Year Reinvestment Needs

Firm Value
Reinvestment Needs as percent of Firm
ln(Reinvestment
Value Needs)
1 $71.00 $1,000.00 7.10% -2.6450754019
2 $33.00 $1,071.00 3.08% -3.479840509
3 $181.00 $1,156.00 15.66% -1.854224018
4 $55.00 $1,211.00 4.54% -3.0918685583
5 $83.00 $1,413.00 5.87% -2.8346297749
6 $233.00 $1,666.00 13.99% -1.9671423692
7 $90.00 $1,870.00 4.81% -3.0338840395
8 $211.00 $2,001.00 10.54% -2.2495442011
9 $122.00 $2,133.00 5.72% -2.8612636737
10 $445.00 $2,225.00 20.00% -1.6094379124

Average Reinvestment Need as % of Valu 9.13%

Standard Deviation in reinvestment needs = 61.25%
tment Needs)
 OPTION WORKSHEET: LONG TERM OPTIONS

VALUING FINANCIAL FLEXIBILITY

This program calculates the value of financial flexibility

on an annualized basis. It can be used to
determine if firms should maintain excess debt capacity.

Assumptions
1. All the assumptions underlying the Black-Scholes model apply
2. The dividend yield over the lifetime of the option is known and a constant.

The user has to input the following variables

1. Expected annual reinvestment needs as percent of firm value
2. Variance in annual expected reinvestment needs
3. Annual Reinvestment Needs that can be financed without financial flexibility (from internal funds or accessible exte
4. Riskless interest rate that corresponds to the life of the option
5. Current Cost of Capital
6. Excess Returns earned on Projects (ROC - Cost of Capital)
 OPTION WORKSHEET: LONG TERM OPTIONS

Inputs relating the underlying asset

Enter annual reinvestment needs as percent of firm v 9.13% (in currency)

Entet the annualized standard deviation in reinvestm 61.25% (in %)

Inputs relating to the option

Enter reinvestment needs that can be financed without 5.00% (in currency)
Enter maximum reinvestment that can be financed with17.00%
General Inputs
Enter the riskless rate that corresponds to the option 6.00% (in %)

Capital Inputs
Enter the current cost of capital for the firm = 12.22%
Enter the firm's current return on capital = 18.69%

Output
Stock Price= 9.13% T.Bond rate= 6.00%
Strike Price= 5.00% Variance= 0.3751563
 OPTION WORKSHEET: LONG TERM OPTIONS

Expiration (in year 1 Annualized dividend yield 0.00%

Annual Excess Return 6.47% Cost of Capital = 12.22%
Maximum Flexibility = 17.00%

Value of Call (lower bound) Value of Call (Maximum Flexibility)

d1 = 1.38727495 d1 = -0.610725754
N(d1) = 0.91732103 N(d1) = 0.27069058

d2 = 0.77477495 d2 = -1.22322575
N(d2) = 0.78076367 N(d2) = 0.11062222

Valueof financial flexibility (in annual terms) 2.1170%

 OPTION WORKSHEET: LONG TERM OPTIONS

ds or accessible external funds)