OPTIONS PACKAGES
You just took a job at an Internet company. As part of your compensation, you've been given options – now you're gonna be rich! But how rich? And how soon? Economists Fischer Black, Robert Merton, and Myron Scholes won a Nobel Prize for devising a formula that estimates the value of options. Their Black-Scholes model relies on factors like the volatility of the marketplace and the length of time you must wait to cash out.
But some experts assert that the model is too conservative for valuing tech companies – particularly Net ventures – since it assumes that the market is both efficient and rational. As an alternative, KPMG Peat Marwick principal David Chase recommends the Discounted Cash Flow model, which recognizes the tremendous upside of technology outfits.
The two formulas paint very different pictures of your earnings. The Black-Scholes model is conservative, while the Discounted Cash Flow model relies on quite a bit of guesswork.
Scenario: You're given 10,000 options of Microsoft with a strike price of $113 13/16 and full vesting in four years.
Black-Scholes model*
| Stock | MSFT
| Current stock price | $113 13/16
| Volatility | 31.24%
| Risk-free interest rate | 5.36%
| Strike price | $113 13/16
| Valuation date | 7/24/98
| Maturity date | 7/24/02
| Value per option | $37.49
| Gross potential value of options| $374,900
*An interactive applet (www.java.sun.com/javareel/isv/Visualnumerics/Smarttable/Examples/Option/Index.html) lets you figure out the value according to the Black-Scholes model.
Discounted Cash Flow model
Value per option
| [ | ( |
| Cash flow multiple | x | Projected '98 cash flow | x |
| Years until vested
| 1.25
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x | 5,851,250,000 | x | <p> | 4
p> <p>
1</p>
<
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1 | ] | x | 10,000 | = | $1,411,200
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