FINC 455 Midterm 2

What are incremental cash flows?

cash flows involved with a new project or investment

What do relevant cash flows not include?

sunk costs, overhead, and financing costs

What does an increase in NWC entail?

cash outflow

What does a decrease in NWC entail?

cash inflow

What happens if sale price<book value?

tax savings

What happens if NPV>0?

accept

What happens if NPV<0?

reject

What are options used for?

hedging risk, speculation, and income strategies

How does an increase in stock price impact call value?

increases

How does an increase in strike price impact call value?

decreases

If time increases, what happens to call value?

increases

If volatility increases, what happens to call value?

increases

If interest rates increase, what happens to call value?

increases

What are the types of real options?

investment timing, growth, and abandonment option

What is a growth option?

expand if successful

What is the investment timing option?

wait or invest now

What is the abandonment option?

exit if bad

What is incorporated in a capital budget analysis?

cannibalization, warehouse, increases in after-tax cfs from new project

What is the exercise value?

value received from a call option if exercised today, difference between stock price and option value

If stock price < strike price, what is exercise value?

0

What is a call option?

right to buy

What is a put option?

right to sell

What is the strike or exercise price?

predetermined option price

What is the expiration date?

last date an option can be exercised

What length of call options are more valuable?

longer maturity

What happens to call option prices when underlying stock price goes up?

increases

What must be true of a call option price?

call option price >= 0 and exercise value

What is an in-the-money call option?

strike price <= stock price, exercise value is positive

What is an out-of-the-money call option?

strike price > stock price, exercise value is 0

What is a payoff?

what you get at expiration not including cost

What is profit?

payoff minus what you paid

What do you want to happen to price with a call option?

to go up

What do you want to happen to price with a put option?

go down