Economics of Enterprise Answers

3. Which of the following statements is CORRECT?

a. An option's value is determined by its exercise value, which is the market price of the stock less its striking price. Thus, an option can't sell for more than its exercise value.
b. As the stock’s price rises, the time value portion of an option on a stock increases because the difference between the price of the stock and the fixed strike price increases.
c. Issuing options provides companies with a low cost method of raising capital.
d. The market value of an option depends in part on the option's time to maturity and also on the variability of the underlying stock's price.
e. The potential loss on an option decreases as the option sells at higher and higher prices because the profit margin gets bigger.

2. Which of the following statements is CORRECT?

a. If the underlying stock does not pay a dividend, it makes good economic sense to exercise a call option as soon as the stock’s price exceeds the strike price by about 10%, because this permits the option holder to lock in an immediate profit.
b. Call options generally sell at a price less than their exercise value.
c. If a stock becomes riskier (more volatile), call options on the stock are likely to decline in value.
d. Call options generally sell at prices above their exercise value, but for an in-the-money option, the greater the exercise value in relation to the strike price, the lower the premium on the option is likely to be.
e. Because of the put-call parity relationship, under equilibrium conditions a put option on a stock must sell at exactly the same price as a call option on the stock.

1. Which of the following statements is CORRECT?

a. Put options give investors the right to buy a stock at a certain strike price before a specified date.
b. Call options give investors the right to sell a stock at a certain strike price before a specified date.
c. Options typically sell for less than their exercise value.
d. LEAPS are very short-term options that were created relatively recently and now trade in the market.
e. An option holder is not entitled to receive dividends unless he or she exercises their option before the stock goes ex dividend.

Analyze the various ways to determine the cost of capital and determine which is the most difficult to get right. Explain your rationale.

Use the Internet to research a company in which you are interested and review their financial statements, with a focus on how the company is currently using options.

Based on what you discovered, determine the best way the company you research could leverage stock options to offset employee compensation. Explain your rationale.

Which of the following statements is CORRECT?
a. Dividends paid reduce the net income that is reported on a company’s income statement.
b. If a company uses some of its bank deposits to buy short-term, highly liquid marketable
securities, this will cause a decline in its current assets as shown on the balance sheet.
c. If a company issues new long-term bonds during the current year, this will increase its
reported current liabilities at the end of the year.
d. Accounts receivable are reported as a current liability on the balance sheet.
e. If a company pays more in dividends than it generates in net income, its retained.
earnings as reported on the balance sheet will decline from the previous year's balance.

Discuss the non-rational factors that may have a role in the valuation of stocks and stock market equilibrium. Provide specific examples to support your response.

4. Church Inc. is presently enjoying relatively high growth because of a surge in the demand for its new product. Management expects earnings and dividends to grow at a rate of 25% for the next 4 years, after which competition will probably reduce the growth rate in earnings and dividends to zero, i.e., g = 0. The company’s last dividend, D0, was $1.25, its beta is 1.20, the market risk premium is 5.50%, and the risk-free rate is 3.00%. What is the current price of the common stock?

a. $26.77
b. $27.89
c. $29.05
d. $30.21
e. $31.42