Valuation of the Liability Structure by Real Options

David Heller is a teacher-researcher in finance and leads the masters in finance program at the ISC in Paris, France.

Introduction ix

Chapter 1 The Utility of Real Options in the Valuation of Liabilities 1

1.1 Introduction 1

1.2 Real options: a mitigating alternative to the deficiency of traditional valuation methods 2

1.2.1 The limits of traditional approaches 3

1.2.2 The alternative of real options 7

1.2.3 Black–Scholes optional modeling 10

1.3 Intersections between approaches to assets valuation 12

1.3.1 Convergence between the Cox–Ross–Rubinstein (1979) and the Black–Scholes (1973) models and the Merton formula (1973) 12

1.3.2 Convergence between the CAPM and the Modigliani–Miller theory 15

1.3.3 Convergence between the Black–Scholes model and the Modigliani–Miller theory outside of taxation 18

1.4 Valuation of liabilities structures with real options 22

1.4.1 The economic value of equity and net debt 22

1.4.2 The impact of the risk debt on the time value of equity and he resolution of conflict between creditors and shareholders 27

1.5 Conclusion 30

Chapter 2 The New Allocation of Company Value Using the Optional Approach 31

2.1 Introduction 31

2.2 Economic value of debt and systematic risk adjustment of equity 34

2.2.1 Optional valuation of debt and the issues associated with getting into debt 34

2.2.2 Combination of CAPM and the options model: the systematic risk of equity and the rate of return required by shareholders 36

2.2.3 Situations that impact financial structure 42

2.3 Integration of organizational problems between shareholders and debtors 45

2.3.1 The interaction of financing decisions 47

2.3.2 Accounting for information costs and protection clauses 53

2.3.3 Bankruptcy costs, getting into permanent debt and optimizing the debt ratio 61

2.4 Mechanisms of refinancing debt and the impact on the value of equity 70

2.4.1 Risks of refinancing 71

2.4.2 Reimbursing loans at intermediate intervals and the impact on the value of equity 76

2.5 Conclusion 82

Chapter 3 Applications of Real Options on Financial Structure Valuation 85

3.1 Introduction 85

3.2 Application to the stock market index of a country: the CAC 40 86

3.2.1 Databases, methodology and hypotheses 87

3.2.2 Equality test for asset and equity volatility and the interpretation of results 94

3.2.3 Equality test for growth potential of stock prices based on the approach of brokers and Black–Scholes–Merton and the interpretation of results 94

3.2.4 Equality test for debt ratios based on net debt from the financial states of companies and the recalculation of net debt using the Black–Scholes–Merton approach, and the interpretation of results 95

3.2.5 Regression coefficient to explain growth potential of stock prices 96

3.3 Application to a business sector: the cinema industry 97

3.3.1 Databases, methodology and hypotheses 97

3.3.2 Equality test for volatility of assets and equity and interpretation of results 100

3.3.3 Equality test for the growth potential of stock prices based on the approach of brokers and Black–Scholes–Merton 100

3.3.4 Test for equal debt ratios based on net debt from the financial reports of companies and the recalculation of net debts using the Black–Scholes–Merton approach 101

Conclusion 103

Appendices 105

Appendix 1 107

Appendix 2 109

Appendix 3 111

Appendix 4 113

Appendix 5 115

Appendix 6 117

Appendix 7 119

Appendix 8 123

Appendix 9 125

Appendix 10 127

Appendix 11 129

Appendix 12 131

Appendix 13 133

Appendix 14 135

Appendix 15 137

Appendix 16 139

Appendix 17 141

Appendix 18 143

Appendix 19 145

Appendix 20 147

Appendix 21 149

Appendix 22 151

Appendix 23 153

Bibliography 159

Index 165