ExecutiveSummaryThischapterextendstheanalysisofoptionscontainedinChapter22.Wedescribefourtypesofoptionsfoundincommoncorporatefinancedecisions.ExecutivestockoptionsTheoptiontoexpandembeddedinastart-up.Theoptioninsimplebusinesscontracts.Theoptiontoshutdownandreopenaproject.第一頁(yè)，共三十三頁(yè)。ChapterOutline23.1ExecutiveStockOptions23.2ValuingaStartUp23.3MoreontheBinomialModel23.4ShutdownandReopeningDecisions23.5SummaryandConclusions第二頁(yè)，共三十三頁(yè)。23.1ExecutiveStockOptionsExecutiveStockOptionsexisttoaligntheinterestsofshareholdersandmanagers.ExecutiveStockOptionsarecalloptions(technicallywarrants)ontheemployer’sshares.InalienableTypicalmaturityis10years.Typicalvestingperiodis3years.Mostincludeimplicitresetprovisiontopreserveincentivecompatibility.ExecutiveStockOptionsgiveexecutivesanimportanttaxbreak:grantsofat-the-moneyoptionsarenotconsideredtaxableincome.(Taxesaredueiftheoptionisexercised.)第三頁(yè)，共三十三頁(yè)。ValuingExecutiveCompensationFASBallowsfirmstorecordzeroexpenseforgrantsofat-the-moneyexecutivestockoptions.Howevertheeconomicvalueofalong-livedcalloptionisenormous,especiallygiventhepropensityoffirmstoresettheexercisepriceafterdropsinthepriceofthestock.Duetotheinalienability,theoptionsareworthlesstotheexecutivethantheycostthecompany.Theexecutivecanonlyexercise,notsellhisoptions.Thushecannevercapturethespeculativevalue—onlytheintrinsicvalue.This“deadweightloss”isovercomebytheincentivecompatibilityforthegrantor.第四頁(yè)，共三十三頁(yè)。TopStockOptionGrantsCompanyCEOStockOptionAwardCitigroup,Inc.SanfordWeill$351,319,000AmericanExpressHarveyGolub$134,102,000CiscoSystems,Inc.JohnChambers$132,100,000BankofAmericaHughMcCollJr.$104,300,000HoneywellInc.MichaelBosignore$121,496,000ALCOAPaulO’Neill$96,353,000第五頁(yè)，共三十三頁(yè)。23.2ValuingaStart-UpAnimportantoptionistheoptiontoexpand.Imagineastart-upfirm,Campusteria,Inc.whichplanstoopenprivatediningclubsoncollegecampuses.Thetestmarketwillbeyourcampus,andiftheconceptprovessuccessful,expansionwillfollownationwide.Nationwideexpansionwilloccurinyearfour.Thestart-upcostofthetestdiningclubisonly$30,000(thiscoversleaseholderimprovementsandotherexpensesforavacantrestaurantnearcampus).第六頁(yè)，共三十三頁(yè)。CampusteriaproformaincomestatementInvestmentYear0Years1-4Revenues$60,000VariableCosts($42,000)FixedCosts($18,000)Depreciation($7,500)Pretaxprofit($7,500)Taxshield34%$2,550NetProfit–$4,950CashFlow–$30,000$2,550Weplantosell25mealplansat$200permonthwitha12-monthcontract.Variablecostsareprojectedtobe$3,500permonth.Fixedcosts(leasepayment)areprojectedtobe$1,500permonth.Wecandepreciateourcapitalizedleaseholderimprovements.第七頁(yè)，共三十三頁(yè)。23.2ValuingaStart-UpNotethatwhiletheCampusteriatestsitehasanegativeNPV,weareclosetoourbreak-evenlevelofsales.Ifweexpand,weprojectopening20Capusteriasinyearfour.Thevalueoftheprojectisintheoptiontoexpand.WewillusetheBlack-Scholesoptionpricingmodeltovaluethisoption第八頁(yè)，共三十三頁(yè)。