M7-Financial Valuation Methods: Part 2

Question 1

“The options can be exercised any time before maturity” does not represent a valid assumption of the Black-Scholes option pricing model. A primary assumption of this model is that the options are European-style, which can be exercised at maturity. In contrast, American-style options can be exercised any time before maturity. (true or false)

Answer 1

true

Some valid assumptions of the Black-Scholes option pricing model are:

• The stock pays no dividends
• stock prices behave in a random manner
• no taxes or transaction costs exist
• the risk-free rate and volatility of the stock price are constant over the option’s life

Question 2

The binomial (Cox-Ross-Rubinstein) model is actually a variation of the Black-Scholes option pricing model. There are 2 primary differences with the Black-Scholes model including:

Answer 2

The consideration of the option over a period of time using American-style options and it can be used for stocks that pay periodic dividends without modifying the model (which would be necessary using the Black-Scholes model).

Question 3

Using industry consensus information pertaining to fixed assets would be the least acceptable method for estimating depreciation and salvage value given that these fixed assets are unique to each company such as condition, degree of use, repairs, and maintenance. (true or false)

Answer 3

true

Question 4

Using the outcome of similar litigation settlements would be a questionable methodology for using estimates on the company’s balance sheet. An acceptable approach is to use an estimate of probable future losses pertaining to that specific lawsuit settlement. (true or false)

Answer 4

true

Question 5

In a scenario in which limited intangible asset transactions exist and there are no reliable estimates of income/cash flows, the cost approach should be used. Under this method, the company determines intangible assets value using a replacement costs or a reproduction cost methodology. (true or false)

Answer 5

true

Question 6

A primary feature of the Black-Scholes option pricing model is that stock options are exercisable only at maturity or as European-style options. (true or false)

Answer 6

true