Concept explainers
a)
To determine: The price of the call option.
Call option:
Call option is an arrangement which gives the option buyer the right but does not give the obligation to buy a stock, commodity, bond or any other instrument at a stated price within a particular period. The stock, bond, or commodity is called as the underlying asset.
b)
To use: A data table to show how a change in volatility changes the value of the option and give an intuitive explanation for the results.
c)
To use: A data table to show how a change in today’s stock price changes the option’s value and give an intuitive explanation for your results.
d)
To use: A data table to show how a change in the option’s duration changes the option’s value and give an intuitive explanation for the results.
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PRACTICAL MGT. SCIENCE (LL)-W/MINDTAP
- It is January 1 of year 0, and Merck is trying to determine whether to continue development of a new drug. The following information is relevant. You can assume that all cash flows occur at the ends of the respective years. Clinical trials (the trials where the drug is tested on humans) are equally likely to be completed in year 1 or 2. There is an 80% chance that clinical trials will succeed. If these trials fail, the FDA will not allow the drug to be marketed. The cost of clinical trials is assumed to follow a triangular distribution with best case 100 million, most likely case 150 million, and worst case 250 million. Clinical trial costs are incurred at the end of the year clinical trials are completed. If clinical trials succeed, the drug will be sold for five years, earning a profit of 6 per unit sold. If clinical trials succeed, a plant will be built during the same year trials are completed. The cost of the plant is assumed to follow a triangular distribution with best case 1 billion, most likely case 1.5 billion, and worst case 2.5 billion. The plant cost will be depreciated on a straight-line basis during the five years of sales. Sales begin the year after successful clinical trials. Of course, if the clinical trials fail, there are no sales. During the first year of sales, Merck believe sales will be between 100 million and 200 million units. Sales of 140 million units are assumed to be three times as likely as sales of 120 million units, and sales of 160 million units are assumed to be twice as likely as sales of 120 million units. Merck assumes that for years 2 to 5 that the drug is on the market, the growth rate will be the same each year. The annual growth in sales will be between 5% and 15%. There is a 25% chance that the annual growth will be 7% or less, a 50% chance that it will be 9% or less, and a 75% chance that it will be 12% or less. Cash flows are discounted 15% per year, and the tax rate is 40%. Use simulation to model Mercks situation. Based on the simulation output, would you recommend that Merck continue developing? Explain your reasoning. What are the three key drivers of the projects NPV? (Hint: The way the uncertainty about the first year sales is stated suggests using the General distribution, implemented with the RISKGENERAL function. Similarly, the way the uncertainty about the annual growth rate is stated suggests using the Cumul distribution, implemented with the RISKCUMUL function. Look these functions up in @RISKs online help.)arrow_forwardExplain why a business's liquidation value would be different from its going concern value. because the liquidation value contains the value of any real estate holdings, while the going concern value does not because the going concern value contains intangible, non- transferable assets like goodwill, while the liquidation value does not because the liquidation value includes the cost of the broker's commission, while the going concern value does not because the going concern value is calculated using replacement value, while the liquidation value is calculated using the cost methodarrow_forwardThe usual face value for most corporate bonds is $5,000.; True or Falsearrow_forward
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- Find the present values of these ordinary annuities. Discounting occurs once a year. Do not round intermediate calculations. Round your answers to the nearest cent. $400 per year for 10 years at 4%. $ $200 per year for 5 years at 2%. $ $300 per year for 6 years at 0%. $ Rework previous parts assuming they are annuities due. Present value of $400 per year for 10 years at 4%: $ Present value of $200 per year for 5 years at 2%: $ Present value of $300 per year for 6 years at 0%: $arrow_forwardCost benefit analysis is a complex approach that considers the cash flows or the value of money over a period of time. True or Falsearrow_forwardAn annuity pays $25,000 semiannually (every 6 months) for 12 years. An alternative investment’s APR is 10% with quarterly compounding. What is the value of this annuity?arrow_forward
- Please answer along with the excel formulas - 1. Sue now has $125. How much would she have after 8 years if she leaves it invested at 8.5% with annual compounding? $205.83 $216.67 $228.07 $240.08 $252.08 2. Suppose you have $1,500 and plan to purchase a 5-year certificate of deposit (CD) that pays 3.5% interest, compounded annually. How much will you have when the CD matures? $1,781.53 $1,870.61 $1,964.14 $2,062.34 $2,165.46 3. Last year Rocco Corporation's sales were $225 million. If sales grow at 6% per year, how large (in millions) will they be 5 years later? $271.74 $286.05 $301.10 $316.16 $331.96arrow_forwardYou have your choice of two investment accounts.Investment A is a 15-year annuity that features end-of-month $1,500 paymentsand has an interest rate of 8.7 percent compounded monthly. Investment B is an8 percent continuously compounded lump-sum investment, also good for 15 years.How much money would you need to invest in B today for it to be worth as much asInvestment A 15 years from now?arrow_forwardIn the financial world, there are many types of complex instruments called derivatives that derive their value from the value of an underlying asset. Consider the following simple derivative. A stocks current price is 80 per share. You purchase a derivative whose value to you becomes known a month from now. Specifically, let P be the price of the stock in a month. If P is between 75 and 85, the derivative is worth nothing to you. If P is less than 75, the derivative results in a loss of 100(75-P) dollars to you. (The factor of 100 is because many derivatives involve 100 shares.) If P is greater than 85, the derivative results in a gain of 100(P-85) dollars to you. Assume that the distribution of the change in the stock price from now to a month from now is normally distributed with mean 1 and standard deviation 8. Let EMV be the expected gain/loss from this derivative. It is a weighted average of all the possible losses and gains, weighted by their likelihoods. (Of course, any loss should be expressed as a negative number. For example, a loss of 1500 should be expressed as -1500.) Unfortunately, this is a difficult probability calculation, but EMV can be estimated by an @RISK simulation. Perform this simulation with at least 1000 iterations. What is your best estimate of EMV?arrow_forward
- Practical Management ScienceOperations ManagementISBN:9781337406659Author:WINSTON, Wayne L.Publisher:Cengage,