Under its executive stock option plan, M Corporation granted options on January 1, 2013, that permit executives to purchase 15 million of the company's $1 par common shares within the next eight years, but not before December 31, 2015 (the vesting date). The exercise price is the market price of the shares on the date of grant, $18 per share. The fair value of the options, estimated by an appropriate option pricing model, is $4 per option. No forfeitures were anticipated; however, unexpected turnover during 2014 caused the forfeiture of 5% of the stock options. Ignoring taxes, what is the effect on earnings in 2014?
A)$18.5 million.
B)$18 million.
C)$20 million.
D)$19 million.

Question

Quizplus · Accepted Answer

The total number of options granted is 15 million, and the grant-date fair value per option is $4, so the total fair value of options granted is:

15,000,000 × $4 = $60,000,000

Since the options do not vest until December 31, 2015, no compensation expense is recognized in 2013 or 2014. The unexpected turnover in 2014 results in the forfeiture of 5% of the options, or 750,000 options:

15,000,000 × 5% = 750,000

The total compensation cost is the same, but the number of options expected to vest is reduced by the forfeitures:

(15,000,000 – 750,000) × $4 = $54,000,000

The compensation expense to be recognized each year is the total compensation cost divided by the number of years of the vesting period, which is 3 years:

$54,000,000 ÷ 3 = $18,000,000

Therefore, the effect on earnings in 2014 is $18 million.

Under Its Executive Stock Option Plan, M Corporation Granted Options