CEP Financial Modeling & Forecasting 2 — Questions and Answers
Question 1: A company grants 10,000 stock options with a Black-Scholes fair value of $8.50 each. Using straight-line attribution over a 4-year vesting schedule, what is the annual compensation expense recognized?
- $21,250 (Correct answer)
- $85,000
- $42,500
- $17,000
Correct answer: $21,250
Annual expense = (10,000 × $8.50) / 4 = $85,000 / 4 = $21,250 per year under straight-line attribution.
Question 2: Which input to the Black-Scholes model represents the annualized standard deviation of the continuously compounded returns on the underlying stock?
- Risk-free rate
- Expected dividend yield
- Expected term
- Expected volatility (Correct answer)
Correct answer: Expected volatility
Expected volatility is the annualized standard deviation of continuously compounded stock returns and is a key Black-Scholes input.
Question 3: Under ASC 718, when an employee forfeits unvested options before the service condition is met, the company should:
- Recognize a forfeiture gain in other comprehensive income
- Reverse previously recognized compensation expense for the forfeited awards (Correct answer)
- Continue recognizing expense over the remaining vesting period
- Accelerate the remaining unrecognized expense into the current period
Correct answer: Reverse previously recognized compensation expense for the forfeited awards
ASC 718 requires that previously recognized compensation expense be reversed when awards are forfeited before vesting.
Question 4: A Monte Carlo simulation is preferred over a lattice model for valuing stock options when:
- Early exercise behavior is a primary concern
- The option has a market condition such as a TSR hurdle (Correct answer)
- The company has no trading history for volatility estimation
- The grant has a simple time-based vesting schedule
Correct answer: The option has a market condition such as a TSR hurdle
Monte Carlo simulation is best suited for awards with market conditions like TSR hurdles because it can model thousands of price paths simultaneously.
Question 5: In a diluted EPS calculation under the treasury stock method, which of the following correctly describes the denominator adjustment for in-the-money options?
- Add all shares underlying options regardless of exercise price
- Add net new shares: options exercisable minus shares repurchased at average market price (Correct answer)
- Subtract shares that could be repurchased from total outstanding shares
- Add shares equal to the intrinsic value divided by the stock price
Correct answer: Add net new shares: options exercisable minus shares repurchased at average market price
The treasury stock method adds the net incremental shares: proceeds from assumed exercise divided by average market price are subtracted from the option shares.
Question 6: Which forfeiture accounting policy did ASU 2016-09 permit companies to elect instead of estimating a forfeiture rate at grant date?
- Recognize forfeitures as they occur rather than estimating upfront (Correct answer)
- Estimate forfeitures only for awards with a market condition
- Apply a flat 5% forfeiture rate to all equity awards
- Use the simplified method for all option grants
Correct answer: Recognize forfeitures as they occur rather than estimating upfront
ASU 2016-09 gave companies the option to account for forfeitures as they occur instead of estimating them at the grant date.
Question 7: A restricted stock unit (RSU) cliff vests after 3 years and the stock price at grant is $40. If the stock price on the vesting date is $55, what amount is recognized as compensation expense per share over the 3-year period?
- $55.00 — the value at vesting
- $15.00 — the appreciation
- $40.00 — the grant-date fair value (Correct answer)
- $47.50 — the average of grant and vest prices
Correct answer: $40.00 — the grant-date fair value
RSU compensation expense equals the grant-date fair value ($40) recognized ratably over the service period, regardless of subsequent price changes.
CEP Financial Modeling & Forecasting 2
A company grants 10,000 stock options with a Black-Scholes fair value of $8.50 each.
Using straight-line attribution over a 4-year vesting schedule, what is the annual compensation expense recognized?