As a newly minted MBA, you've taken a management position withExotic Cuisines, Inc., a restaurant chain that just went publiclast year. The company's restaurants specialize in exotic maindishes, using ingrediants such as alligator, buffalo, and ostrich.A concern you had going in was that the restaurant business is veryrisky. However, after some due diligence, you discovered a commonmisperception about the restaturant industry. It is widely thoughtthat 90 percent of new restaurants close within three years;however, recent evidence suggests the failure rate is 60 percentover three years. So it is a risky business, althought not as riskyas you originally thought.
During your interview process, one of the benefits mentioned wasemployee stock options. Upon signing your employment contract, youreceived options with a strik price of $50 for 100,000 shares ofcompany stock. As is fairly common, your stock options have athree-year vesting period and a 10-yaer expiration, meaning thatyou cannot exercise the options for three years, and you lose themif you leave before thy vest. After the three-year vesting period,you can exercise the options at any time. Thus, the employee stockoptions are European (and subject to forfeit) for the first threeyears and American afterward. Of course, you cannot sell theoptions, nor can you enter into any sort of hedging agreement. Ifyou leave the company after the options vest, you must exercisewithin 90 days or forfeit.
Exotic Cuisines stock is currently trading at $38.15 per share,a slight increase from the initial offering price last year. Thereare no market-traded options on the company's stock. Because thecompany has been traded for only about a year, you are reluctant touse the historical returns to estimate the standard deviation ofthe stock's return. However, you have estimated that the averageannual standard deviation for restaurant company stocks is about 55percent. Because Exotic Cuisines is a newer restaurant chain, youdecide to use a 60 percent standard deviation in your calculations.The company is relatively young, and you expect that all earningswill be reinvested back into the company for the near future.Therefore, you expect no dividends will be paid for at least thenext 10 years. A three-year Treasury note currently has a yield of3.8 percent, and a 10-year Treasury note has a yield of 4.4.percent.
2. Suppose that in three years the company's stock is trading at$60. At that time, should you keep the options or exercise themimmediately? What are some of the important determinants in makingsuch a decision?
3. Your options, like most employee stock options, are nottransferable or tradable. Does this have a significant effect onthe value of the options? Why?
As a newly minted MBA, you've taken a management position withExotic Cuisines, Inc., a restaurant chain that just went publiclast year. The company's restaurants specialize in exotic maindishes, using ingrediants such as alligator, buffalo, and ostrich.A concern you had going in was that the restaurant business is veryrisky. However, after some due diligence, you discovered a commonmisperception about the restaturant industry. It is widely thoughtthat 90 percent of new restaurants close within three years;however, recent evidence suggests the failure rate is 60 percentover three years. So it is a risky business, althought not as riskyas you originally thought.
During your interview process, one of the benefits mentioned wasemployee stock options. Upon signing your employment contract, youreceived options with a strik price of $50 for 100,000 shares ofcompany stock. As is fairly common, your stock options have athree-year vesting period and a 10-yaer expiration, meaning thatyou cannot exercise the options for three years, and you lose themif you leave before thy vest. After the three-year vesting period,you can exercise the options at any time. Thus, the employee stockoptions are European (and subject to forfeit) for the first threeyears and American afterward. Of course, you cannot sell theoptions, nor can you enter into any sort of hedging agreement. Ifyou leave the company after the options vest, you must exercisewithin 90 days or forfeit.
Exotic Cuisines stock is currently trading at $38.15 per share,a slight increase from the initial offering price last year. Thereare no market-traded options on the company's stock. Because thecompany has been traded for only about a year, you are reluctant touse the historical returns to estimate the standard deviation ofthe stock's return. However, you have estimated that the averageannual standard deviation for restaurant company stocks is about 55percent. Because Exotic Cuisines is a newer restaurant chain, youdecide to use a 60 percent standard deviation in your calculations.The company is relatively young, and you expect that all earningswill be reinvested back into the company for the near future.Therefore, you expect no dividends will be paid for at least thenext 10 years. A three-year Treasury note currently has a yield of3.8 percent, and a 10-year Treasury note has a yield of 4.4.percent.
2. Suppose that in three years the company's stock is trading at$60. At that time, should you keep the options or exercise themimmediately? What are some of the important determinants in makingsuch a decision?
3. Your options, like most employee stock options, are nottransferable or tradable. Does this have a significant effect onthe value of the options? Why?
