CH3-Answers - Answers to End of Chapter 3 (2nd edition)...

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Answers to End of Chapter 3 (2 nd edition) Problems Arbitrage and Financial Decision Making 3-1. Honda Motor Company is considering offering a $2000 rebate on its minivan, lowering the vehicle’s price from $30,000 to $28,000. The marketing group estimates that this rebate will increase sales over the next year from 40,000 to 55,000 vehicles. Suppose Honda’s profit margin with the rebate is $6000 per vehicle. If the change in sales is the only consequence of this decision, what are its costs and benefits? Is it a good idea? The benefit of the rebate is tat Honda will sell more vehicles and earn a profit on each additional vehicle sold: Benefit = Profit of $6,000 per vehicle × 15,000 additional vehicles sold = $90 million. The cost of the rebate is that Honda will make less on the vehicles it would have sold: Cost = Loss of $2,000 per vehicle × 40,000 vehicles that would have sold without rebate = $80 million. Thus, Benefit – Cost = $90 million – $80 million = $10 million, and offering the rebate looks attractive. (Alternatively, we could view it in terms of total, rather than incremental, profits. The benefit as $6000/vehicle × 55,000 sold = $330 million, and the cost is $8,000/vehicle × 40,000 sold = $320 million.) 3-2. You are an international shrimp trader. A food producer in the Czech Republic offers to pay you 2 million Czech koruna today in exchange for a year’s supply of frozen shrimp. Your Thai supplier will provide you with the same supply for 3 million Thai baht today. If the current competitive market exchange rates are 25.50 koruna per dollar and 41.25 baht per dollar, what is the value of this deal? Czech buyer’s offer = 2,000,000 CZK / (25.50 CZK/USD) = 78,431.37 USD Thai supplier’s offer = 3,000,000 THB / (41.25 THB/USD) = 72,727.27 USD The value of the deal is $78,431 – 72,727 = $5704 today. 3-3. Suppose the current market price of corn is $3.75 per bushel. Your firm has a technology that can convert 1 bushel of corn to 3 gallons of ethanol. If the cost of conversion is $1.60 per bushel, at what market price of ethanol does conversion become attractive? The price in which ethanol becomes attractive is ($3.75 + $1.60 / bushel of corn) / (3 gallons of ethanol / bushel of corn) = $1.78 per gallon of ethanol. 3-4. Suppose your employer offers you a choice between a $5000 bonus and 100 shares of the company stock. Whichever one you choose will be awarded today. The stock is currently trading for $63 per share. a. Suppose that if you receive the stock bonus, you are free to trade it. Which form of the bonus should you choose? What is its value? b. Suppose that if you receive the stock bonus, you are required to hold it for at least one year. What can you say about the value of the stock bonus now? What will your decision depend on? a. Stock bonus = 100 × $63 = $6,300 Cash bonus = $5,000 Since you can sell (or buy) the stock for $6,300 in cash today, its value is $6,300 which is better than the cash bonus.
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b. Because you could buy the stock today for $6,300 if you wanted to, the value of the stock bonus cannot be more than $6,300. But if you are not allowed to sell the company’s stock for the next year, its value to you could be less than $6,300. Its value will depend on what you expect the stock to be worth in one year, as well as how you feel about the risk involved. You might decide that it is better to
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This note was uploaded on 02/02/2011 for the course FINA 3001 taught by Professor Molly during the Spring '10 term at University of Minnesota Duluth.

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CH3-Answers - Answers to End of Chapter 3 (2nd edition)...

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