Ross et al.: Fundamentals
of Corporate Finance, Sixth
Edition, Alternate Edition
14. Options and Corporate Finance
Finance
© The McGraw−Hill^481
Companies, 2002
CHAPTER
14
Options and Corporate
Finance
In July 2001,Fortunemagazine ran a cover picture with the headline “The Great
CEO Pay Heist,” which also mentioned that Steven Jobs of Apple Computer was
granted stock options worth $872,000,000! Fortunewent on to clarify that this
was actually the face value, but the true value was estimated to be about $291
million based on a rule of thumb that options are worth one-third of the
exercise price. The issue also included a letter from Jobs with his estimate of the
value of the options: $0. That’s a big difference! So who is correct? As we will
see in this chapter, they’re probably both wrong. The options certainly have
value, but that value is a lot more complicated than indicated by Fortune’s rule
of thumb.
ptions are a part of everyday life. “Keep your options open” is sound business ad-
vice, and “We’re out of options” is a sure sign of trouble. In finance, an optionis
an arrangement that gives its owner the right to buy or sell an asset at a fixed
price anytime on or before a given date. The most familiar options are stock op-
tions. These are options to buy and sell shares of common stock, and we will discuss
them in some detail in the following pages.
Of course, stock options are not the only options. In fact, at the root of it, many dif-
ferent kinds of financial decisions amount to the evaluation of options. For example, we
will show how understanding options adds several important details to the NPV analy-
sis we have discussed in earlier chapters.
Also, virtually all corporate securities have implicit or explicit option features, and
the use of such features is growing. As a result, understanding securities that possess op-
tion features requires a general knowledge of the factors that determine an option’s
value.
This chapter starts with a description of different types of options. We identify and
discuss the general factors that determine option values and show how ordinary debt and
equity have optionlike characteristics. We then examine employee stock options and the
important role of options in capital budgeting. We conclude by illustrating how option
features are incorporated into corporate securities by discussing warrants, convertible
bonds, and other optionlike securities.
O
453
option
A contract that gives its
owner the right to buy or
sell some asset at a fixed
price on or before a
given date.