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The Group had the following share-based payment plans in operation during the year:

Performance Share Plan (PSP)
This plan involves the award of shares to participants subject to performance conditions. Vesting of the performance shares is based on the achievement of both non-market based conditions (EPS and Cash Flow Per Share) and a market based performance condition (Total Shareholder Return –TSR).

ShareSave share option plan
Based on a three or five year monthly savings contract, eligible employees are granted share options with an exercise price of up to 20 per cent below the share price when the contract is entered into. Vesting of the options is not subject to the achievement of a performance target. In the UK, the plan is HM Revenue & Customs approved. Overseas, employees in 33 countries participate in ShareSave plans through arrangements which provide broadly comparable benefits to the UK plan. From 2007 onwards, the overseas plans are cash-settled schemes.

Executive Share Option Plan (ESOP)
This plan involves the grant of market value share options to participants. The options are subject to a non-market based performance condition (growth in EPS). The options have a maximum contractual life of ten years. Following the introduction of the PSP, it is not intended to grant any further executive share options. The plan terminates in 2009.

Annual Performance Related Award (APRA) plan deferred shares
Deferred shares are awarded as part of the APRA plan. One third of the value of any annual bonus is delivered in the form of a deferred share award. The release of deferred share awards is not dependent on the achievement of any further performance conditions other than that participants remain employed by the Group for two years from the date of the award in order to retain the full number of shares. During the two year deferral period, participants are entitled to receive dividends, or equivalent, on the deferred shares.

Share Incentive Plan (SIP)
There is a ‘Free Share’ element of the UK Share Incentive Plan. Eligible employees may receive shares with a value of up to one and a half week’s salary as part of any bonus paid. There are no conditions attached to the shares. Further information regarding the operation of the plans can be found on the Directors' remuneration report.

In accordance with the transitional provisions of IFRS 2 Share-based Payment, the Group has recognised an expense in respect of all grants under these plans made after November 7, 2002 and unvested at January 1, 2005.

During the year the Group recognised a total expense of £40m (2007 £36m), of which £0.4m (2007 £0.1m) related to cash-settled arrangements. At December 31, 2008, the Group had a liability of £0.6m (2007 £0.2m) relating to cash-settled arrangements.

The movements in awards under the Group’s various share plans are shown in the tables below.

	Number of shares awarded
PSP	2008 Millions	2007 Millions
Outstanding at January 1	14.0	15.7
Awarded during the year	5.1	4.6
Forfeited during the year	(0.7)	(0.8)
Additional entitlements arising from TSR performance	1.3	1.3
Vested during the year	(6.5)	(6.8)
Outstanding at December 31	13.2	14.0

	2008 2007
ShareSave	Number of share options Millions	Weighted average exercise price Pence	Number of share options Millions	Weighted average exercise price Pence
Outstanding at January 1	43.3	260p	54.7	160p
Granted during the year	—	—	13.0	416p
Forfeited during the year	(1.7)	333p	(0.8)	207p
Exercised during the year	(11.9)	144p	(23.6)	116p
Outstanding at December 31	29.7	303p	43.3	260p
Exercisable at December 31	1.6	141p	—	—

	2008 2007
ESOP	Number of share options Millions	Weighted average exercise price Pence	Number of share options Millions	Weighted average exercise price Pence
Outstanding at January 1	2.3	175p	19.0	188p
Exercised during the year	(0.2)	156p	(16.7)	189p
Outstanding at December 31	2.1	177p	2.3	175p
Exercisable at December 31	2.1	177p	2.3	175p

	Number of shares awarded
Deferred shares under APRA	2008 Millions	2007 Millions
Outstanding at January 1	3.4	4.9
Awarded during the year	1.5	1.9
Forfeited during the year	(0.1)	(0.1)
Additional shares accrued from conversion of B Shares	0.1	0.2
Vested during the year	(2.1)	(3.5)
Outstanding at December 31	2.8	3.4
	Number of shares awarded
Free Shares under SIP	2008 Millions	2007 Millions
Awarded during the year	1.2	0.7

Options were exercised on a regular basis during the year. The average share price during the year was 382p (2007 510p).

