Options, Free cashflow — OpenTuition Forums

Aaditya9y ago

Hi Sir, I have a couple of queries - 1) In question 48 of BPP revision kit Kenduri co. for the options solution the total payments are calculated differently for the two exercise prices (the second option includes unhedged amount). So can we arrive at the total payments in either of the ways or one way of calculating is preferred over the other? 2) While doing the free cashflow to equity calculations for perpetuity, I have noticed in some answers they have taken the present value instead of the net cashflow figure (in the terminal value formula) resulting in a different answer. Is that wrong or are both methods fine? Thank you Aditya

John MoffatTutor9y ago#1

1. They have done both the same way. It is just that at an exercise price of $1.60 it comes to an exact number of contracts and so there is no under or over hedging. In the second case it comes to 23.7 contacts and so they have gone for 23 contracts and have under hedged (I would actually have gone for 24 contracts in which case the would have over hedged - but either would get full marks). The over or under hedged amount is a minor point and although you should mention it (in words) the calculations on it are more of a bonus mark. 2. I am really not sure what you are referring to. Best is if you give me the name of a question where you had the problem.

Aaditya9y ago#2

Thank you, Question number 81 Laceto, while calculating the value of the firm they have used 19 (the present value) instead of 32 (the net cashflow). Look forward to your reply.

John MoffatTutor9y ago#3

That is not a terminal value formula - it has nothing to do with the terminal value!! They are using the dividend growth formula (which you can use to get the present value of any inflating perpetuity). By all means use the cash flow of 32 in the formula. However because the inflating stream starts 4 years late (i.e. at time 5 instead of time 1) you then need to discount the result from the formula for 4 years. That will end up giving exactly the same result.

Aaditya9y ago#4

My bad, I thought it was the terminal value formula. Thank you for the reply. Aditya

John MoffatTutor9y ago#5

You are welcome :-)