Problem 2 Information from the question Project 1 - Quite Risky Market Value $ 50,000,000.

00 Tenure 2 years Face value of Company debt payable in 2 year

Project 2 - much more certain Market Value high as Low as $ 25,000,000.00 $ 15,000,000.00 $ 20,000,000.00

a) What are the possible payoffs to the bondholders under projects 1 and 2? Answer: Project 1 Total pay off Debt Distribution $ 50,000,000.00 $ 20,000,000.00 0 0 Project 2 Total pay off Debt Distribution $ 25,000,000.00 $ 20,000,000.00 $ 15,000,000.00 $ 15,000,000.00 b) What are the possible payoffs to the shareholders under projects 1 and 2? Answer: Project 1 Total pay off Equity Distribution $ 50,000,000.00 $ 30,000,000.00 0 0 Project 2 Total pay off Equity Distribution $ 25,000,000.00 $ 5,000,000.00 $ 15,000,000.00 0

c) Which will the shareholders favor? The bondholders? Answer: Shareholders will favor project 1, which provides an equal or higher payoff in each state. Bondholders favor project 2 for the same reason.

Problem 3 Information from the question: Present Value of Gold $ 300.00 an ounce Cost to the company $ 250.00 an ounce to produce the gold Quantity produce last yr 50,000 ounces Mine will be exhaustive in 7 year at this rate of production Require rate of return 10% a) What is the value of the mine? Answer: The present value of the mine is the present value of 7 years of payments of $50/oz ? 50,000 oz = $ 2,500,000.00 discounted at 10% The present value $ 12,171,047.04 b) Suppose inflation is expected to increase the cost of producing gold by 10 percent a year but the price of gold does not change because of large sales of stock-piled gold by foreign governments. Furthermore, imagine that the inflation raises the required rate of return to 21 percent. Now, what is the value of the mine? Answer: If the costs rise by 10% per year while the price remains the same, we will not operate the mine after one year 10% cost rise = $ 275.00 Revenue $ 15,000,000.00 Cost $ 13,750,000.00 Income $ 1,250,000.00 Discounted 1 yr at 21% is the present value of the mine $ 1,033,057.85 c) Suppose the company may shut, reopen, or abandon the mine in response to fluctuations in the price of gold. Can the NPV method be used to value the mine under these conditions?

Answer: The NPV method can be used to determine the value of the mine if the company can choose an optimal extraction policy. The analysis requires a potentially complex decision tree formulation, and the determination of the optimal strategy as a function of the path of the price for gold. The correct solution of the problem requires option pricing methodologies.