1、McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 23-0 Executive Summary This chapter extends the analysis of options contained in Chapter 22. We describe four types of options found in common corporate finance decisions. Executive stock options The option to e 。

2、xpand embedded in a start-up. The option in simple business contracts. The option to shut down and reopen a project. McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 23-1 Chapter Outline 23.1 Executive Stock Options 23.2 Valuing a Start Up 23.3 More on the Bin 。

3、omial Model 23.4 Shutdown and Reopening Decisions 23.5 Summary and Conclusions McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 23-2 23.1 Executive Stock Options Executive Stock Options exist to align the interests of shareholders and managers. Executive Stock 。

4、 Options are call options (technically warrants) on the employers shares. Inalienable Typical maturity is 10 years. Typical vesting period is 3 years. Most include implicit reset provision to preserve incentive compatibility. Executive Stock Options give executives an important tax break: grants of。

5、at-the-money options are not considered taxable income. (Taxes are due if the option is exercised.) McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 23-3 Valuing Executive Compensation FASB allows firms to record zero expense for grants of at- the-money execut 。

6、ive stock options. However the economic value of a long-lived call option is enormous, especially given the propensity of firms to reset the exercise price after drops in the price of the stock. Due to the inalienability, the options are worth less to the executive than they cost the company. The ex 。

7、ecutive can only exercise, not sell his options. Thus he can never capture the speculative valueonly the intrinsic value. This “dead weight loss” is overcome by the incentive compatibility for the grantor. McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 23-4。

8、Top Stock Option Grants CompanyCEOStock Option Award Citigroup, Inc.Sanford Weill$351,319,000 American ExpressHarvey Golub$134,102,000 Cisco Systems, Inc.John Chambers$132,100,000 Bank of AmericaHugh McColl Jr.$104,300,000 Honeywell Inc.Michael Bosignore$121,496,000 ALCOAPaul ONeill$96,353,000 McGra 。

9、w-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 23-5 23.2 Valuing a Start-Up An important option is the option to expand. Imagine a start-up firm, Campusteria, Inc. which plans to open private dining clubs on college campuses. The test market will be your campus,。

10、and if the concept proves successful, expansion will follow nationwide. Nationwide expansion will occur in year four. The start-up cost of the test dining club is only $30,000 (this covers leaseholder improvements and other expenses for a vacant restaurant near campus). McGraw-Hill/Irwin Copyright 2 。

11、002 by The McGraw-Hill Companies, Inc. All rights reserved. 23-6 Campusteria pro forma income statement InvestmentYear 0Years 1-4 Revenues$60,000 Variable Costs($42,000) Fixed Costs($18,000) Depreciation($7,500) Pretax profit($7,500) Tax shield 34%$2,550 Net Profit$4,950 Cash Flow$30,000$2,550 We pl 。

12、an to sell 25 meal plans at $200 per month with a 12-month contract. Variable costs are projected to be $3,500 per month. Fixed costs (lease payment) are projected to be $1,500 per month. We can depreciate our capitalized leaseholder improvements. 84.916,21$ )10. 1 ( 550, 2$ 000,30$ 4 1 t t NPV McGr 。

13、aw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 23-7 23.2 Valuing a Start-Up Note that while the Campusteria test site has a negative NPV, we are close to our break-even level of sales. If we expand, we project opening 20 Capusterias in year four. The value of th 。

14、e project is in the option to expand. We will use the Black-Scholes option pricing model to value this option McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 23-8 23.2 Valuing a Start-Up with Black-Scholes The Black-Scholes Model is )N()N( 210 dEedSC rT Where 。

15、 C0 = the value of a European option at time t = 0 r = the risk-free interest rate. T T rES d ) 2 ()/ln( 2 1 Tdd 12 N(d) = Probability that a standardized, normally distributed, random variable will be less than or equal to d. The Black-Scholes Model allows us to value options in the real world just 。

16、 as we have done in the 2-state world. McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 23-9 23.2 Valuing a Start-Up with Black-Scholes We need to find the value of a four-year call option on chain with an exercise price of $600,000 = $30,00020 The interest ra 。

17、te available is r = 10%. The option maturity is four years. The volatility of the underlying asset is 30% per annum. The current value of the underlying assets is $110,418 418,110$ )10. 1 ( 14.663,161$ )10. 1 ( )10. 1 ( 550, 2$ 20 44 4 1 t t McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Compan 。

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