Earlier this year, Barracuda Company issued 5,000 employee stock options. Recently, 2,000 options were exercised at a price of $10 per share. To avoid dilution, Barracuda purchased 2,000 shares at an average price of $12 per share. Barracuda reported both transactions as financing activities in its cash flow statement. For analytical purposes, what adjustment is necessary to better reflect the substance of the stock repurchase? Operating cash flow____________ Financing cash flow A) Decrease $4,000________________No adjustment B) Decrease $4,000________________Increase $4,000 C) No adjustment__________________Increase $4,000 I thought that it doesn’t matter when the options are exercised. I was under the impression that the expense is allocated evenly over the vesting period. So is this question accurate? wouldn’t we need to know how long the options are good for to be able to answer this question (the answer was B by the way)…
since both the activities were listed under the financing cf umbrella - an amount of 4000 (2000*(12-10)) was listed as an outflow into the cff. since it related to “Compensation expense due to option exercise” the amount should have actually been a CFO Outflow. so reclassify the 4000$ by reducing the CFO and increasing the CFF by 4000$.
@rn: you are correct that expense is allocated evenly over the vesting period for options, but this expense only relates to the FMV of the options when they are issued. Note the company is under no obligation here to preempt dilution by buying in the market to cover the calls, they can just print more stock and dilute existing shareholders.
I don’t get it sorry cpk… “To avoid dilution, Barracuda purchased 2,000 shares at an average price of $12 per share” meaning he exercised 2000 shares at $10 and bought a separate 2000 shares at $12. Why is that the same as one purchase of 2000*($12-$10)?
both went into the cff umbrella. so they received 10$ per share due to the exercise of the options. then bought 12$ per share. which also went into the CFF. so net effect was 2$ per share showing up on the CFF as an outflow. does that make sense?
cpk is damn right. no one challenge him pls. heres my reasoning: Assume company can only issue call options. So company wrote call options giving employees the right to buy company stock for $10. Since employees don’t pay for this option, company has to expense the premium they’d recognize by writing this option as if to a third party. Now in future if the stock goes to $20, and the option gets exercised then company will incur one of the two: a) dilute existing shareholders by issuing 5k shares. (assuming 1 share per option). b) or settle the options trade by paying the premium differential (the day options gets excerised against them - we are not given this data so it can’t be relevant to question). But the question is saying company is trying to avoid a dilution and hence purchases 2k shares from open market, so when the employee options get exercised, company will have 2k shares to deliver. Two things happen now: a) company buys stock, so subtracts cash from CFF, and creates treasury stock. b) company deliveries the stock, retires the outstanding obligation. so essentially company is buying stock for 12, and selling it for 10. Hence loss of $2. so 2*2k loss. But this loss needs to go via CFO, and not CFF. hence CFO needs to be deducted, and CFF needs to be increased.