INTERPRETING STOCK OPTION DISCLOSURES. Exhibit 6.18 sum- marizes the information disclosed by General Electric Company (GE) regarding its stock option plans for Year 2 to Year 4. Assume an income tax rate of 35 percent.
Required
a. The average option price per share and market price per share at time of grant is equal in each year ($27.37 for Year 2, $31.19 for Year 3, and $32.26 for Year 4). Speculate on why GE structured the stock option grants this way in each year.
b. What are the likely reasons that the fair value of options granted per share increased from Year 2 to Year 3?
c. Compute the amount that GE received from the exercise of stock options each year versus the amount it would have received if it had issued the same number of shares on the market.
d. Refer to your answer to Part c. Discuss why GE is willing to sell shares of its stock to employees at a price (average option exercise price) much lower than the firm could obtain for shares sold on the market (average market price at time of exercise).
e. Refer again to your answer to Part c. Compute the effect of stock-based compensation on net income for each year, assuming that stock option compensation expense equaled the difference between the market price and the exercise price of options exercised.
f. Discuss the strengths and weaknesses of each of the following approaches to recogniz- ing the cost of stock options: (1) no expense as long as the option price equals the mar- ket price on the date stock options are granted, (2) expense in the year of the grant equal to value of options granted, and (3) expense in the year of exercise equal to the benefit realized by employees from purchasing shares for less than market value.
Text Book: Financial Reporting, Financial Statement Analysis and Valuation: A Strategic Perspective By James Wahlen, Stephen Baginski, Mark Bradshaw.