Wahoo, Inc., is a high-tech Internet company. It is trying to decide whether to issue NQOs or ISOs to its employees. Each employee will get 10 options. For purposes of this problem, assume that the options are exercised in 3 years and that the underlying stock is sold in 5 years. Here are the facts: Corporate tax rate = 35% Personal (employee) ordinary income tax rate = 40% Personal (employee) capital gains tax rate = 28% Personal (employee) after-tax discount rate = 5%.
Exercise price of the options = $5 Market price of Wahoo stock at date of grant = $4 Market price of Wahoo stock at date of
Exercise = $30 Market price of Wahoo at date of sale = $40
a. Considering these facts, which type of option plan does Wahoo, Inc., prefer?
b. Which type of option plan do Wahoo’s employees prefer?
c. Which type of plan should be used? Why?
d. Assuming that you know that the personal capital gains tax rate is going to be cut to 20% in 4 years from the current 28%, which type of plan should be used? Why?