The going rate for paying a CEO in the widget industry is $1,000,000 per year.You find that the CEO of MasterWidgets has a contract that pays him $1,200,000 per year for five years if he cannot work for any other firm (for any reason during the contractual period).What is the value of a real option for a CEO to not work for a firm other than MasterWidgets? Assume a discount rate of 10%.

Question

Quizplus · Accepted Answer

Value of market rate: 1,000,000 PVIFA(10%,5)= 1,000,000 * 3.7907868 = 3,790,787
Value of contract: 1,200,000 PVIFA(10%,5)= 1,200,000 * 3.7907868 = 4,548,944
Value of option: 4,548,944 -3,790,787 = 758,157

The Going Rate for Paying a CEO in the Widget