Harmer Inc. is now a successful company. In the early days(before it became profitable), it issued ISOs to its employees. NowHarmer is trying to decide whether to issue NQOs or ISOs to itsemployees. Initially, Harmer would like to give each employee 20options (each option allows the employee to acquire one share ofHarmer stock). For purposes of this problem, assume that theoptions are exercised in three years (three years from now) andthat the underlying stock is sold in five years (five years fromnow). Assume that taxes are paid at the same time the incomegenerating the tax is recognized. Also assume the following facts:(Leave no answer blank. Enter zero ifapplicable.)
- The after-tax discount rate for both Harmer Inc. and itsemployees is 10 percent.
- The Corporate tax rate is 21 percent.
- The Personal (employee) ordinary income rate is 37percent.
- The Personal (employee) long-term capital gains rate is 20percent.
- 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.
Answer the following questions:
Problem 12-32 Part b
b. Assuming Harmer issues NQOs, what isHarmer’s tax benefit from the options for each employee in the yeareach employee exercises the NQOs? (Round your final answerto nearest whole dollar amount.)
c. Assuming Harmer issues ISOs, what is the tax benefit toHarmer in the year the ISOs are exercised?
d. Which type of option plan should Harmer’semployees prefer?
e. What is the present value of each employee’safter-tax cash flows from year 1 through year 5 if the employeesreceive ISOs? Use Exhibit 3.1. (Round your intermediatecalculations and final anwser to 2 decimal places.)
f. What is the present value of each employee’safter-tax cash flows from year 1 through year 5 if the employeesreceive NQOs? Use Exhibit 3.1. (Round your intermediatecalculations and final anwser to 2 decimal places.)
g. How many NQOs would Harmer have to grant tokeep its employees indifferent between NQOs and 20 ISOs?(Do not round intermediate calculations. Round up yourfinal answer to the next whole number.)
