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CHAPTER 10
Corporate Valuation and Value-Based Management
Corporate Valuation
Value-Based Management
Corporate Governance
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Corporate Valuation
!ist t"e t#o t$pes o% assets t"at acompan$ o#ns&
Assets-in-place' includinggro#t" options
(inancial' or nonoperating'assets
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Assets-in-Place
Assets-in-place are tangi)le' suc" as)uildings' mac"ines' inventor$&
*suall$ t"e$ are e+pected to gro#&
T"e$ generate %ree cas" %lo#s&
T"e PV o% t"eir e+pected %uture %reecas" %lo#s' discounted at t"e ,ACC'is t"e value o% operations&
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Value o% perations
= +
=
1t
t
tOp
)WACC1(
FCFV
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.onoperating Assets
Mar/eta)le securities
#ners"ip o% non-controllinginterest in anot"er compan$
Value o% nonoperating assets usuall$is ver$ close to %igure t"at isreported on )alance s"eets&
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Total Corporate Value
Total corporate value is sum o%
Value o% operations
Value o% nonoperating assets
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Claims on Corporate Value
e)t"olders "ave %irst claim&
Pre%erred stoc/"olders "ave t"e ne+tclaim&
An$ remaining value )elongs tostoc/"olders&
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Appl$ing t"e Corporate Valuation
Model(orecast t"e %inancial statements as
practised )$ companies in t"e industr$&
Calculate t"e proected %ree cas" %lo#s&
Model can )e applied to a compan$t"at does not pa$ dividends' a privatel$
"eld compan$' or a division o% acompan$' since (C( can )e calculated%or eac" o% t"ese situations&
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ata %or Valuation
(C(02 340 million
,ACC 2 105
g 2 65Mar/eta)le securities 2 3100 million
e)t 2 3400 million
Pre%erred stoc/ 2 360 million
Boo/ value o% e7uit$ 2 3410 million
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Value o% perations
Constant Gro#t"8uppose (C( gro#s at constant rate g&
( )
( )
=
=
+
+=
+=
1tt
t0
1tt
tOp
WACC1
)g1(FCF
WACC1FCFV
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Constant Gro#t" (ormula
.otice t"at t"e term in parent"esesis less t"an one and gets smaller as t
gets larger& As t gets ver$ large' termapproac"es 9ero&
= + += 1t
t
0OpWACC1g1FCFV
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Constant Gro#t" (ormula :Cont&;
T"e summation can )e replaced )$ asingle %ormula
( )
( )gWACC
)g1(FCF
gWACCFCFV
0
1Op
+=
=
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(ind Value o% perations
( )
( ) 42005.010.0
)05.01(20
V
gWACC
)g1(FCF
V
Op
0
Op
=
+
=
+
=
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Value o% E7uit$
8ources o% Corporate Value
Value o% operations 2 3
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Value o% E7uit$
Total corporate value 2 Vp> M/t& 8ec&
2 3 3100
2 3640 million
Value o% e7uit$ 2 TCV - e)t - Pre%&
2 3640 - 3400 - 360
2 34?0 million
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Mar/et Value Added :MVA;
MVA 2 Total corporate value o% %irmminus total )oo/ value o% %irm
Total )oo/ value o% %irm 2 )oo/ valueo% e7uit$ > )oo/ value o% de)t > )oo/value o% pre%erred stoc/
MVA 2 3640 - :3410 > 3400 > 360;
2 3@0 million
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Brea/do#n o% Corporate Value
0
100
400
00
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E+pansion Plan .onconstant Gro#t"
(inance e+pansion )$ )orro#ing 3
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T"e #eig"ted average cost o% capital'rc' is 105&
T"e compan$ "as 10 million s"areso% stoc/&
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Hori9on Value
(ree cas" %lo#s are %orecast %ort"ree $ears in t"is e+ample' so t"e
%orecast "ori9onis t"ree $ears&Gro#t" in %ree cas" %lo#s is not
constant during t"e %orecast'so #e
canDt use t"e constant gro#t"%ormula to %ind t"e value o%operations at time 0&
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Hori9on Value :Cont&;
Gro#t" is constant a%ter t"e "ori9on: $ears;' so #e can modi%$ t"e
constant gro#t" %ormula to %ind t"evalue o% all %ree cas" %lo#s )e$ondt"e "ori9on' discounted )ac/ to t"e"ori9on&
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Hori9on Value (ormula
Hori9on value is also called terminalvalue' or continuingvalue&
( )gWACC
)g1(FCFVHV tttimeatOp
+
==
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Vopat
(ind t"e value o% operations )$ discounting
t"e %ree cas" %lo#s at t"e cost o% capital&0
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(ind t"e price per s"are o% common
stoc/&Value o% e7uit$ 2 Value o% operations
- Value o% de)t
2 3
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Value-Based Management :VBM;
VBM is t"e s$stematic applicationo% t"e corporate valuation model
to all corporate decisions andstrategic initiatives&
T"e o)ective o% VBM is to
increase Mar/et Value Added:MVA;
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MVA and t"e (our Value rivers
MVA is determined )$ %our drivers
