You own a small networking startup. You have just received an offer to buy your firm...

You own a small networking startup. You have just received an offer to buy your firm from a large, publicly traded firm, JCH Systems. Under the terms of the offer, you will receive 1 million shares of JCH. JCH stock currently trades for $24.63 per share. You can sell the shares of JCH that you will receive in the market at any time. But as part of the offer, JCH also agrees that at the end of one year, it will buy the shares back from you for $24.63 per share if you desire. Suppose the current one-year risk-free rate is 5.73%, the volatility of JCH stock is 30.5%, and JCH does not pay dividends. Round all intermediate values to five decimal places as needed.

a. Is this offer worth more than $24.63 million? Explain.

b. What is the value of the offer?

Solutions

Expert Solution

a) The offer consists of 2 parts.

1) One is the value of 1 million shares at current market price ($24.63). This translates to $24.63 millions

2) The second part is a put option to sell these shares at $24.63 after one year. This is essentially a put option.

We know that the value of a put option can never be less than zero. The value of the offer is

$24.63 million +V, where V is the value of option and V is greater than or equal to zero.

Hence, the offer is worth more than $24.63 millions

b) Now we need to calculate the value of put option. We use any option calculator (available online) and plug in following values

The value of put option comes out to be $2.26705. WE need to multiply it by 1 million as there are 1 million shares

= $2.26705 million

Hence the total value of offer is $24.63+$2.26705 = $26.89705 millions.

NOTE: We can also calculate the value of put option ourselves by using the Black-Scholes formula formulas but it will be very lengthy process.

Kindly let me know if you have any doubt.
Don't forget to rate the answer if you found my effort helpful :)

jeff jeffy answered 11 months ago

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