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
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