999346845 Assignment 16 RSM 1331 Finance I: Capital Markets & Valuation 1 2 AM 3 PM 4 5

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1. Describe, in general terms, Sally’s Executive Stock Option decision. You should recognize this as an NPV problem that compares alternative future cash flows. What is the NPV of the cash alternative? The cash alternative being referred to here is the Telstar Communications option tranche on offer, the present value of which needs to be compared with that of the cash option. • • PV [Cash Option]: $5,000.000 PV [Stock Options]: $11,724.000 • Calculated using Black Scholes Option Valuation Model (approach / methodology follows)

2. Describe Sally’s ESOs in terms of the parameters which would be input into an option pricing model. Which option pricing model is appropriate? • Sally is being offered 3,000 options to purchase Telstar Communications shares at $35.000 on her fifth anniversary with the firm. In other words, Sally is being granted the right to, but not the obligation to, purchase these shares on (not before) her fifth anniversary with Telstar. Since Sally cannot exercise her options before five years with the firm, these are European options, which can be valued using...

...SallyJameson: Valuing StockOptions in a Compensation Package
By Group 10
1. If we ignore tax consideration and assume that SallyJameson is free to sell her options at any time after she joins Telstar, which compensation package is worth more?
First scenario, if Sally chooses stockoptions and hold until maturity date. Ignoring the taxation and other constraints, the future value of cash compensation at the end of the 5th year will be 5000 * (1 + 0.0602) ^ 5 = 6697.44. We can easily form the equation 3000 * (P – 35) = 6697.44, where P is the future stock price of Telstar, so the stock price must increase to at least 37.23 at the end of 5th year to get the same amount of the cash compensation and if the stock price where to stay below 35, Sally’ option would be worth nothing. The stock, which pays no dividend and is not expected to pay one in the foreseeable future, is trading at 18.75. It seems significant difference between the exercise price and the spot price. As shown in Exhibit 2, Telstar stock price has increased higher than $35 only once and 10-year average stock price is around 20. Therefore, the chance that the value of option is greater than the cash compensation is very rare.
Second scenario,...

...NOTE
SallyJameson: Valuing StockOptions in a Compensation Package (Abridged)
Objectives
This case has two educational objectives. First, it serves as an introductory case on option valuation in which students can use market data to place a dollar value on an option they are likely to encounter in their business careers. As such, the case encourages a discussion of the application ofoption pricing models, such as Black-Scholes, and exposes students to popular misconceptions of how options should be valued. Second, the case permits a discussion of the wisdom and efficacy of incentive stock compensation plans using options.
Synopsis
This case details a thinly disguised situation faced by a recent Harvard MBA graduate who was forced by a prospective employer to place a dollar value on a grant of stockoptions. In the case, the potential employee must choose between a cash bonus and a stockoption grant. (In the actual case, the student's stockoption grant was rescinded based on a change in corporate policy, and she was asked to suggest a fair cash value for the lost option grant.)
Do
No
Suggested Assignment Questions
1. If we ignore tax considerations and assume that SallyJameson is free...

...SallyJameson Case Study
Thomas Virolle
Pablo Méndez
Question 1
If we ignore tax considerations and assume that SallyJameson is free to sell her options at any time after she joins Telstar she has several chooses.
She can either choose to take the cash bonus, either take the options and sell it, or she can take the option and keep it until it is worth use.
Let’s compare the situations :
1- She takes the cash bonus and decide to invest it in a 5-year bond which rate is 6,02%.
So at the end she will win 5310$ (=5000*1,0602).
2- She takes the options in order to sell it.
Let’s assume that it is easy to find someone who want to buy the option at the value of the call option.
Seeing the exhibit 3, the standard deviation of the Telstar common stock is 30%.
S= 18,75
K= 35
r= 6,02%
t= 5
σ= 30%
So C= 2,9245
Assuming that she can easily and quickly find someone to buy her options, she can sell it at 3000*2,9245= 8773,5$
Then she could even invest these 8773,5$ in a 5years bond and win 8773,5*1,0602=9301,7$
3- She keeps the options until it is worth use it and sell her shares.
If she wants to earn more than she could have won by taking the cash bonus we have to find the value of the stock that would make her win more than 5301$ ...

...SallyJameson: Valuing StockOptions in a Compensation Package (Abridged)
SallyJameson, a second-year MBA student at Harvard Business School, was thrilled but confused. It was late May 1992, graduation was approaching, and she had finally landed the job of her choice. She had just finished an early morning telephone conversation with Bob Marks, the MBA recruiting coordinator at Telstar Communications, a large, publicly held multinational company. Mr. Mark had offered Ms. Jameson a unique position in operations at Telstar, and from the description, it sounded exactly like the job that she wanted Since her first interview with Telstar, she had been very impressed with the company and its people while Ms. Jameson was certain that she would accept the job, there was still one unsettled, yes crucial, matter---her compensation.
During the conversation with Marks, Jameson had asked what her compensation package would be
Marks: “Well, Sally, we are all very impressed with you and would like to offer you a starting salary of 50,000. In addition, you will also, receive a signing bonus”
Jameson: “that has salary is a little below what I had expected. Is that negotiable?”
Marks: “I’m afraid not. That’s the same starting package all MBAs get However, you will receive a bonus upon accepting our offer. You can...

