Derivative Instruments and Hedging Activities

3 Months Ended

Oct. 31, 2012

Derivative Instruments and Hedging Activities:

Schedule of Derivative Instruments, Gain (Loss) in Statement of Financial Performance

The Company has various convertible instruments outstanding more fully described in Note 5. Because the number of shares to be issued upon settlement cannot be determined under these instruments, the Company cannot determine whether it will have sufficient authorized shares at a given date to settle any other of its share-settleable instruments. As a result, under ASC 815-15 “Derivatives and Hedging”, all other share-settleable instruments must be classified as liabilities.

Embedded Derivative Liabilities in Convertible Notes

During the nine months ended October 31, 2012, the Company recognized new derivative liabilities of $373,721 as a result of convertible debt instruments having embedded conversion options. The fair value of these derivative liabilities exceeded the principal balance of the related notes payable by $251,221, and was recorded as a loss on derivatives for the three and nine months ended October 31, 2012.

As a result of conversion of notes payable described in Note 5, the Company reclassified $30,917 of derivative liabilities to equity and the change in fair value of derivatives was $67,091.

As of October 31, 2012, the fair value of the Company’s derivative liabilities was $275,713 and $67,091 was recognized as a gain on derivatives due to change in fair value of the liability during the nine months ended October 31, 2012.

The following table summarizes the derivative liabilities included in the consolidated balance sheet:

	Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
Derivative Liabilities:
Balance at January 31, 2012	$	—
ASC 815-15 additions		373,721
Change in fair value		(67,091)
ASC 815-15 deletions		(30,917)
Balance at October 31, 2012	$	275,713

	Included in Other Income (Expense) on Consolidated Statement of Operations
Gain/(Loss) on Derivative Liability:
Change in fair value of derivatives	$	67,091
Derivative expense		(251,221)
Balance for three and nine months ended October 31, 2012	$	(184,130)

The fair values of derivative instruments were estimated using the Binomial pricing model based on the following weighted-average assumptions:

	Convertible Debt Instruments
Risk-free rate		0.21% - 0.25%
Expected volatility		100% - 500%
Expected life		9-12 months

Derivatives and Fair Value

Derivatives

The Company evaluates embedded conversion features within convertible debt under ASC 815 “Derivatives and Hedging” to determine whether the embedded conversion feature should be bifurcated from the host instrument and accounted for as a derivative at fair value with changes in fair value recorded in earnings. The Company uses a Binomial pricing model to estimate the fair value of convertible debt conversion features at the end of each applicable reporting period. Changes in the fair value of these derivatives during each reporting period are included in the consolidated statement of operation. Inputs into the Binomial pricing model require estimates, including such items as estimated volatility of the Company’s stock, risk-free interest rate and the estimated life of the financial instruments being fair valued.

If the conversion feature does not require derivative treatment under ASC 815, the instrument is evaluated under ASC 470-20 “Debt with Conversion and Other Options” for consideration of any beneficial conversion feature.