SD14-EMPLOYEE STOCK OPTIONS AND VALUATION

SD14-EMPLOYEE STOCK - CHAPTER 14 EMPLOYEE STOCK OPTIONS AND VALUATION LEARNING OBJECTIVES 1 2 3 4 5 6 7 What stock options are and why they are

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CHAPTER 14 EMPLOYEE STOCK OPTIONS AND VALUATION LEARNING OBJECTIVES 1. What stock options are and why they are valuable. 2. How the Black-Scholes option-pricing formula works. 3. Why companies grant employee stock options. 4. How employee stock options differ from publicly traded options. 5. How the financial reporting for employee stock options works. 6. How the employee stock options affect income taxes. 7. How to generalize valuation theory to deal with employee stock options. TRUE/FALSE QUESTIONS 1. The reason analysts are interested in employee stock options is because firms that give employees stock options may have to sell its stock for less than its market value at some point in the future. (easy, L.O. 1, Section 1, true) 2. Employee stock options are always put options, not call options. (moderate, L.O. 1, Section 1, false) 3. When the strike price of an option is less than the market value of the stock, the amount of the difference is the intrinsic value of the option. (moderate, L.O. 1, Section 1, true) 4. The Black-Scholes option-pricing formula was one of the most important breakthroughs in finance. (moderate, L.O. 2, Section 1, true) 5. Holding stock options cause employees to behave more like shareholders. (moderate, L.O. 3, Section 2, true) 6. Recent academic research shows that an analyst using Black-Scholes can adapt the formula for ESOs by replacing the actual time to expiration ( t ) with the expected time the option will be held. (difficult, L.O. 3, Section 2, true) 7. Most firms follow the intuitive value method of accounting for ESOs. (moderate, L.O. 4, Section 3, false) 8. Since the FASB has released SFAS No. 123, “Accounting for Stock-Based Compensation,” firms now recognize ESO costs and no longer use APB Opinion No. 25 for guidance in this area. (difficult, L.O. 5, Section 3, false) 9. Analysts who believe earnings should reflect ESO costs might view a firm’s use of APB Opinion No. 25 as a manipulation of earnings. (moderate, L.O. 5, Section 3, true) 10. The classification of ESOs as ISOs or NSOs determines whether a firm gets a tax deduction when the ESO is exercised. (moderate, L.O. 6, Section 3, true) 11. Although a firm may not recognize any expense in its income statement for an ESO, the option may generate income tax savings through tax deductions, and so the savings is credited directly to equity. (moderate, L.O. 6, Section 3, true) 93
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12. An analyst can incorporate ESOs in the valuation by considering outstanding ESOs to be free cash flow equivalents and expected ESO grants to be capital claims. (difficult, L.O. 7, Section 4, false) 13. Not all ESOs generate a tax deduction for the firm. (moderate, L.O. 7, Section 4, true) 14. An option-pricing model can be used to determine the value of yet-to-be-granted ESOs.
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This note was uploaded on 11/22/2010 for the course CAC BSA taught by Professor Kairus during the Spring '10 term at Korea University.

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SD14-EMPLOYEE STOCK - CHAPTER 14 EMPLOYEE STOCK OPTIONS AND VALUATION LEARNING OBJECTIVES 1 2 3 4 5 6 7 What stock options are and why they are

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