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Your firm faces a potential $10 million loss that it would like to insure. Because of tax benefits and the avoidance of financial distress and issuance costs, each $1 received in the event of a loss is worth $2 to the firm. Two policies are available: One pays $5 million and the other pays $10 million if a loss occurs. The insurance company charges 30% more than the actuarially fair premium to cover administrative expenses. To account for adverse selection, the insurance company estimates a 2% probability of loss for the $5 million policy and a 3% probability of loss for $10 million policy. Suppose the beta of the risk is -0.5, the risk-free rate is 1%, and the expected market return is 7%.
a. Which policy should the firm choose if its risk of loss is 2%? What’s the NPV of this choice?
b. Which policy should the firm choose if its risk of loss is 3%? What’s the NPV of this choice?
A financial asset is anything which could be listed on the asset side of a firm’s balance sheet. Capital markets trade in real assets. Capital markets trade in financial assets.
A project has the following estimated data: price = $64 per unit; variable costs = $42 per unit; fixed costs = $15,000; required return = 15 percent; initial investment = $28,000; life = four years. Ignoring the effect of taxes, what is the accountin..
Wells Fargo & Company, headquartered in San Francisco, is one of the nation’s largest financial institutions. Suppose it reported the following selected accounts (in millions) as of December 31, 2014. Retained earnings $40,000 Preferred stock 8,333 C..
Stock X has an average realized return of 24.8% and stock Z has an average realized return of -3.1%. The variances for stock X and stock Z are 0.125447467 and 0.032239975 respectively. Covariance is 0.045469287. The variance on a portfolio that is ma..
Calculating Future Values [LO 1] You have just made your first $4,500 contribution to your individual retirement account. Assume you earn a 11.00 percent rate of return and make no additional contributions. What will your account be worth when you re..
The relationship between NPV and IRR is such that:
The Webster Wonders Corporation (WWC) has begun selling a new product and they want you to help them determine if they need additional funding (AFN) next year. Using the AFN formula method, calculate WWC’s AFN for next year (if any). Sales growth nex..
Using the information provided by IBM and others, indicate which of the principles designed to provide insight into effective and efficient strategies on how to best deploy financial management systems, which were outlined within the related article,..
Company plans to pay a $1.10 dividend per share in 3 months and a $1.15 dividend in 6 months. HAW's share price today is $45.60 and the continuously compounded quarterly interest rate is 2.1%. What is the price of a forward contract, which expires im..
In 2011 the Keenan Company paid dividends totaling $2,830,000 on net income of $16 million. Note that 2011 was a normal year and for the past 10 years, earnings have grown at a constant rate of 7%. Its 2012 dividend payment is set to force dividends..
A company’s balance sheets show a total of $30 million long-term debt with a coupon rate of 9 percent. The yield to maturity on this debt is 11.11 percent, and the debt has a total current market value of $25 million. What weighted average cost of ca..
In 1904, the first Putting Green Championship was held. The winner’s prize money was $300. In 2009, the winner’s check was $1,560,000. What was the annual percentage increase in the winner’s check over this period? If the winner’s prize increases at ..
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