On 1 July 2012 York Ltd (a start-up biotech company)grants its senior manager a choice of receiving cash equivalent of 100 000 shares or 120000 shares.The grant is conditional upon the senior manager working for the entity for 3 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 3 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 determine the number of shares that will vest based on each alternative.

For the cash alternative, the senior manager will receive the cash equivalent of 100,000 shares.

For the share alternative, the senior manager will receive 120,000 shares, which will vest after two years. The post-vesting transfer restrictions imply that the senior manager will not be able to sell the shares immediately after they vest. Therefore, we need to discount the fair value of the shares to account for this restriction. Assuming a discount rate of 5%, the present value of the shares is:

PV = FV / (1 + r)^t
PV = 12 / (1 + 0.05)^2
PV = 10.98

Thus, the fair value of the equity component is:

Fair value = 100,000 x $12.50 + 10,980 x 120,000
Fair value = $1,500,000 + $1,317,600
Fair value = $2,817,600

Therefore, the best choice is C, with a fair value of $2,817,600.

On 1 July 2012 York Ltd (A Start-Up Biotech Company)grants