Spot the options in Enigma Drugs plc. The mini-case presented below incorporates five options. Can you identify the type of option, its length and exercise price? Recall that American options offer the holder the right to exercise at any time up to a certain date, while a European option is exercised on one particular date.
Enigma Drugs plc is an innovative pharmaceutical company. The management team is considering setting up a separate limited company to develop and produce a new drug.
The project is forecast to incur development costs and new plant expenditure totalling £50 million and to break even over the next five years (by which time its competitors are likely to have found a way round the patent rights). Enigma's management is considering deferring the whole decision by two years, when the outcome of a major court case with important implications for the drug's success will be known.
The risks on the venture are high, but should the project prove unsuccessful and have to be abandoned, the 'know-how' developed from the project can be used inside the group or sold to its competitors for a considerable sum. Enigma's management realises that there is little or no money to be made in the initial five years, but it should allow them to gain vital expertise for the development of a 'wonder drug' costing £120 million, which could be launched in four years' time.
The newly formed company would be largely funded by borrowing £40 million in the first instance, repayable in total after eight years, unless the company prefers to be 'wound up' for defaulting on the loan. Some of the debt raised will be by 9 per cent Convertible Loan Stock, giving holders the right to convert to equity at any time over the next four years at 360p compared with the current price of 297p.