grantsonvalue.However,mostfirmsthatgrantoptionswill
continue to use them in the future, thus affecting future
earnings. The expected option grants are employee
compensationandwillincreaseoperatingexpensesinfuture
yearsandreduceoperatingincome.Thevalueofafirmtoday
isthepresentvalueofexpectedcashflows,andthesewillbe
muchlowerforafirmthatisexpectedtobemoregenerous
with its option grants.
Accounting standards havefinally come to grips with the
effect of granting options on current earnings (see FAS
123R),andanalystsdoattempttocapturethedilutioneffect,
albeitsloppily,withdilutedsharenumbers.Analysts,though,
arestillhaphazardaboutdealingwithexpectedfutureoption
grants. While some try to forecast the magnitudeof these
grants,mostvaluationseithercompletelyignorethemorbuild
themin implicitlybyforecasting a currentincome number
that incorporates option expenses.
11
WaysofIncorporatingExistingOptionsintoDiscountedCash
Flow Valuations
Aswenotedintheprevious section,thevaluepershare is
weighed down by the cumulative effect of all options
outstanding. There are four approaches that are used to
incorporatethateffectofoptionsthatarealreadyoutstanding
intothevaluepershare.Thefirstistoadjustthenumberof
sharesoutstandingtoreflectoptionsoutstanding.Thesecond
istotrytoforecastwhentheoptionswillbeexercisedandthe
effectonsharenumbersinfutureyears.Thethird,calledthe
treasurystockapproach,isanextensionofthefirstapproach.
Inadditiontousingdilutedshares,thisapproachalsoadjusts