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Gb550: Financial Management
Unit 6 Assignment
GB550: Financial Management

Alberto Silveira
Kaplan University
Prof: Ana Machuca
April 11, 2011
Chapter 13: Problem 13-5:

How is it possible for an employee stock option to be valuable even if the firm's stock price fails to meet shareholders' expectations?

Solution:

Employees are given the option of buying stocks at a specified time at a specified price without investing any money. For example, if the price of stock is $10 today and the employee is given the option to buy 1000 shares at the price of $10 per share two years from now. If the stock price increases to $12 per share in two years, then the employee will gain $2,000 ($2 x 1000) from these stock options. Let’s say that the expected capital appreciation was 20%, the value of the stock would have increased to $14.4 per stock. Even though the stock price fell short of the expected value, it still created additional income of $2,000 for the employee. The options pay off if, at the time of option expiration, the stock price is higher than the option’s strike price, even if the company failed to meet shareholders’ expectations.

Chapter 15: Problem 15-8:

The Rivoli Company has no outstanding debt and its financial position is given with the following data:

Assets (book=market) $3,000,000
EBIT $500,000
Cost of equity, rs 10%
Stock price, P0 $15
Shares outstanding n0 200,000
Tax rate, T (federal plus state) 40%

The firm is considering selling bonds and simultaneously repurchasing some of its stock. If it moves to a capital structure with 30% debt based on market values, its cost of equity, rs, will increase to 11% to reflect the increased risk. Bonds can be sold at a cost, rd, of 7%. Rivoli is a no-growth firm. Hence, all its earnings are paid out as dividends. Earnings are expected to be constant over time.

a) What effect…...

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