Company Valuation Under IFRS : Interpreting and Forecasting ...

Company valuation under IFRS
Exhibit 2.24: Equity as call option
Equity as a Call Option
Payoff to equity
Par value of debt
Valueofassets
If the value of the assets is lower than the par value of the debt, shareholders in
a limited liability company are free to walk away, leaving the company with the
creditors. At above the par value of the debt, the intrinsic value of their equity
rises in line with the value of the assets.
Another way to think about the nature of the option is to imagine that instead of
buying a call on the assets, the shareholder had instead achieved the same effect
as is achieved by limited liability through buying a put option from the creditors.
In this instance, the value of the equity would rise as the value of the assets rose,
but would fall only to the exercise price of the put. Below that, any further loss
would be attributable to the writers of the put. If we think from the point of view
of the writer of the put, not the buyer, he receives his payment so long as the
value of the assets stay above the exercise price of the option. Below that price
his receipts decline until if the asset falls in value to the exercise price minus the
price that he received for the put option. Below that point, he loses money. This
payoff is shown in Exhibit 2.25.
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