Chapter 4 Problem 2 2 possible new product lines Project 1 Mkt value of firm: Time period in years company debt,

payable in 2 years $50 mil or -02 $20 mil

a). What are the possible payoffs to the bondholders under projects 1&2? Project 1 Total Payoff A) 50 mil B) 0 Project 2 A) B) Total Payoff 25 15

b). What are the possible payoffs to the shareholders under projects 1&2? Project 1 Total Payoff A) 50 mil B) 0 Project 2 A) Total Payoff 25

B)

15

c). Which will shareholders favor? Which will bondholders favor?

Project 1, as equal or higher payoff in each state Project 2, as equal or higher payoff in each state

Project 2 $25 mil or $15 mil 2

r projects 1&2? Debt payout 20 mil 0 bond holders get -0-

Debt payout 20 15 bond holders get 20 bond holders get 15

er projects 1&2? Equity Distribution 30 mil payoff debt first 0

Equity Distribution 5

payoff debt first

higher payoff in each state higher payoff in each state

Chapter 4 Problem 3 Eastern Shallow, Ltd. Info: Price for gold Cost to produce gold Gross margin on gold Production last yr Mine will be exhausted in Req. rate of return on gold mines a). What is the value of the mine? 7 years of payments at $50/oz. Gross margin on gold Production last yr GM on gold for 1 yr. PVIFA Value of the Mine $ $ $ 300 250 50 50,000 7 10% per oz per oz per oz ounces yrs.

50 50,000 oz. $2,500,000 4.8684 12,171,000

10% and 7 yrs.

http://www.miniwebtool.

b). Inflation increases cost of producing gold by 10% a year, but no change in price of g Req. rate of return also increases to 21% What is value of the mine? We will only run the mine yr 1, as lose money yr 2 thereafter 7 years of payments at $50/oz. Gross margin on gold $ 25 Production last yr 50,000 GM on gold for 1 yr. $1,250,000 PVIFA 0.8264 Value of the Mine $ 1,033,000

c). Not assigned, (beyond scope) The NPV method can be used to determine the value of the mine if the company can choose an optimal extraction policy. This anlaysis requires complex use of decision tree formulation, using option price methodologies.

part b) yr 1 y2 y2 $ 300 $ 300 $ 275 302.5 $ 25 $ (3)

10% and 7 yrs. http://www.miniwebtool.com/pvifa-calculator/?r=10&n=7

o change in price of gold