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Week 4-Quest-Finance

Week 4-Quest-Finance - Answer the following questions 1 Use...

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Answer the following questions: 1. Use Excel and the following template to build an option calculator for a call. You should further verify model validity even if the initial work conforms to the example shown. To do so, you should be using examples discussed in "A9-Use Option Concept to Analyze Merger and Diversification" or "A10. Use Option Concept to Analyze Capital Budgeting Decision" in Week Four. If your model works in all three cases, then it should be good to go. If not, you should go back and debug. Here is the A-9 example reference in the question Use Option Concept to Analyze Merger and Diversification Diversification is a frequently mentioned reason for mergers. But can diversification be the only reason for mergers? To examine this question, let us assume diversification is the only benefit to a merger; there is no synergistic benefit, tax benefit, or any other benefit to the merger we consider in the following case: 1. Since equity can be viewed as a call option, should the merger increase or decrease the value of the equity? What happens to the value of the risky debt? 2. Overall, what has happened with the merger and is it a good decision in view of the goal of stockholder wealth maximization?
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Case Study: Does it pay to merge for diversification reasons alone? Consider the following two merger candidates. The merger is for diversification purposes only with no synergies involved. The risk-free rate is 4%. The following table provides the pre-merger information about these firms. Company A Company B Market value of assets $40 million $15 million Face value of zero coupon debt $18 million $7 million Debt maturity 4 years 4 years Asset return standard deviation 40% 50% Using Black-Scholes option pricing equations, we can determine the existing market value of each company’s equity as a call option. Since value of assets = value of the debt + value of equity, we
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