# Without referring to your notes....

A firm grants employee stock options to a director. The director receives 100,000 options with a strike price of \$10 per share. The shares currently trade at \$8 in the market. The firms financial controller has valued these options using a BSM model and the model is telling him the options are worth \$4 each. FASB has issued guidance on how to record the granting of these options on the firms financial statements. How would they be recorded before, and after FASB issued this guidance.

Compensation expense spread over the vesting period? It doesn’t seem the FASB guidance would make a difference since there were no changes mentioned in the fact pattern.

Incorrect.

before - 0. Strike price=10, current price=8. No value. Now = 100000*4 spread over the vesting period. e.g. if 4 years -> 100000 per year.

cpk123 Wrote: ------------------------------------------------------- > before - 0. Strike price=10, current price=8. No > value. > > Now = 100000*4 spread over the vesting period. > e.g. if 4 years -> 100000 per year. Well done sir.

Hmm…I guess I should adjust my line of thinking. I was assuming they were being recorded according to current US GAAP and FASB issued another piece of guidance which wasn’t specified.

Another easy one… Analysis of the capital structure, paying particular attention to PIK issues & zero-coupon bonds is of particular importance when analyzing what? And why?

PIK - is it Payment in Kind? Liability - not properly stated on the B/S. Off Balance sheet liabs. So all liability ratios understated if Liab is on the top. If liab is on the denominator - they are overstated. once adjusted - liab on top ratios will be increased e.g. D/E, D/TC would go up?

Yes, PIK is payment in kind. You’re on the right track, but what am I trying to determine?

leverage…

I was trying to determine capacity to repay for a high yield issuer. Last one. True or false. This property is going to appreciate. Type: Warehouse NOI: \$150,000 Capitalization rate: 16% Discount rate: 12%

no, it is depreciating. Cap rate = (R-G) R=12 so G = -4 since (R-G)=16

It certainly is depreciating.

Soddy1979 is a level 2 candidate in the CFA program. One of Soddy’s clients “Moon Enterprises” is considering the purchase of a privately held firm called “Sun & Sons”. The CEO of Sun & Sons is really bright, and has decided to pay herself \$300,000 or 150% of the going market rate for CEO’s in the Intergalactic Space Exploration industry. She also owns 90% of the issued ordinary shares in Sun & Son’s. Moon Enterprises believes they will achieve significant operating cost synergies, to the value of \$3,000,000 if their acquisition of Sun & Son’s is successful. Soddy believes a control premium of 12% and a discount for lack of marketability of 15% is appropriate for his analysis. Sun & Son’s income statement looks like this. Revenues: \$25,000,000 COGS: \$20,000,000 Gross Profit: \$5,000,000 Operating expenses: \$3,000,000 EBIT: \$2,000,000 Taxes at 40% \$800,000 Net Income: \$1,200,000 1) Moon enterprises is a financial buyer. True or False? 2) Adjust the income statement. 3) If Soddy’s assumptions on premiums and discounts are appropriate, what should the total discount be?

A True B Revenues: \$25,000,000 COGS: \$17,000,000 (-3 synergy) Gross Profit: \$8,000,000 Operating expenses: \$2,900,000 (-100k ceo pay) EBIT: \$5,100,000 Taxes at 40% \$2,040,000 Net Income: \$3,060,000 3 28.8%

no wait the discount is 24.12% and they are a strategic buyer my brain hurts

I accept your answer as correct. I would have put operating cost synergies below gross profit. However I structured the question badly, and this would have resulted in negative operating costs. Well done sir! Come back tomorrow for questions on AI & Portfolio Management.

why zero-coupon bonds is of particular importance when analyzing capacity to repay for a high yield issuer???

i was going to do that as well, but opex was already 3m so i couldn’t take 3.1m off

neilzuo Wrote: ------------------------------------------------------- > why zero-coupon bonds is of particular importance > when analyzing capacity to repay for a high yield > issuer??? It is because over the life of the bond more liability accrues with PIK and zero-coupon securities. As this accrues and the increased liability is incorporated into the debt structure it will negatively affect the firms ability to repay senior debt.