A limited is considering introducing an executive share option scheme. The scheme would be offered to all middle level managers of the company. It would replace the existing scheme of performance bonuses linked to the post tax earnings per share of the company. Such bonuses in the last year ranged between sh 500,000 and sh 700,000. If the option scheme is introduced, new options are expected to be offered to the managers each year. It is proposed that for the first year, all middle level managers be offered options to purchase 500,000 shares at a price of sh 5.00 per share, after the options have been held for one year. If the options are not exercised at that time, they will lapse. Assume that the tax authorities allow the exercise of such options after they have been held for one year. The company’s shares have a current market price of sh 6.10 per share. The dividend paid was sh 0.25 per share, a level that has remained constant for the last three years. Assume the dividends are only paid annually. The company’s share price has experienced a standard deviation of 38% during the last year. The short term risk free interest rate is 6% per annum. Required: Evaluate whether or not the proposed share option scheme is likely to be attractive to the middle level managers of A limited. When informed of the scheme in (a) above, one middle level manager of A limited stated that he would rather receive put options than call options as they would be more valuable to him. Explain whether or not A Ltd. should agree to offer him put options. Is the manager correct in his statement that put options would be more valuable to him? Explain
A limited is considering introducing an executive share option scheme. The scheme would be offered to all middle level managers of the company. It would replace the existing scheme of performance bonuses linked to the post tax earnings per share of the company. Such bonuses in the last year ranged between sh 500,000 and sh 700,000. If the option scheme is introduced, new options are expected to be offered to the managers each year. It is proposed that for the first year, all middle level managers be offered options to purchase 500,000 shares at a price of sh 5.00 per share, after the options have been held for one year. If the options are not exercised at that time, they will lapse. Assume that the tax authorities allow the exercise of such options after they have been held for one year. The company’s shares have a current market price of sh 6.10 per share. The dividend paid was sh 0.25 per share, a level that has remained constant for the last three years. Assume the dividends are only paid annually. The company’s share price has experienced a standard deviation of 38% during the last year. The short term risk free interest rate is 6% per annum. Required: Evaluate whether or not the proposed share option scheme is likely to be attractive to the middle level managers of A limited. When informed of the scheme in (a) above, one middle level manager of A limited stated that he would rather receive put options than call options as they would be more valuable to him. Explain whether or not A Ltd. should agree to offer him put options. Is the manager correct in his statement that put options would be more valuable to him? Explain
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Question
- A limited is considering introducing an executive share option scheme. The scheme would be offered to all middle level managers of the company. It would replace the existing scheme of performance bonuses linked to the post tax earnings per share of the company. Such bonuses in the last year ranged between sh 500,000 and sh 700,000. If the option scheme is introduced, new options are expected to be offered to the managers each year.
It is proposed that for the first year, all middle level managers be offered options to purchase 500,000 shares at a price of sh 5.00 per share, after the options have been held for one year. If the options are not exercised at that time, they will lapse. Assume that the tax authorities allow the exercise of such options after they have been held for one year.
The company’s shares have a current market price of sh 6.10 per share. The dividend paid was sh 0.25 per share, a level that has remained constant for the last three years. Assume the dividends are only paid annually.
The company’s share price has experienced a standard deviation of 38% during the last year. The short term risk free interest rate is 6% per annum.
Required:
Evaluate whether or not the proposed share option scheme is likely to be attractive to the middle level managers of A limited.
- When informed of the scheme in (a) above, one middle level manager of A limited stated that he would rather receive put options than call options as they would be more valuable to him.
- Explain whether or not A Ltd. should agree to offer him put options.
- Is the manager correct in his statement that put options would be more valuable to him? Explain
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