23.2ValuingaStart-UpwithBlack-ScholesTheBlack-ScholesModelisWhereC0=thevalueofaEuropeanoptionattimet=0r=therisk-freeinterestrate.N(d)=Probabilitythatastandardized,normallydistributed,randomvariablewillbelessthanorequaltod.TheBlack-ScholesModelallowsustovalueoptionsintherealworldjustaswehavedoneinthe2-stateworld.第九頁(yè)，共三十三頁(yè)。23.2ValuingaStart-UpwithBlack-ScholesWeneedtofindthevalueofafour-yearcalloptiononchainwithanexercisepriceof$600,000=$30,000×20Theinterestrateavailableisr=10%.Theoptionmaturityisfouryears.Thevolatilityoftheunderlyingassetis30%perannum.Thecurrentvalueoftheunderlyingassetsis$110,418第十頁(yè)，共三十三頁(yè)。23.2ValuingaStart-UpwithBlack-ScholesLet’stryourhandagainatusingthemodel.Ifyouhaveacalculatorhandy,followalong.Then,Firstcalculated1andd2第十一頁(yè)，共三十三頁(yè)。23.2ValuingaStart-UpwithBlack-ScholesN(d1)=N(-1.8544)=0.032N(d2)=N(-2.45)=0.007Theoptiontoexpand,whilevaluable,isnotasgreatasthenegativeNPVofopeningthetrialCampusteria.Soweshouldnotproceed.第十二頁(yè)，共三十三頁(yè)。TheOptiontoDelay:ExampleConsidertheaboveproject,whichcanbeundertakeninanyofthenext4years.Thediscountrateis10percent.Thepresentvalueofthebenefitsatthetimetheprojectislaunchedremainconstantat$25,000,butsincecostsaredecliningtheNPVatthetimeoflaunchsteadilyrises.Thebesttimetolaunchtheprojectisinyear2—thisscheduleyieldsthehighestNPVwhenjudgedtoday.第十三頁(yè)，共三十三頁(yè)。23.3MoreontheBinomialModelThebinomialoptionpricingmodelisanalternativetotheBlack-Scholesoptionpricingmodel—especiallygiventhecomputationalefficiencyofspreadsheetssuchasExcel.Insomesituations,itisasuperioralternative.Forexampleifyouhavepathdependencyinyouroptionpayoff,youmustusethebinomialoptionpricingmodel.Pathdependencyiswhenhowyouarriveataprice(thepathyoufollow)fortheunderlyingassetisimportant.Oneexampleofapathdependentsecurityisa“noregret”calloptionwheretheexercisepriceisthelowestpriceofthestockduringtheoptionlife.第十四頁(yè)，共三十三頁(yè)。ThreePeriodBinomialOptionPricingExampleThereisnoreasontostopwithjusttwoperiods.Findthevalueofathree-periodat-the-moneycalloptionwrittenona$25stockthatcangoupordown15percenteachperiodwhentherisk-freerateis5percent.第十五頁(yè)，共三十三頁(yè)。ThreePeriodBinomialProcess:StockPrices$2528.7521.252/31/333.0624.442/31/318.062/31/315.352/31/338.022/31/320.772/31/328.10第十六頁(yè)，共三十三頁(yè)。$2528.7521.252/31/315.352/31/338.0228.102/31/320.772/31/333.0624.442/31/318.062/31/313.023.10009.251.9706.501.254.52ThreePeriodBinomialProcess:CallOptionPrices第十七頁(yè)，共三十三頁(yè)。ValuationofaLookbackOptionWhenthestockpricefallsduetothestockmarketasawholefalling,theboardofdirectorstendstoresettheexercisepriceofexecutivestockoptions.Toseehowthisresetprovisionaddsvalue,let’spricethatsamethree-periodcalloption(exercisepriceinitially$25)witharesetprovision.Noticethattheexercisepriceofthecallwillbethesmallestvalueofthestockpricedependinguponthepathfollowedbythestockpricetogetthere.