operating expenses to allowfor the factthat the expected
effect of option issues in future periods will be smaller.
Inmakingforecastsoffutureoptionissues,itisimportantto
consideralsotheeffectsofthechangingsizeofthefirmon
optionissues.Asfirmsbecomelarger,theoptiongrantsasa
percent of revenuesor valuewill tendto become smaller.
Thus,weshouldmoveoptiongrantsforfirmstowardindustry
averagesormaturefirmpracticesasweforecastfurtherinto
the future.
ILLUSTRATION 11.5: Valuing with Expected Option Issues
When valuing Cisco and Google, the current operating
incomeofthecompaniesandtheindustryaverageswerekey
inputs. The way the two firms have dealt with employee
optionexpenseswillplayakeyroleinwhatoperatingincome
we will use in valuation. With Cisco, the stated pretax
operatingincomeforthemostrecentyearis$7,416million.
The firm, however, neither expenses employee options
granted in the current year nor shows the cost of option
exerciseinitsearnings.Instead,itadjustsforthelatterinthe
book valueof equity. Consequently, theentire cost of the
optiongrantforthisyear,valuedatfairmarketvalue,should
benettedoutagainstthepretaxoperatingincometoarriveat
a more reasonable measure of operating income:
Stated pretax operating income$7,416
million
+ Expenses from option exercise considered $ 0 million
Fair market value of options granted during
year$1,628
million