8ales gro#t"
perating pro%ita)ilit$:P2.PAT8ales;
Capital re7uirements:CR2perating capital 8ales;
,eig"ted average cost o% capital
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MVA %or a Constant Gro#t" (irm
=
)g1(
CRWACCOP
gWACC
)g1(Sales
MVA
t
t
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nsig"ts %rom t"e Constant Gro#t"
ModelT"e %irst )rac/et is t"e MVA o% a %irm
t"at gets to /eep all o% its sales
revenues :i&e&' its operating pro%itmargin is 1005; and t"at never "asto ma/e additional investments inoperating capital&
gWACC
)g1(Salest
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nsig"ts :Cont&;
T"e second )rac/et is t"e operatingpro%it :as a 5; t"e %irm gets to /eep'
less t"e return t"at investors re7uire%or "aving tied up t"eir capital in t"e%irm&
)g1(
CRWACCOP
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mprovements in MVA due to t"e
Value riversMVA #ill improve i%
,ACC is reduced
operating pro%ita)ilit$ :P;increases
t"e capital re7uirement :CR;decreases
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T"e mpact o% Gro#t"
T"e second term in )rac/ets can )eeit"er positive or negative'
depending on t"e relative si9e o%pro%ita)ilit$' capital re7uirements'and re7uired return )$ investors&
)g1(
CRWACCOP
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T"e mpact o% Gro#t" :Cont&;
% t"e second term in )rac/ets isnegative' t"en gro#t" decreases
MVA& n ot"er #ords' pro%its are notenoug" to o%%set t"e return on capitalre7uired )$ investors&
% t"e second term in )rac/ets ispositive' t"en gro#t" increases MVA&
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E+pected Return on nvested
Capital :ERC;T"e e+pected return on invested
capital is t"e .PAT e+pected ne+t
period divided )$ t"e amount o%capital t"at is currentl$ invested
t
1t
t Capital
NOPAT
EROIC +
=
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MVA in Terms o% E+pected RC
[ ]gWACC
WACCEROICCapitalMVA ttt
=
% t"e spread )et#een t"e e+pectedreturn' ERCt' and t"e re7uired
return' ,ACC' is positive' t"en MVAis positive and gro#t" ma/es MVAlarger& T"e opposite is true i% t"espread is negative&
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T"e mpact o% Gro#t" on MVA
A compan$ "as t#o divisions& Bot" "avecurrent sales o% 31'000' current e+pectedgro#t" o% 65' and a ,ACC o% 105&
ivision A "as "ig" pro%ita)ilit$ :P2@5;)ut "ig" capital re7uirements :CR2?5;&
ivision B "as lo# pro%ita)ilit$ :P2
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,"at is t"e impact on MVA i% gro#t"goes %rom 65 to @5=
ivision A ivision B
P @5@5
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E+pected RC and MVA
ivision A ivision B
Capital0 3?03?034?0 34?0
Gro#t" 65@5 65@58ales1 31'06031'0@0 31'06031'0@0
.PAT1 3@3@&@3
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Anal$sis o% Gro#t" 8trategies
T"e e+pected RC o% ivision A is lesst"an t"e ,ACC' so t"e division s"ouldpostpone gro#t" e%%orts until itimproves ERC )$ reducing capitalre7uirements :e&g&' reducing inventor$;andor improving pro%ita)ilit$&
T"e e+pected RC o% ivision B isgreater t"an t"e ,ACC' so t"e divisions"ould continue #it" its gro#t" plans&
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T#o Primar$ Mec"anisms o%
Corporate Governance8tic/ :Punis"ments;
Provisions in t"e c"arter t"ata%%ect ta/eovers&
Composition o% t"e )oard o%directors&
Carrot Compensation plans:Re#ards;
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Entrenc"ed Management
ccurs #"en t"ere is little c"ancet"at poorl$ per%orming managers #ill
)e replaced&T#o causes
Anti-ta/eover provisions in t"e
c"arter
,ea/ )oard o% directors
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Ho# are entrenc"ed managers
"arm%ul to s"are"olders=Management consumes per/s
!avis" o%%ices and corporate ets
E+cessivel$ large sta%%s
Mem)ers"ips at countr$ clu)s
Management accepts proects :orac7uisitions; to ma/e %irm larger' eveni% MVA goes do#n&
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Anti-Ta/eover Provisions
Targeted s"are repurc"ases :i&e&'greenmail;
8"are"older rig"ts provisions :i&e&'poison pills;
Restricted voting rig"ts plans
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Board o% irectors
,ea/ )oards "ave man$ insiders:i&e&' t"ose #"o also "ave anot"er
position in t"e compan$; compared#it" outsiders&
nterloc/ing )oards are #ea/er :CE
o% compan$ A sits on )oard o%compan$ B' CE o% B sits on )oardo% A;&
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8toc/ ptions in Compensation
PlansGives o#ner o% option t"e rig"t to
)u$ a s"are o% t"e compan$Ds stoc/
at a speci%ied price :called t"ee+ercise price; even i% t"e actualstoc/ price is "ig"er&
*suall$ canDt e+ercise t"e option %orseveral $ears :called t"e vestingperiod;&
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8toc/ ptions :Cont&;
CanDt e+ercise t"e option a%ter a certainnum)er o% $ears :called t"e e+piration' ormaturit$' date;&
Helps to motivate sta%% :emplo$ees; to#or/ "arder and smarter' t"us ma/ingcompan$ more valua)le and )ene%icial to
s"are"oldersners"ipDs interest :)eing s"are"olders;