To: Prof. Chalmers
From: Travis Ramme and Meghan Smith
Date: April 26th, 2007
Re: Ms. Chalmers’ Compensation Choices
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’s options 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 would have much more inherent risk. The current value of the options is derived from their market value. This market value means nothing if Ms. Jameson cannot sell the options. If this where the case, Ms. Jameson’s potential profits would be created solely by the Telstar stock rising to a price that was greater than $35 by the end of 5 years.
In fact, to equal the $6697.44 value of the bonus she could have chosen instead, the stock would have to reach a price of at least $37.23. This value would allow the 3000 options to be exercised for a profit of $6697.44. This, however, is...
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