Sara’s Options

Case Analysis

Agenda

• Introduction & Pay Package Summary

• Broad Comparison of 3 Options

• Davis & Rockefeller: Analysis

• Clear Lake: Analysis

• WebScale: Analysis

• Conclusion

Introduction

• Sara Becker, a graduation MBA student

• Analysed the offers on various dimensions: economic attractiveness of the industries; the strategic positions and characteristics of each of the companies; the specific tasks she would perform etc.

• Prime Focus: “ability to generate long term wealth”

Stock options - links the performance of the company to the performance of the employee

Davis & Rockefeller

(Vice President)

Clear Lake(Associate,

Strategic Investment)

WebScale(Manager of Marketing &

Strategy Developmen

t)

OFFERS

Pay Package Summary:

She analysed the three options with the help of:-

• Salary and bonus offered at the three jobs + tax rates

• Summarized the terms of the option awards from WebScale and Clear Lake.

• Sara’s guesses of how likely she would stay at each firm for three years, and what her likely salary might be at that time. Sara estimated the chance of changing the job in three years time period.

• The value of options were a function of a variety of factors: terms of the contract, market conditions

• The “implied volatilities” of traded options on the two firms from Bloomberg.

• To value options - Black-Scholes model

Broad ComparisonBenefits Davis & Rockefeller Clear Lake WebScale

Cash Signing Bonus Yes Nil Nil

Annual Bonus 100 – 300 %40% of base + profit sharing

of $10,000 per year + portion of deal carry

20% of base salary

Stocks or Stock Options None “Standard” stock options“OutPerformance Stock

Options” (OSOs)

Exercise Price NA-Stock price at employee’s

start date

Scaled to account for gains or losses in market - S&P stock

index

Vesting Period -NA½ options in first 3 years & ½

options in last 2 years

Options vest over 2 years with 1/8th options vesting at

end of each quarter

Expiration Period -NA 5 years 4 years

BenefitSara will benefit if the unit’s

performance is able to get her 300% annual bonus

Sara will benefit when stock price rises over exercise

price

Sara will benefit when WebScale’s performance is

better than S&P

OutPerformance Plan

• Number of shares dependent on performance with respect to the S&P Index through multiplier• Payoff = Multiplier * Dollar Outperformance

Formulae :

• Dollar Outperformance = market value of one WebScale share – Adjusted Exercise Price• Adjusted Exercise Price = WebScale stock price at the time of issue * (1+ % change in value of S&P 500

index since the time of option grant)• Multiplier =(outperform percentage * 8/10) * 100• Outperform % = % change in WebScale stock minus - % change in S&P Index in the same time

• For competitive levels, option grants by awarding dollar value of options – analyze competitors compensation awards and determine price using proprietary options pricing algorithm

Davis & Rockefeller

Year --> 1 2 3 4 5

Base Salary 125000 125000 125000 175000 175000

Signing Bonus 50000 0 0 0 0

Annual Bonus (100%) 125000 125000 125000 175000 175000

Total Salary (before tax) 300000 250000 250000 350000 350000

Tax calculation 90,200.50 35,156.50 35,156.50 90,200.50 90,200.50

Pay Over: 16850 119750 119750 66850 66850

% over above 6672.6 43110 43110 26472.6 26472.6

Total Tax 96873.1 78266.5 78266.5 116673.1 116673.1

Total Pay after tax 203126.9 171733.5 171733.5 233326.9 233326.9

Minimum Combination Pay

Year --> 1 2 3 4 5

Base Salary 125000 125000 125000 175000 175000

Signing Bonus 75000 0 0 0 0

Annual Bonus (300%) 375000 375000 375000 525000 525000

Total Salary (before tax) 575000 500000 500000 700000 700000

Tax calculation 90,200.50 90,200.50 90,200.50 90,200.50 90,200.50

Pay Over : 291850 216850 216850 416850 416850

% over above 115572.6 85872.6 85872.6 165072.6 165072.6

Total Tax 205773.1 176073.1 176073.1 255273.1 255273.1

Total Pay after tax 369226.9 323926.9 323926.9 444726.9 444726.9

Maximum Combination Pay

Year 1 Year 2 Year 3 Year 4 Year 50

50000

100000

150000

200000

250000

300000

350000

400000

450000

500000

Option 1: Davis & Rockefeller

Minimum Pay Maximum Pay

Black Scholes methodOptions pricing Model

• Objective: estimates premium on options.

• Formula derived by three econonomists-Fischer Black, Mayron Scholes and Robert Merton.

• The model looks at the present value of the strike price (Cash) and the stock at the time of exercise

• Assumptions: Constant volatility and risk free interest rate, dividend free, European style options, efficient market (liquid, equal access to information, fair and transparent, zero transparent cost, returns on the stock normally distributed

Formula

Expected benefit of purchasing the option

Exercise price’s current value

Clear LakeBlack-Scholes Option Value

Input Data After 3 years  After 5 years 

Exercise Price of Option (EX) 137 137Number of periods to Exercise in years (t) 3 5Compounded Risk-Free Interest Rate (rf) 6.43% 6.33%

Standard Deviation (annualized s) 48.00% 48.00%

Output Data    Present Value of Exercise Price (PV(EX)) 112.9653 99.8312

s*t^.5 0.8314 1.0733d1 0.6477 0.8315d2 -0.1837 -0.2418

Delta N(d1) Normal Cumulative Density Function 0.7414 0.7972Bank Loan N(d2)*PV(EX) 48.2516 40.3795

Value of Call 53.3223 68.8321Value of Put 29.2876 31.6634

Clear Lake

After 3 years After 5 years

Base Salary 175000 175000

Annual Bonus 70000 70000

10000 10000

Annual Options 102393.6 528630.528

Total 357393.6 783630

Tax 117596.3884 288390.58

Total Pay after Tax 239797.2116 495239.42After 3 years After 5 years

0

100000

200000

300000

400000

500000

600000

Clear Lake: Option 2

Total Pay

Black Scholes Call Value *

1920

Black Scholes Call Value *

(3840 + 1920+1920)

WebScale

Call value at Year   3rd year 5th year39.8    

No of shares 2388.8889 2388 555.5556 555

stock price 90   As a deffered value 2666.389 assumed value 2666

Adjusted exercise price 109.8  Webscales stock at 129.8  % increase 3 years 44.22%  

Outperform % 22.22%  

Multiplier 17.777778   > 8; so 8 is taken

Dollar outperformance 20  payoff 160  

Total payoff 426560  Base salary 12500  

Annual bonus 2500  Total taxable income 441560  

Tax 152930.86  

Income after tax 288629.14  

Conclusion

Final Pay0

50000

100000

150000

200000

250000

300000

350000

Snapshot of 3 Options

Davis & Rockefeller Clear Lake WebScale

Offer made by David and Rockefeller is the most lucrative when the compensation and benefits earned only in the first three years is analysed.

Thank You

• Presented By:

• HR 019 Vaishali Gupta

• HR 020 Arpita Gupta

• HR 033 Anurag Mohapatra

• HR 038 Deepti P.V.L

• HR 039 Priyanju Pal

• HR 049 Anjum Sheikh

• HR 055 Rupam Srivastav