A company's board is deciding whether to grant the company's current CEO an option to buy one million shares of the company's stock at the price of $18 per share. The company's stock is currently trading at $20 per share. The option will expire in six years and the owner of the option can have the flexibility to exercise the option anytime up until (and including) the option's expiration. This option is not transferrable. Assuming that the risk-free interest rate is 1.5% per annum. a) If the annualized volatility of this company's stock price is 20% and the public expects the company to pay one dividend of $5 per share in 5 years time from now and another dividend of $3 per share 7 years from now. What is the current value of this option? (12 marks) b) If the CEO is granted the option stated above today, does he have incentive to pay more or less dividend in the next 6 years? Explain your answer. (2 marks) c) Suppose if in addition to the discrete dividends described in a), the company is expected to pay another small dividend of $1 per share 2 years from now, would you be able to use the same approach used in a) to compute the value of Mr. Key's stock options? If yes, explain how you would do that in the simplest way; if no, explain why not. (4 marks) d) If the shareholders are strongly against the company from taking more risky projects over the next 6 years, do you think the board should grant the CEO the option described in a)? Explain your answer. (2 marks) A company's board is deciding whether to grant the company's current CEO an option to buy one million shares of the company's stock at the price of $18 per share. The company's stock is currently trading at $20 per share. The option will expire in six years and the owner of the option can have the flexibility to exercise the option anytime up until (and including) the option's expiration. This option is not transferrable. Assuming that the risk-free interest rate is 1.5% per annum. a) If the annualized volatility of this company's stock price is 20% and the public expects the company to pay one dividend of $5 per share in 5 years time from now and another dividend of $3 per share 7 years from now. What is the current value of this option? (12 marks) b) If the CEO is granted the option stated above today, does he have incentive to pay more or less dividend in the next 6 years? Explain your answer. (2 marks) c) Suppose if in addition to the discrete dividends described in a), the company is expected to pay another small dividend of $1 per share 2 years from now, would you be able to use the same approach used in a) to compute the value of Mr. Key's stock options? If yes, explain how you would do that in the simplest way; if no, explain why not. (4 marks) d) If the shareholders are strongly against the company from taking more risky projects over the next 6 years, do you think the board should grant the CEO the option described in a)? Explain your answer. (2 marks)
