APPLICATION OF FASB STATEMENT NO 123 in .NET

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(iii) Expected Option Lives The expected life of an employee stock option award should be estimated based on reasonable facts and assumptions on the grant date The following factors should be considered: (1) the vesting period of the grant, (2) the average length of time similar grants have remained outstanding, and (3) historical and expected volatility of the underlying stock The expected life must at least include the vesting period and, in most circumstances, will be less than the contractual life of the option Option value increases at a higher rate during the earlier part of an option term For example, a two-year option is worth less than twice as much as a one-year option if all other assumptions are equal As a result, calculating estimated option values based on a single weighted-average life that includes widely differing individual lives may overstate the value of the entire award Companies are encouraged to group option recipients into relatively homogeneous groups and calculate the related option values based on appropriate weighted-average expectations for each group For example, if top level executives tend to hold their options longer than middle management, and nonmanagement employees tend to exercise their options sooner than any other groups, it would be appropriate to stratify the employees into these three groups in calculating the weighted-average estimated life of the options (iv) Minimum Value Method FASB Statement No 123 indicates that a nonpublic company may estimate the value of options issued to employees without consideration of the expected volatility of its stock This method of estimating an option s value is commonly referred to as the minimum value method The underlying concept of the minimum value method is that an individual would be willing to pay at least an amount that represents the bene t of the right to defer payment of the exercise price until a future date (time value bene t) For a dividend-paying stock, that amount is reduced by the present value of dividends forgone due to deferring exercise of the option Minimum value can be determined by a present value calculation of the difference between the current stock price and the present value of the exercise price, less the present value of expected dividends, if any Minimum value also can be computed using an option-pricing model and an expected volatility of effectively zero Although the amounts computed using present value techniques may produce slightly different results than option-pricing models for dividend-paying stocks, the Board decided to permit either method of computing minimum value Exhibit 399 illustrates a minimum value computation for an option, assuming an expected ve-year life with an exercise price equal to the current stock price of $40, an expected annual dividend yield of 125 percent, and a risk-free interest rate available for ve-year investments of 6 percent The FASB Statement No 123 does not allow public companies to account for employee stock options based on the minimum value method because that approach was considered inconsistent with the overall fair value concept However, the FASB acknowledged that estimating expected volatility for the stock of nonpublic companies is not feasible Accordingly, FASB Statement No 123 permits nonpublic companies to ignore expected volatility in estimating the value of options granted As a result, nonpublic entities are allowed to use the minimum value method for stock
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MINIMUM VALUE METHOD Current stock price Less: Present value of exercise price Present value of expected dividends Minimum value of option1 $4000 (2989) (211) $ 800
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1 The $800 minimum value was determined by a present value calculation By way of contrast, application
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of a Black Scholes option-pricing model results in a minimum value of $770 Exhibit 399 Minimum value computation
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