subtle meaning behind it
all. Simply plot a few points and connect the dots. Take Figure E for
example. If the stock price is zero, then you have to repay the 100
that you borrowed, that's -100. The 2 shares of stock are worth zero
and the call option you sold is zero, so the total is -100. If the
stock price is 100, then the borrowing is again -100, the two shares are
200 and the option payoff is zero, for a total of 100. Then if stock is
101, then borrowing is -100, stock is 202 and the option is -1, so
that's 101. Connect the three dots and you are done.

The only thing to be careful about in these cases is to plot points at,
above and below the exercise prices of the options. That's where all
the action will be. So if there are several options involved in a
particular strategy, be sure to plot points at each exercise price and
at points in between.

The search for additional meaning is pointless. After a bit of practice
though, you should be able to start to see some patterns.

> -----Original Message-----
> From: Shenaz_Keshwani@mercer.com [SMTP:Shenaz_Keshwani@mercer.com]
> Sent: Monday, April 19, 1999 2:58 PM
> To: studygroup5b@lists.casact.org; Richard Goldfarb
> Subject: 5B, Fall 94, #28
>
>
> Chapter 20/21
>
> What do figures B and E represent. I have tried to draw the figures
> in the
> attached file.
>
> Thanks
>
>
> Shenaz << File: MS Excel spreadsheet >>