VMware 2007 Annual Report Download - page 89

Table of Contents
VMWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
For the equity awards granted prior to the Company’s IPO, VMware performed a contemporaneous valuation of the Company’s Class A
common stock each time an equity grant of common stock was made. In determining the fair value of the equity, VMware analyzed general
market data, including economic, governmental and environmental factors; considered its historic, current and future state of its operations;
analyzed its operating and financial results; analyzed its forecasts; gathered and analyzed available financial data for publicly traded companies
engaged in the same or similar lines of business to develop appropriate valuation multiples and operating comparisons, and analyzed other facts
and data considered pertinent to the valuation to arrive at an estimated fair value.
VMware utilized both the income approach and the market approach in estimating the value of the equity. The market approach estimates
the fair value of a company by applying to the company’s historical and/or projected financial metrics market multiples of the corresponding
financial metrics of publicly traded firms in similar lines of business. The use of the market approach requires judgments regarding the
comparability of companies that are similar to VMware. If different comparable companies had been used, the market multiples and resulting
estimates of the fair value of the Company’s stock also would have been different. The income approach involves applying appropriate risk-
adjusted discount rates to estimated debt-free cash flows, based on forecasted revenue and costs. The projections used in connection with this
valuation were based on the Company’s expected operating performance over the forecast period. There is inherent uncertainty in these
estimates. If different discount rates or other assumptions had been used, the resulting estimates of the fair value of the Company’s stock would
have been different. Due to the prospect of an imminent public offering, VMware did not apply a marketability discount in carrying out either
approach. Further, VMware did not apply a minority interest discount in concluding on fair value.
In reaching its estimated valuation range, VMware considered the indicated values derived from each valuation approach in relation to the
relative merits of each approach, the suitability of the information used, and the uncertainties involved. The results of the approaches overlapped,
with the income approach results falling within a narrower range, which VMware ultimately relied on in its concluding estimate of value.
In addition to the aforementioned analysis, with respect to grants of options to purchase Class A common stock with a per share exercise
price of $23.00, the Company believes that the fair value of its equity at that time was further substantiated by the arm’s-length transaction with
Intel Capital, whereby Intel agreed to purchase 9.5 million shares of VMware’
s Class A common stock at $23.00 per share, subject to adjustment
if the price in the offering is below $23.00 per share. VMware believes that the fair value of its equity at the time of the grant of options at
$25.00 per share was substantiated by the contemporaneous arm’s-length transaction whereby Cisco agreed to purchase 6.0 million shares of
VMware’s Class A common stock from EMC at $25.00 per share. The Company believes that the fair value of VMware’s equity at the time of
the grant of options at $29.00 per share was substantiated by the proximity to the IPO.
The fair value of each VMware option granted at $23.00 was estimated on the date of grant using the Black-Scholes option-pricing model
with the following weighted average assumptions:
85
Dividend yield
None
Expected volatility
39.2
%
Risk
-
free interest rate
5.0
%
Expected life (in years)
3.4