...Since the late 1980's more and more people have been given the opportunity to purchase stockoptions. As of 2001, ten million employees have chosen to purchase stockoptions. Another survey established that 97 of the top 100 e-commerce companies gave the choice of options this year. For these reasons, it is important to understand what stockoptions are, the different types ofoptions, and their advantages and disadvantages.
A stockoption gives any employee the right to buy a certain number of shares in the company at a fixed price for a certain number of years. Employees who have been given the choice of stockoptions hope that the share price will go up and that they will be able to cash in by purchasing the stock at the lower grant price and then selling the stock at the current market price. Stockoption plans can be a flexible way for companies to share ownership with employees, reward them for performance, and attract and retain a motivated staff. These plans could also encourage the employees to look in that best interest of the company and other shareholders.
For growth-oriented smaller companies, options are a great way to preserve cash while giving employees a piece of future growth. They can also work for...

...ago stockoptions were rarely used as incidental benefits for top executives. Nowadays, compensating employee whit stockoptions has become an increasingly common practice. Before the year 1996, only the intrinsic value method was used to record these transactions. This method distorted the issuer’s reported financial condition and results of operations, which could lead to inappropriate decisions taken by investors. Followed by the increased use of employee stockoptions and the surrounding controversy of its recording method, on the year 1996 the fair value method was introduced to be used as an alternative to the intrinsic method and on 2004 the intrinsic value method was completely discontinued. The Fair value method represent a better approach to the benefit of financial statements users given its many advantages.
Employee stockoptions allow employees to purchase shares of their company’s stock at a “strike” price set by the company. The employee must exercise the right to purchase these options within a specified period of time also established by the company. Usually the strike or grant price is the market price of the stock at the time the option is granted. There is usually a minimum waiting period during which the employee must remain employed by the company before the individual may...

... 1. Ignoring taxation and other constraints, Ms. Jameson is better off taking the options. The stock currently trading at $18.75 and the exercise price is $35. This may seem drastically far away. However, 5 year T-Bill rates are currently at 6.02%. Combined with a current stock volatility of approximately 42%, this allows each option to be valued at approximately $4.93.
At this amount, Ms. Jameson’soptions would be presently worth $14,790 were she to sell them. Where she to hold them instead, Ms. Jameson’s potential upside is limitless. Her possible gains would be equal to her number of options multiplied by the difference between the stock price and her exercise price of $35, assuming that the stock price is higher than $35.
There is risk involved, however. If Ms. Jameson decides to hold onto the options and not sell them, it would be possible for her to earn nothing. If the stocks price where to stay below $35 dollars, Ms. Jameson’s options would be worth nothing.
Comparatively, the $5000 cash bonus, where it to be invested over the 5 years at the risk free rate of 6.02%, would yield only $6697.44.
2. If Ms. Jameson was not allowed to sell her options before the allotted 5 years, the choice to take the options...

...Wang
E09-G11
SallyJameson Case
1. How much is the option compensation package worth
With the 5-year T-Bill yield, we can calculate the rf rate, compounded continuously, input for the BlackScholes model.
e5r = 1 + (5-year T-Bill yield)
e5r = 1.0602
r = 0.0117
Exercise price
X
35
Given by case text
Current stock price
Volatility of stock returns
Time to maturity
S
ơ
Ƭ
18.75
43%
5
r
6.02%
1.17%
Given by case text
Approximation given by Exhibit 3
Given by case text, assumed that Sally will not leave
the company within 5 years
Annualized 5-year T-Bill rate
Simple interest rate
Continuously compounded
interest rate
Using a Black-Scholes excel template, we know that each option is worth $3.867, meaning that the 3000
options is worth $11,607.
Template - Black-Scholes Option Value
Input Data
Stock Price now (P)
Exercise Price of Option (EX)
Number of periods to Exercise in years (t)
Compounded Risk-Free Interest Rate (rf)
Standard Deviation (annualized ơ)
18.75
35
5
1.17%
43.00%
Output Data
Present Value of Exercise Price (PV(EX))
ơ *t^.5
d1
d2
Delta N(d1) Normal Cumulative Density Function
Bank Loan N(d2)*PV(EX)
33.0129
0.9615
-0.1076
-1.0691
0.4572
4.7047
Value of Call
Value of Put
3.8670
18.1299
E09-G11
Mridul Arora, Florent Bernard, Jacqueline Kwok, Pu Wang
Ignoring tax considerations, Sally...