On 1 July 2009 York Ltd (a start-up biotech company)grants its senior manager a choice of receiving cash equivalent of 100,000 shares or 120,000 shares.The grant is conditional upon the senior manager working for the entity for three years but if the share alternative is chosen,the grant vests after two years.At grant date the entity's share price is $12.50.The entity does not expect to pay dividends in the next three years.After taking into account the effects of post-vesting transfer restrictions,the entity estimates the grant-date fair value of the share alternative to be $12. What is the fair value of the equity component of the compound instrument?

Question

Quizplus · Accepted Answer

To calculate the fair value of the equity component, we need to first determine the fair value of the cash component. The fair value of the cash component can be calculated by multiplying the number of shares in the share alternative by the share price:

120,000 x $12.50 = $1,500,000

Since the vesting period for the share alternative is 2 years, we need to discount the fair value of the cash component back by 2 years using a risk-free rate. Assuming a risk-free rate of 2%, the present value of the cash component is:

$1,500,000 / (1 + 2%)^2 = $1,404,840

To calculate the fair value of the equity component, we need to subtract the fair value of the cash component from the grant-date fair value of the share alternative:

$12 - $12.50 = -$0.50 per share

Since the senior manager has a choice between 100,000 shares or 120,000 shares, we need to multiply the fair value per share by the number of additional shares in the share alternative:

-$0.50 x 20,000 = -$10,000

Therefore, the fair value of the equity component is negative $10,000. However, since the fair value of the cash component is greater than the grant-date fair value of the share alternative, the senior manager would likely choose the cash component.

On 1 July 2009 York Ltd (A Start-Up Biotech Company)grants