Company Valuation Under IFRS : Interpreting and Forecasting ...

Company valuation under IFRS
Exhibit 2.27: The components of an option price
dThe Components of an Option Price
The time value of an option is the option price minus the intrinsic value.
Call Option
Time Value
Exercise
Price
Intrinsic
Value
Underlying
Stock Price
An example: Vivendi Universal
The tables and charts in Exhibit 2.28 illustrate a valuation of the equity and debt
in Vivendi Universal, at the high point of worries surrounding its debt level, in
April 2003. It is fairly self-explanatory, though it should be noted that the
valuation and forecast cash flows on part 2 of the model were those produced by
an investment analyst at the time, based on information then available. Because
the volatility of the underlying assets is not directly visible, this is derived in part
3 using the standard two-asset variance-covariance model, as illustrated in the
BP/British Airways portfolio discussed above. The Black-Scholes model in part
5 is adjusted to take loss of cash flow into account when valuing the option, and
a period of two years was taken to be the life of the option, as that was the point
at which a significant tranche of Vivendi’s debt was payable. The chart illustrates
the extent to which the company’s equity was undervalued, and its debt
overvalued, even if the fair asset values on which it was based were correct.
The commonsense way to think about this is to argue that if a company has an
enterprise value that is very close to the par value of its debt, then there is a
significant risk that it will default on its debt. So the debt must trade at a discount
to its par value. In Vivendi’s case it was trading at 95 per cent of its value, but the
model implied that it should at the time have been trading at 74 per cent of its
value. If value is being subtracted from the debt then it is being added to the
equity. So the model shows that, if the valuations on which it is based were
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