Sally Jameson Valuing Stock Options

1. If we overlook tax consideration and assume that Sally Jameson is totally free to sell her choices at any time after she signs up with Telstar, which compensation package is worth more?

First situation, if Sally chooses stock alternatives and hold up until maturity date. Disregarding the tax and other restraints, the future value of cash compensation at the end of the fifth year will be 5000 * (1 + 0.0602) ^ 5 = 6697.44. We can easily form the formula 3000 * (P-- 35) = 6697.44, where P is the future stock price of Telstar, so the stock price need to increase to a minimum of 37.

23 at the end of 5th year to get the exact same amount of the money settlement and if the stock rate where to stay listed below 35, Sally' choice would deserve nothing. The stock, which pays no dividend and is not expected to pay one in the foreseeable future, is trading at 18.75.

It appears substantial distinction in between the exercise cost and the spot rate. As displayed in Exhibition 2, Telstar stock price has actually increased higher than $35 just as soon as and 10-year typical stock rate is around 20.

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For that reason, the opportunity that the worth of option is greater than the cash settlement is extremely rare. 2nd scenario, presume Sally is totally free to offer choices at any time after her signing up with Telstar, she might sell her alternative right away after receiving. Then we try to price the worth of stock alternative by utilizing Black - Scholes Design.

We understand that the stock is currently trading at .

75 and the exercise rate is $35. We take the 5 year T-bill rate 6.02% as the risk totally free rate. From the Exhibition 2, we can compute the volatility of Telstar stock return is around 27.65%. Plug them into the formula, the call option rate will be 2.53. At this amount, Sally's choices would be currently worth 2.53 * 3000 = 7590. She is much better off taking the option.

2. How should we factor in the issues neglected in question 1? How would they impact the worth of the choice to Ms. Jameson? What should she do? Why?

In considering taxes, transaction costs and difficulty of option liquidity, we conclude that cash package is worth more than stock option package and therefore, it is suggested that Sally choose cash package. The tax impact calculation:

Taking account of the calculation above and following uncertainties that exist if Sally selects stock option, we consider it is better for her to choose signing bonus. The likelihood that stock price exceeds USD 37.28 is low. From the exhibit 2, we note that ceiling of Telstar Common Stock seems to be nearly USD 35. Uncertain factors from the time value and other risk points in the future. If Ms. Jameson leaves Telstar during the vesting period ( salary reaches a certain level, they need more training as rewards. Because training can provide better career developments and labor value.

4. What if Ms. Jameson decided that the option was a better deal, but she did not want to have all her financial wealth (as well as her human capital) tied to the fortunes of Telstar? Assuming she works at Telstar and accepts the option grant, is there anything she could do to untie some of her financial wealth from Telstar? Although the option sounded a good choice, if Sally did not want to have all her financial wealth (as well as her human capital) tied to the fortunes of Telstar, she had better choose the cash rather than the option. Because the option was a better deal depended on a fact that the volatility was computed on the base of 10 years.

There was a very big chance that in less than 5 years or even only 1 or 2 years, the volatility would much less than the number we computed before, as the year 1988 had contributed the biggest volatility because of economy reasons. It means that the value of the option tended to be valueless in short time if the stock price happened to performance steadily. Assuming Sally works at Telstar and accepts the option grant, she can sell some of her options when the price exceed 5000/3000=1.67 or execute some of her options when the stock price is above $35. Sally could keep a portion of the stock options and trade some in the market. That would somehow untie some of her financial wealth from Telstar.