FIN 422 Week 5 Textbook Problems

Week 5 Textbook Problems

FIN/422

Week 5 Textbook Problems

2. Your employer has awarded you 3,000 shares of SARs with a strike price of $20 per share. When SARs are exercised, the company converts the gain and compensates the employee with shares of company stock. The SARs have a five-year graduated and equal vesting schedule and a ten-year term. On the third anniversary of the grant, the market price is $25 per share and you decide to exercise your SARs. (a) Briefly explain the tax consequences, if any, of your exercise. (b) Briefly explain how you would calculate the “spread” owed to you on exercise. (c) Briefly explain how you would calculate the number of shares you would receive.

Answer:

– As a result of exercising the option, there would be a tax deduction. The reason for this is because of the compensation expenses that are going to be incurred in the year the SARs is exercised.

– The spread would be computed as follows:

Spread = ($25 – $20) * 3000 = $5 * 3000 = $15000

$25 = market price$20 = strike price3000 = number of shares exercised

– The number of shares will be calculated using formula above and then dividing it by the strike price.

Spread = ($25 – $20) * 3000 = 15000

Shares = 15000 / 20 = 750 shares

3. You have received a grant of 2,000 NQSO shares. They vest on a graduated basis over a five-year period. The strike price was $10 per share. It is now three years since the grant and the current price is $20 per share. You decide to exercise on a cashless basis. (a) How many shares can you exercise? (b) What will be your “pretax” gain on the exercise? (c) How will the options be taxed? (d) Assume the price has increased only $0.50 since the grant. What financial reason would there be to exercise now?

Answer:

– The shares to be exercised are computed as follows:

Cash receivable = ($20 – $10) * 2000 = $20,000

Shares = 20,000 / 10 = 2000 shares

– Pretax gain = (2000 * 20) – (2000 * 10) = $20,000

– Options taxed:

($20,000 * 35%) = $7000

– The financial reason would be that the value of a dollar appreciates over time, so one dollar today is worth more than a dollar tomorrow. An increase of $0.50 is not worth waiting for, making it more economical from a financial standpoint to go ahead and exercise the right today.