Topic 6 - Options and Corporate Finance: Extensions and Applications

Question 1

What is the main goal of Executive Stock Options?

Answer 1

Align the interests of shareholders and managers.

Question 2

Why can Executive Stock Options never capture the speculative value—only the intrinsic value

Answer 2

because the executive can only exercise and not sell his options

Question 3

What do Operational options allow for?

Answer 3

Operational options allow flexibility and discretion once project is commenced. Includes shut down temporarily, expand or scale down or switch. Such options cause asset returns to be skewed up while avoiding downside payoffs. DCF method ignores these options.

Question 4

When valuing a call option to expand for a negative NPV project, when should you accept or reject the project based on the value of the call option?

Answer 4

if the value of the call option is large enough to offset the negative NPV then accept.
If not large enough, should still reject the project

Question 5

What are three issues when applying real options valuation?

Answer 5

• Risk-free rate does not exist for non-tradeable assets because a replicating portfolio cannot be formed
• Volatility difficult to determine for non-traded assets
• Option payoffs contingent on actions of competitors