Under its executive stock option plan, National Corporation granted options on J

Question

Under its executive stock option plan, National Corporation granted options on January 1, 2016, that permit executives to purchase 20 million of the company’s $1 par common shares within the next seven years, but not before December 31, 2019 (the vesting date). The exercise price is the market price of the shares on the date of grant, $24 per share. The fair value of the options, estimated by an appropriate option pricing model, is $3 per option. Suppose that unexpected turnover during 2017 caused the forfeiture of 5% of the stock options.

Compute the amount of compensation expense for 2017 and 2018. (Enter your answers in millions rounded to 2 decimal places (i.e., 5,500,000 should be entered as 5.50))

Under its executive stock option plan, National Corporation granted options on January 1, 2016, that permit executives to purchase 20 million of the company’s $1 par common shares within the next seven years, but not before December 31, 2019 (the vesting date). The exercise price is the market price of the shares on the date of grant, $24 per share. The fair value of the options, estimated by an appropriate option pricing model, is $3 per option. Suppose that unexpected turnover during 2017 caused the forfeiture of 5% of the stock options.

Explanation / Answer

To compute the amount of compensation expense for 2017 and 2018, we have to first calculate the compensation expense for 2016.

Compensation expense for 2016 = Number of options x fair value of option / Vesting period
= 20,000,000 x $3 / 7 = $8.57 million

In 2017, 5% options were forfeited. So, revised total fair value of options = 20,000,000 x 95% x $3 = 57,000,000

Total amount required to be recognized in 6 years i.e. from 2017 to 2022 = Revised total fair value - Amount recognized as compensation expense in 2016
= 57 - 8.57 = $48.43 million

So, the amount of compensation expense for 2017 and 2018 each = 48.43 / 6 = $8.07 million.

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