Definition for : Option model

An option model used for valuing a company is based on the asymmetry of rights of creditors and Shareholders (see asymmetry - shareholder/creditor). The Shareholders' equity of a levered company can be seen as a Call option, granted by creditors to Shareholders, on the company's Operating assets. The Strike price is the Value of the Debt and its Maturity is the Exercise date. Using this options-based approach, the Value of Equity can be Split into intrinsic Value and Time value. Intrinsic Value is the difference between the Present value of Capital employed and the Debt to be repaid upon Maturity. Time value is the hope that when the Debt matures, e nterprise Value will have risen to exceed the amount of the Debt to be repaid.

(See Chapter 35 Working out details: The design of the capital structure of the Vernimmen)

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