9 Happyface Corporation is about to launch a newproduct. Depending on the success of the newproduct, Happyface may have one of five valuesnext year: $200 million, $180 million, $160 million,$100 million, and $80 million. These outcomes areall equally likely, and this risk is diversifiable.Suppose the risk-free interest rate is 5% and that, inthe event of default, 20% of the value ofHappyface's assets will be lost to bankruptcy costs.(Ignore all other market imperfections, such astaxes.)Now suppose Happyface has zero-coupon debt witha $120 million face value due next year. What is theinitial value of Happyface's equity? What isHappyface's total value with leverage?

There is equal chance of 5 values ext year. Hence, the probability for each is 100%/5 = 20%. risk…

Answered: Happyface Corporation is about to…

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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Assume that the Pure Expectations Theory of the term structure is correct. Also assume that the interest rate today on a 9-year security is 6.40%, while the interest rate today on a 15-year security is 8.00%. Finally assume that the interest rate on a 3-year security to be bought at Year 9 and held over Years 10, 11, and 12 is 6.80%. Given this information, determine the average annual return that investors today must expect that they will receive from investing in a 3-year security in 12 Years (that is, buying the security at Year 12 and holding it over Years 13, 14, and 15). O 13.00% O 12.50% 13.50% O 12.00% O 14.00%
Epsilon Corp. is evaluating an expansion of its business. The cash-flow forecasts for the project are as follows: Years Cash Flow($ millions) 0 −230 1-8 51 The firm's existing assets have a beta of 1.4. The risk-free interest rate is 5% and the expected return on the market portfolio is 10%. What is the project's NPV? (Enter your answer in millions. A negative answer should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to 2 decimal places.)
You are an investor in the world where short-selling assets is prohibited. Suppose that the price of asset X in period 0 is $200. This asset will pay a dividend of $8 one year from now in period 1. Let the riskless interest rate from 0 to period q be 5%.Assume the price for a future contract delivery in period 1 is $210. a) Can you make an arbitrage profit when $210 is the price? If so, state specifically what financial transaction? b) Now, assume the price for a futures contract with delivery in period 1 is K190. Can you make an arbitrage profit when this is the price? If so, state specifically what financial transaction you would make in 0 and period 1 to realize a profit. If not, explain?
Suppose the term structure of risk-free interest rates is as shown below. 1 yr Term 2 yr 3 yr 5 yr 7 yr 10 yr 20 yr Rate (EAR %) 2.08 2.42 2.61 3.24 3.87 4.04 5.07 a. Calculate the present value of an investment that pays $5,000 in two years and $3,000 in five years for certain. b. Calculate the present value of receiving $300 per year, with certainty, at the end of the next five years. To find the rates for the missing years in the table, linearly interpolate between the years for which you do know the rates. (For example, the rate in year 4 would be the average rate in year 3 and year 5.) c. Calculate the present value of receiving $2,300 per year, with certainty, for the next 20 years. Infer rates for the missing years using linear interpolation. (Hint: Use a spreadsheet.) a. Calculate the present value of an investment that pays $5,000 in two years and $3,000 in five years for certain, The present value of the investment is $ (Round to the nearest dollar.)
2. Suppose there are two possible states for the economy over the next year, boom or bust, and these two states are equally likely to occur. An asset you may invest in has a payoff forecast of b160 million in the boom state and £64 million in the bust state. The risk-free rate is 20% and a risk premium of 20% is required for assets with similar risk features. What is the maximum price you would agree to pay for this asset today?
H4. Work out the value of European Call on a risky asset A, currently selling at $600. The European Call has a term to maturity of 1.5 years and a strike price of $675. SD(dA/A), the volatility of returns on the risky asset is 18% per year, and the discrete risk-free rate is 0.9% per year
Epsilon Corp. is evaluating an expansion of its business. The cash-flow forecasts for the project are as follows: Years Cash Flow($ millions) 0 −150 1-9 25 The firm's existing assets have a beta of 1. The risk-free interest rate is 3% and the expected return on the market portfolio is 10%. What is the project's NPV?
Suppose the price of gasoline per gallon is currently $5. The risk manager of Universe Airlines expects the price per gallon next year to be either $7 or $4 with equal probabilities. The company plans to buy 1 million gallons of gasoline in one year. The risk manager is concerned about future rising cost of gasoline and is considering using either futures or calls to hedge against the risk. Suppose the riskfree interest rate is 10% per annum. What is the futures price of gasoline per gallon for delivery in one year? What are the possible payoffs of the futures one year from now? If calls are used, only the ones with the same exercise price as the futures price are available now. How much would it cost to buy the calls? What are the possible profits of the calls (the payoffs net of the call premium) one year from now? Suppose the investors of the company are risk averse and their collective risk attitude can be described by log utility. Assume that the risk manager maximizes the…
You currently have $50,000 in cash. You have access to a project which requires an initial investment of $50,000. One year from now this project will pay either $40,000 with a probability 50% or $100,000 with probability 50%. After this, there are no further cash flows. Assume risk neutrality and an annual discount rate of 10%. This is also the risk-free rate. (d) You have found investors who will give you a loan for the full cost of the project. You will invest your cash at a risk-free rate. Assume in case of default, these investors can claim all of the project's cash flows, but cannot claim the cash you have invested outside of the project. What is the face value of the loan and the interest rate? How much money do you expect to have one year from now? (e) In light of your numerical answers above, discuss Modigliani and Miller's 1st proposition.
Your firm has a risk-free investment opportunity where it can invest $160,000 today and receive $170,000 in one year. For what level of interest rate is this project attractive? The project will be attractive when the interest rate is any positive value less than or equal to ____________%? (Round to two decimal places.)
4) The table below shows the interest rates available from investing in risk-free U.S. Treasury securities with different terms to maturity. Put another way, the table below presents the current spot yield curve. What is the present value (PV) of an investment that promises to pay $4,000 at the end of each year for the next four years with the first cash flow being paid one year from today? (provide your answer in the space below) Term in years: Rate: 1 1.8% 2 3 4 2.25% 2.30% 2.66% The Present Value of the annuity described above is: 5 3.13%
Suppose you borrow $42,121.59M when financing a gym which cost is at $90,956.02M. You expect to generate a cash flow of $47,287.93M at the end of the year if demand is weak, $87,482.45M if demand is as expected and $107,854.66M if demand is strong. Each scenario is equally likely. The current risk-free interest rate is 5.42% (risk of debt) and there's a 12.67% risk premium for the risk of the assets. What is the expected return of equity?

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