Assume gold price risk is diversifiable, and the riskless rate is 5%. A firm produces a unit of gold a year from today. Assume all interest is compounded annually and is tax deductible. The price of gold is either $500 or $189, with probability p and 1-p, respectively. Suppose the firm pays taxes at a rate of 40% for all its cash flow in excess of $300. The value of the firm is the expected discounted value of its cash flow less the expected discounted value of bankruptcy costs and taxes that it pays. The firm can hedge by buying/selling forward contracts on gold. Assume that bankruptcy costs are zero. When p = 0.4, Find the value of unhedged unlevered firm.
Assume gold price risk is diversifiable, and the riskless rate is 5%. A firm produces a unit of gold a year from today. Assume all interest is compounded annually and is tax deductible. The price of gold is either $500 or $189, with probability p and 1-p, respectively. Suppose the firm pays taxes at a rate of 40% for all its cash flow in excess of $300. The value of the firm is the expected discounted value of its cash flow less the expected discounted value of bankruptcy costs and taxes that it pays. The firm can hedge by buying/selling forward contracts on gold. Assume that bankruptcy costs are zero. When p = 0.4, Find the value of unhedged unlevered firm.
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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Transcribed Image Text:Assume gold price risk is diversifiable, and the riskless rate is 5%. A firm produces a unit of gold a year from today. Assume all interest is compounded annually and is tax deductible. The price of gold is
either $500 or $189, with probability p and 1 - p, respectively. Suppose the firm pays taxes at a rate of 40% for all its cash flow in excess of $300. The value of the firm is the expected discounted
value of its cash flow less the expected discounted value of bankruptcy costs and taxes that it pays. The firm can hedge by buying/selling forward contracts on gold. Assume that bankruptcy costs are
zero.
When p = 0.4, Find the value of unhedged unlevered firm.
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