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Practice problem--it's very helpful ~

2 Pages
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Department
Economics
Course Code
ECO359H5
Professor
Sun

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ECO359/2011UniversityofToronto
PracticeProblems3  DepartmentofEconomics
1
ECO 359 Practice Problems 3 –Solution Guidelines
1. NA.
2. (a) They are exactly indifferent. Denote profit by è, the expected profit of release is
Lwr¨ H:sástrárrr Fwwrárrr;Ewr¨ H:rFwwrárrr;Lsrárrrä
(b) The most important part of this question is to understand what the movie company would
do once they have the information. Namely, that with the preview the company will only
proceed with the release if the review is positive! Therefore they will only need to pay
$550,000 if they get $1,120,000 in revenues.
Assuming that they get the preview for free, their expected profit is
ÙåØØãåØéÜØê Lwr¨ H:sástrárrr Fwwrárrr;
ã
ç
ç
ç
ç
ç
ç
ç
ç
ç
ä
ç
ç
ç
ç
ç
ç
ç
ç
ç
å
Úââ×\åØßØÔæØêâåß×êÜ×Ø
Ewr¨ Hsrárrr
ã
ç
ç
ç
ä
ç
ç
ç
å
ÕÔ×\åØßØÔæØÜáÍ
Lt{rárrr
Hence, with the preview the company can make $280,000 more in revenues than without the
preview. Answers to (c) and (d) follow directly from here.
(c) $280,000.
(d) $280,000.
3. Solutions are posted separately.
4.
(a) 8
ÅL$E5Lsr Hsw Esr Hsr LDtwrä No, by MM proposition I (no taxes).
(b) 8
ÅL8
ÎL'$+6N
4 (assuming perpetual cash flows), \'$+6L8
ÎHN
4LDuyäw
(c) i. By MM proposition, no change in value or share price. \Issue 94
59 Lu
5
7 debt contracts.
ii. $250.
iii. By MM proposition II, N
æLN
4E»
Ì:N
4FN
»;Lsw¨ E644
94 :sw¨ Fz¨;Lvu¨.
(d) (Not required before the midterm).
Note: Assume that the same debt-equity structure, i.e., the same amount of debt.
8
ÅL8
ÎE6
Ö$ (Hint: compute 8
Î with taxes!) \8
Î =$150
i. $210. ii. $230. iii. $250.
5.
(a) 8
ÅL$E5LDurárrr EDty Hsrárrr LDurrárrr.
(b) No taxes \ 8
ÅL8
ÎL'$+6N
4\'$+6 LDvwárrr.
(c) By MM proposition II, N
æLN
4E»
Ì:N
4FN
»;Lsw¨ E74á444
744á444 :sw¨ Fw¨;Lsx¨.
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Description
ECO3592011 UniversityofToronto PracticeProblems3 DepartmentofEconomics ECO 359 Practice Problems 3 Solution Guidelines 1. NA. 2. (a) They are exactly indifferent. Denote profit by , the expected profit of release is L MH 0 IIJHHHH . MMHHHH - MH 0 :H . MMHHHH; L IHHHH (b) The most important part of this question is to understand what the movie company would do once they have the information. Namely, that with the preview the company will only proceed with the release if the review is positive! Therefore they will only need to pay $550,000 if they get $1,120,000 in revenues. Assuming that they get the preview for free, their expected profit is L MHH ; - HHH L J{HHHH Hence, with the preview the company can make $280,000 more in revenues than without the preview. Answers to (c) and (d) follow directly from here. (c) $280,000. (d) $280,0
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