第十八頁(yè)，共三十三頁(yè)。ThreePeriodBinomialProcess:LookbackCallOptionPrices$2528.7521.2533.0624.4418.0624.4415.3520.7728.1020.7720.7728.1038.0228.10第十九頁(yè)，共三十三頁(yè)。ThreePeriodBinomialProcess:LookbackCallOptionPrices$2528.7521.2533.0624.4418.0615.3538.0220.7728.1028.1028.1024.4420.7720.7713.02$3.10$6.85$3.66002.710第二十頁(yè)，共三十三頁(yè)。ThreePeriodBinomialProcess:LookbackCallOptionPrices$2528.7521.2533.0624.4418.0615.3538.0220.7728.1028.1028.1024.4420.7720.7713.02$3.10$6.85$3.66002.7109.252.334.351.72第二十一頁(yè)，共三十三頁(yè)。ThreePeriodBinomialProcess:LookbackCallOptionPrices$2528.7521.2533.0624.4418.0615.3538.0220.7728.1028.1028.1024.4420.7720.7713.02$3.10$6.85$3.66002.7109.252.334.351.726.613.315.25第二十二頁(yè)，共三十三頁(yè)。ExcelApplicationsoftheBOPMTheBOPMiseasilyincorporatedintoExcelspreadsheets第二十三頁(yè)，共三十三頁(yè)。23.4ShutdownandReopeningDecisionsCaneasilybeseenasoptions.The“WoeisMe”goldmineiscurrentlyclosed.ThefirmispubliclyheldandtradesunderthetickerWOE.Thefirmhasnodebtandhasassetsofaround$30million.Themarketcapitalizationis$240millionWhatcouldpossiblyexplainwhyafirmwith$30millioninassetsandaclosedgoldminethatisproducingnocashflowatallhasthiskindofmarketcapitalization?Options.Thisfirmhastheminspades.第二十四頁(yè)，共三十三頁(yè)。DiscountedCashFlowsandOptionsWecancalculatethemarketvalueofaprojectasthesumoftheNPVoftheprojectwithoutoptionsandthevalueofthemanagerialoptionsimplicitintheproject.Agoodexamplewouldbecomparingthedesirabilityofaspecializedmachineversusamoreversatilemachine.Iftheybothcostaboutthesameandlastthesameamountoftimethemoreversatilemachineismorevaluablebecauseitcomeswithoptions.第二十五頁(yè)，共三十三頁(yè)。TheOptiontoAbandon:ExampleSupposethatwearedrillinganoilwell.Thedrillingrigcosts$300todayandinoneyearthewelliseitherasuccessorafailure.Theoutcomesareequallylikely.Thediscountrateis10%.ThePVofthesuccessfulpayoffattimeoneis$575.ThePVoftheunsuccessfulpayoffattimeoneis$0.第二十六頁(yè)，共三十三頁(yè)。TheOptiontoAbandon:ExampleTraditionalNPVanalysiswouldindicaterejectionoftheproject.第二十七頁(yè)，共三十三頁(yè)。TheOptiontoAbandon:ExampleThefirmhastwodecisionstomake:drillornot,abandonorstay.DonotdrillDrillFailureSuccess:PV=$500Selltherig;salvagevalue=$250Sitonrig;stareatemptyhole:PV=$0.TraditionalNPVanalysisoverlookstheoptiontoabandon.第二十八頁(yè)，共三十三頁(yè)。TheOptiontoAbandon:ExampleWhenweincludethevalueoftheoptiontoabandon,thedrillingprojectshouldproceed:第二十九頁(yè)，共三十三頁(yè)。ValuationoftheOptiontoAbandonRecallthatwecancalculatethemarketvalueofaprojectasthesumoftheNPVoftheprojectwithoutoptionsandthevalueofthemanagerialoptionsimplicitintheproject.第三十頁(yè)，共三十三頁(yè)。Enron’sInefficientPlantsIn1999Enronplannedtoopengas-firedpowerplantsinMississippiandTennessee.Theseplantswereexpectedtositidlemostoftheyear,and,whenoperatedtoproduceelectricityatacostofatleast50percenthigherthanthemostefficients