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Multiple choice questions on earnings per share, derivatives (call and put options)

Volga Publishing is considering a proposed increase in its debt ratio, which will also increase the company's interest expense. The plan would involve the company issuing new bonds and using the proceeds to buy back shares of its common stock. The company's CFO expects that the plan will not change the company's total assets or operating income. However, the company's CFO does estimate that it will increase the company's earnings per share (EPS). Assuming the CFO's estimates are correct, which of the following statements is most correct?

1. Since the proposed plan increases Volga's financial risk, the company's stock price still might fall even though its EPS is expected to increase.
2. If the plan reduces the company's WACC, the company's stock price is also likely to decline.
3. Since the plan is expected to increase EPS, this implies that net income is also expected to increase.
4. Statements a and b are correct
5. Statements a and c are correct

Which of the following statements is correct?

1. Put options give investors the right to buy a stock at a certain exercise price before a specified date
2. Call options give investors the right to sell a stock at a certain exercise price before a specified date.
3. Options typically sell for less than their exercise value.
4. LEAPS are very short-term options which have begun trading on the exchanges in recent years
5. Call option holders are not entitled to receive dividends unless they choose to exercise their option.

Solution Preview

Answer: 1. Since the proposed plan increases Volga's financial risk, the company's stock price still might fall even though its EPS is expected to increase.

Stock price depends on discount rate of stock not WAC, therefore WACC is not ...

Solution Summary

The solution provides answers to 2 multiple choice question on EPS and derivatives. At around 150 words, this solution gives short explanations as to why each multiple choice answer was selected.

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