Fair values
The weighted average fair values per share for PSP awards, ShareSave grants, APRA deferred share awards, and SIP Free Share awards included in the expense for the year were as follows:

	2008 Pence	2007 Pence	2006 Pence	2005 Pence	2004 Pence
PSP awards	458p	557p	494p	282p	249p
ShareSave – 3 year grants	—	230p	—	131p	—
ShareSave – 5 year grants	—	264p	—	154p	—
APRA deferred share awards	440p	502p	448p	260p	220p
SIP Free Share awards	439p	499p	462p	257p	231p

Details of the assumptions used in the calculation of these fair values are set out below. Expected volatility was based on the historical volatility of the Company's share price over the seven years prior to the grant or award date. Until 2007, expected dividends were based on the Company's payments to shareholders over the five years prior to the grant or award date. From 2008, expected dividends were based on the Company's payments to shareholders in respect of 2007.

PSP awards
The fair value of shares awarded under the PSP are calculated using the market value of shares at the time of the award adjusted to take into account non-entitlement to dividends (or equivalent) during the vesting period and the TSR performance condition. The PSP fair values were calculated using the following assumptions:

	2008	2007	2006	2005	2004
Weighted average share price	430p	501p	444p	262p	233p
Expected dividends	13.00p	8.30p	7.92p	7.81p	7.61p
Volatility	29%	29%	32%	34%	35%
Correlation	29%	26%	19%	19%	22%
Expected life	3 years	3 years	3 years	3 years	3 years
Risk free interest rate	4.1%	5.2%	4.3%	4.9%	5.2%

As explained on Directors' remuneration report, the PSP has a TSR market-based performance condition, such that the Company's TSR over the performance period will be compared with the TSR of the companies constituting the FTSE 100 index on the date of grant. If the Company's TSR exceeds the median TSR of the FTSE 100, the number of shares that vest will be increased by 25 per cent. The fair value of an award of shares under the PSP has been adjusted to take into account this market-based performance condition using a pricing model based on expectations about volatility and the correlation of share price returns in the group of FTSE 100 companies and which incorporates into the valuation the interdependency between share price performance and TSR vesting. This adjustment increases the fair value relative to the share price at the date of grant.

ShareSave awards
The fair value of options granted under the ShareSave plan are calculated using a binomial pricing model with the following assumptions:

	2007	2005	2003
Weighted average share price	553p	351p	173p
Exercise price	416p	298p	142p
Volatility	37%	40%	43%
Expected dividends	8.80p	7.86p	7.61p
Expected life1 – 3 year ShareSave	3.3-3.8 years	3.3-3.8 years	3.2-3.7 years
– 5 year ShareSave	5.3-5.8 years	5.3-5.8 years	5.2-5.7 years
Close periods:
From January 1	6 weeks	6 weeks	6 weeks
From July 1	1 month	1 month	1 month
Risk free interest rate	5.0%	4.4%	4.6%

¹The binomial pricing model assumes that participants will exercise their options at the beginning of the six month window if the share price is greater than the exercise price. Otherwise it assumes that options are held until the expiration of their contractual term. This results in an expected life that falls somewhere between the start and end of the exercise window.

Deferred shares under APRA and Free Shares under SIP

The fair value of shares awarded under these plans is calculated as the share price on the date of the award.

At December 31, 2008, the following ordinary shares were subject to options:

	Date of grant	Number	Exercise price	Exercisable dates
Executive Share Option Plan	1999	52,403	269p	2009
	2000	193,831	194p	2009-2010
	2001	1,069,069	216p	2009-2011
	2001	8,161	218p	2009-2012
	2002	239,544	188p	2009-2012
	2003	519,555	77p	2009-2013
ShareSave plans	2001	5,451,109	108p	2009
	2003	1,597,604	142p	2009
	2005	10,414,054	298p	2009/2011
	2007	12,206,498	416p	2011/2013

Under the terms of the Rolls-Royce 1999 Executive Share Option Plan, options granted to 54 directors and senior executives were outstanding at December 31, 2008.