Question

Dell Computer had outstanding stock options of 344 million at the end of fiscal year 2001 (outstanding shares are 2,601 million). This is a potential problem to investors because:

	a.	Potential dilution of common stock of over 13%
	b.	Severe leverage problem because of the option obligations
	c.	Of the huge compensation expense that reduces net income
	d.	The company is obviously near bankruptcy

Answer 1

Answer: c. Of the huge compensation expense that reduces net income.

Stock options are an expense, and are expensed according to the stock options fair value.  The amount by which the fair market value of the stock at the time of grant exceeds the exercise price must be expensed over the vesting period of the stock option.

A decrease in net income will reduce earnings per share for the investors, and resultantly, the market price per share falls. This leads to decrease in stockholder wealth.