Duc Nguyen

AF 495, Financial Policy

Professor: Lal, Chugh

Sally Jameson
A. Value of each individual compensation package
Stock Option Compensation
In order to forecast the value of the stock option package, determining the call price is
initially. There are two approaches to calculate the call price for each option, blackscholes and binominal pricing. In addition, the current stock price, exercise price, time of
option, annualized interest rate, and the riskiness of the stock are the inputs for either
approach. In the market, the current price is $18.75. It is much lower than the 5 year-offer
exercise price for each option which is $35. Besides, the risk free rate is 6.02% for the 5year Treasury bill (Exhibit 4). As well, the stock volatility would be approximately 40%.
This assumption is based on historical average of 4 years from 1989-1992. As a result,
the forecast call prices would be $4.6304 and $4.5929, binominal and stock-scholes
pricing model respectively. Therefore, with the offer of 3000 European options, the total
value of the package would make up to 3000 * $4.6304 = $13,902.13.
Cash Compensation
The cash compensation offers Sally with the amount of $5000. With the assumption that
there is no tax on the money, the investment of $5000 on 5-year Treasury bill at rate of
6.02% would yield the amount of $6,697.44 compounding.
Nevertheless, the stock option compensation is worth more than the cash compensation
as the total value of $13,902 to $6.697.44. However, the companys stock option
possesses some major issues which more or less could affect Sallys decision such as the
liquidity and early exercise.

B. Stock Option Cost

Granting stock option is the companys policy to compensate employees. It implies that
the company would deduct the employees cash compensation in replacement for options.
This can be considered as the employee stock options, in which the company is option
writer and employees are option holders. In other words, employees pay for options value
by receiving less cash compensation by an amount equivalent to options value. As the
cost of stock option is based on its value, companies do not pay for these values directly.
In term of accounting cost, this would be regarded as non-cash operating expenses.

C. Incentives
The stock option plans can create the appropriate incentives to either corporations or
employees. For the recipients, it can be regarded to tax reduction. By avoiding the
income tax payments, stock option would help the employees with high annualized
income salaries by converting part of income to capital gains. Furthermore, stock options
are effective way to correlate performance and compensation. In the other words, it
implies that compensation would boost the individual performance as well the overall

performance of the firm. For the employees in high positions, the compensation would
encourage them to act in the best interest of company to foster company growths as well
as increase the stock prices. Employees, talented and excellent, are the main purposes of
creating incentive plans by the company. Generally, the stock option only benefits the
executives with high income salaries and in the decision-making positions, where have
ability to impact on the companys profitability and growth. Therefore, in order to make
the stock option plans are more favorable, the company should individualize the package
based on different positions. Further, granting the privileges of early exercise or lessen
the period of stock options would also motivate the employees to take the plans. These
set up of granting stock option plans would also help to encourage the performances of
employees to lead to both the short and long term success of the firm.