On January 1, Year 1, Stone Company issued 100 stock options with an exercise price of $38 each to 10 employees (1,000 options in total). The employees can choose to settle the options either (a) in shares of stock ($1 par value) or (b) in cash equal to the intrinsic value of the options on the vesting date. The options vest on December 31, Year 3 after the employees have completed three years of service. Stone Company expects that only seven employees will remain with the company for three years and vest in the options. Two employees resign in Year 1, and the company continues to assume an overall forfeiture rate of 30 percent at December 31, Year 1. In Year 2, one more employee resigns. As expected, seven employees vest on December 31, Year 3 and exercise their stock options.

The following represents the share price and fair value at the relevant dates:

	Share	Fair Value of	Fair Value of
Date	Price	Cash Alternative	Stock Alternative
January 1, Year 1	$UJ	$6.00	$6.00
December 31, Year 1, Year 2.	$45	$8.00	$8.00
December 31, Year 3	$47	$9.00	$9.00

Required:

Determine the fair value of the stock options at the grant date and the amount to be recognized as compensation expense in Year 1, Year 2, and Year 3. Prepare journal entries assuming that the vested employees choose (a) the cash alternative and (b) the stock alternative.

Part B. Now assume that if the employees choose to settle the stock options in shares of stock that the employees receive a 10 percent discount on the exercise price (i.e., the exercise price would be $34.20). As a result, the fair value of the share alternative on the grant date is $8.80.

Required:

Determine the fair value of the stock options at the grant date and the amount to be recognized as compensation expense in Year 1.