Question

Suppose your employer offers you a choice between a

$5,800

bonus and

400

shares of the company stock. Whichever one you choose will be awarded today. The stock is currently trading for

$58

per share. Ignore transaction costs.

a. Suppose that if you receive the stock? bonus, you are free to trade it. Which form of the bonus should you? choose? What is its? value?

b. Suppose that if you receive the stock? bonus, you are required to hold it for at least one year. What can you say about the value of the stock bonus? now? What will your decision depend? on?

Answer 1

Solution:-

a) Value of the stock bonus today =400 ´$58 =$23,200

Value of the cash bonus today =$5800

We can sell the stock for $23,200 in cash today , hence the value of stock bonus will be = $23,200 which is better than the cash bonus of $5800 today.

Hence we should take the stock bonus option .

b) Since 400 shares could be bought at $23,200 today, hence the value of stock bonus will be $23,200 or less than that. If we are not allowed to sell the company stock for next 1 year, its value could be less than $23,200. The value of stock sock dividend will depend on what we expect the stock price next year and the risk . We cannot simply say which option to choose by surety.

            But since the value of stock dividend is much higher than cash bonus, unless we are very bearish in the stock of company it might be profitable to take stock bonus . Because stock prices have to fall 75% from current level to reach the cash bonus value. It seems less likely , hence stock bonus might be profitable.

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