compensation. The resulting increase in operating
expenses will decrease operating income and
after-taxcashflowsinfutureyears,thusreducingthe
value that we would attach to the firm today.WaysofIncorporatingFutureOptionsintoDiscountedCash
Flow Value
Itismuchmoredifficulttoincorporatetheeffectofexpected
optionissuesintovaluethanexistingoptions.Thisisbecause
wehavetoforecastnotonlyhowmanyoptionswillbeissued
byafirminfutureperiods,butalsowhatthetermsofthese
optionswillbe.While thismaybepossibleforacoupleof
periodswithproprietaryinformation(wherethefirmletsus
knowhowmuchitplanstoissueandatwhatterms),itwill
becomemoredifficultbeyondthatpoint.Wewillconsideran
approachthatwecanusetoobtainanestimateoftheoption
value,andlookattwowaysofdealingwiththisestimateonce
obtained.
Estimate Option Value as an Operating or Capital Expense
Wecanestimatethevalueofoptionsthatwillbegrantedin
future periods as a percentage of revenues or operating
income. Bydoingso,wecanavoidhavingto estimatethe
numberandtermsoffutureoptionissues.Estimationwillalso
becomeeasiersincewecandrawonthefirm’sownhistory
(bylookingatthevalueofoptiongrantsinpreviousyearsasa
proportion of revenues or operating expenses) and the
experiencesofmorematurefirmsinthesector.Generally,as
firmsbecomelarger,thevalueofoptionsgrantedasapercent
of revenues should become smaller.