Harmer Inc. is now a successful company. In the early days (before it became profitable), it issued ISOs to its employees. Now Harmer is trying to decide whether to issue NQOs or ISOs to its employees. Initially, Harmer would like to give each employee 20 options (each option allows the employee to acquire one share of Harmer stock). For purposes of this problem, assume that the options are exercised in three years (three years from now) and that the underlying stock is sold in five years (five years from now). Assume that taxes are paid at the same time the income generating the tax is recognized. Also assume the following facts: (Leave no answer blank. Enter zero if applicable.) The after-tax discount rate for both Harmer Inc. and its employees is 10 percent. The corporate tax rate is 21 percent. The personal (employee) ordinary income rate is 37 percent. The personal (employee) long-term capital gains rate is 20 percent. The exercise price of the options is $7. The market price of Harmer at date of grant is $5. The market price of Harmer at date of exercise is $25. The market price of Harmer at date of sale is $35. Q: 1) What is the present value of each employee’s after-tax cash flows from year 1 through year 5 if the employees receive ISOs? Use Exhibit 3.1. (Round your intermediate calculations and final anwser to 2 decimal places.) 2）How many NQOs would Harmer have to grant to keep its employees indifferent between NQOs and 20 ISOs? (Do not round intermediate calculations. Round up your final answer to the next whole number.)

Corporate Financial Accounting

14th Edition

ISBN:9781305653535

Author:Carl Warren, James M. Reeve, Jonathan Duchac

Publisher:Carl Warren, James M. Reeve, Jonathan Duchac

Chapter10: Liabilities: Current, Installment Notes, And Contingencies

Section: Chapter Questions

Problem 10.5EX: Entries for discounted note payable A business issued a 60-day note for 75,000 to a creditor on...

See similar textbooks

Related questions

Concept explainers

Question

100%

Harmer Inc. is now a successful company. In the early days (before it became profitable), it issued ISOs to its employees. Now Harmer is trying to decide whether to issue NQOs or ISOs to its employees. Initially, Harmer would like to give each employee 20 options (each option allows the employee to acquire one share of Harmer stock). For purposes of this problem, assume that the options are exercised in three years (three years from now) and that the underlying stock is sold in five years (five years from now). Assume that taxes are paid at the same time the income generating the tax is recognized. Also assume the following facts: (Leave no answer blank. Enter zero if applicable.)

The after-tax discount rate for both Harmer Inc. and its employees is 10 percent.
The corporate tax rate is 21 percent.
The personal (employee) ordinary income rate is 37 percent.
The personal (employee) long-term capital gains rate is 20 percent.
The exercise price of the options is $7.
The market price of Harmer at date of grant is $5.
The market price of Harmer at date of exercise is $25.
The market price of Harmer at date of sale is $35.

Q: 1) What is the present value of each employee’s after-tax cash flows from year 1 through year 5 if the employees receive ISOs? Use Exhibit 3.1. (Round your intermediate calculations and final anwser to 2 decimal places.)

2）How many NQOs would Harmer have to grant to keep its employees indifferent between NQOs and 20 ISOs? (Do not round intermediate calculations. Round up your final answer to the next whole number.)

EXHIBIT 3-1 Present Value of a Single Payment at Various Annual Rates of
Return
4%
5%
6%
7%
8%
9%
10%
11%
12%
Year 1
.962
.952
.943
.935
.926
.917
909
.901
.893
Year 2
.925
.907
.890
.873
.857
.842
.826
.812
.797
Year 3
.889
.864
.840
.816
.794
.772
.751
.731
.712
Year 4
.855
.823
.792
.763
.735
.708
.683
.659
.636
Year 5
.822
.784
.747
.713
.681
.650
.621
.593
.567
Year 6
.790
.746
.705
.666
.630
.596
.564
.535
.507
Year 7
.760
.711
.665
.623
.583
.547
.513
482
452
Year 8
.731
.677
.627
.582
.540
.502
.467
.434
.404
Year 9
.703
.645
.592
.544
.500
460
.424
.391
.361
Year 10
.676
.614
.558
.508
.463
.422
.386
.352
.322
Year 11
.650
.585
.527
.475
429
.388
.350
.317
.287
Year 12
.625
.557
497
444
.397
.356
.319
.286
.257
Year 13
.601
.530
.469
415
.368
.326
.290
.258
.229
Year 14
.577
.505
.442
388
.340
.299
.263
.232
.205
Year 15
.555
481
417
.362
.315
.275
.239
.209
.183

Expert Solution

Trending now

This is a popular solution!

Step by step

Solved in 4 steps

SEE SOLUTION Check out a sample Q&A here

Knowledge Booster

Accounting for Employee Compensations and Benefits

Learn more about

Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.