the value of any stock, bond or business today is determined by
DESCRIPTION
The value of any stock, bond or business today is determined by the cash inflows or outflows – discounted by an appropriate discount rate – that can be expected to occur during the remaining life of an asset. - Warren Buffett, Berkshire Hathaway Annual Report (1992). - PowerPoint PPT PresentationTRANSCRIPT
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The value of any stock, bond or business today is determined by
the cash inflows or outflows – discounted by an appropriate
discount rate – that can be expected to occur during the
remaining life of an asset.
- Warren Buffett, Berkshire Hathaway Annual Report (1992)
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The Evolution of Value Based Management
Firm value = PV (future free cash flows).
Firm value = ΣPV t (EVA t ) + Invested Capital.
Firm value = ΣPV t (CVA t ) + Invested Capital.
EVA Stern Stewart & Co.
CVA BCG and HOLT Value Associates
Basic Notion
Firm value = PV (FCF of existing assets)+ PV (Growth opportunities)
Strategic Value Analysis LEK / Alcar
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Free Cash Flow Approach
Firm’s FCF = Financing or Investors’ cash flow
Firm’s perspective
EBITDA – cash tax payments
– incremental investment in operating assets
Investor’s perspective
FCF = The amount received by investors
interest payment to creditors+ repayment of debt principal- additional debt issued+ dividends+ share repurchases- additional stock issued
Financing cash flow
1. Net working capital (CA-CL)
2. Capital expenditures and long-term assets.
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Free Cash Flow& Firm valuation
FirmValue
Present value of free cash flow
Value of Non-operating assets
= +
- Marketable securities- Excess real state- Over funded pension plan
FirmValue
Shareholder valueFuture claim= +
- Interest-bearing debt- Capital lease obligations- Under funded pension plan - Contingent liabilities
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Free Cash Flow Approach
Free cash flow and firm’s valuation
1. How long should we calculate? 1. CF during strategic planning period2. After strategic planning period, “residual value”• How long is strategic planning period?
2. How to forecast free cash flow? (Value drivers)- Assumption of “Value Drivers”
a) Sales growth b) Operating profit margin c) Cash tax rate d) Net working capital / sales e) Other long-term assets / sales
3. Determine the discount rate. - Based on opportunity cost.
Through value drivers, we can analyze how to improve to firm’s FCF.
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Forecasting Free Cash Flow
Value driver assumptions
Case : Ashley Corporation
Residual periodbegins
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Free Cash Flow Calculations
Sales of prior year= $ 240,000Year 1 =(1+Sales growth rate) × Prior year sales = ( 1+0.08) × $ 240,000=259,200
Incremental asset investment in year t =
( Sales in year t – Sales in year t-1) × Asset-to-sales percent
Year1
Net working capital=( $ 259,200- $ 240,000) ×5.5 % = $ 1,056
Fixed assets=( $ 259,200- $ 240,000) ×40 % = $ 7,680
Other long term assets= =( $ 259,200- $ 240,000) ×2 % = $ 384
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Determining the Discount Rate
【 Cost of debt×(1-Tax rate) ×Debt/Firm Value 】
7.68 % ×(1-0.27)=5.61 %
+【 Cost of equity × Equity/Firm value 】
risk free rate+ company beta × market premium
6 %+ (1.35×8 % )=16.8 %
Weighted cost of capital
Debt 25 % 5.61 % 1.40 %
Equity 75 % 16.80 % 12.60 %
WACC 14.00 %
Percentage
of capital
After-Tax
Cost
Weighted
Cost
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Free Cash Flow Calculations
Planning period present value
Residual value in year T
rateGrowth -capital ofCost
1Tyear in flowcash Free
Residual value in year 10= $ 18,623/(0.14-0.026)=$163,36
Present value of residual CF=$163,36/(1+0.14) 10 =$44.06
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Firm’s Economic value
Economic value=present value of all cash flows
= Present value of the planning period free cash flow
+Present value of the residual period free cash flow
Present value of the cash flows for year1-10 $ 38.52
Present value of the cash flows for the residual value $ 44.06
Firm’s economic value $ 82.58
Excess real estate 7.5
Firm value $ 90.08
Debt $ 42.00
Shareholder value $ 48.08
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Magic Value Drivers
Threshold profit margin=7.2%
Sales growth increase
Firm value decreaseSales growth increase
Firm value increase
Myth of Growth & Firm Value
In Case Table 4.2 PV of cash flow= $ 82.6 million
If sales growth =0 PV of cash flow= $ 87.6 million
Potential value = negative 5 million
Firm value = PV (FCF of existing assets)+ PV (Growth opportunities)
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Further Dissuasion of Value Driver
sensitivity Analysis of operating margin
6.00%6.00% $27,36$27,3699
--$20,71$20,71
88
6.50%6.50% 37,73137,731 --10,35310,353
7.00%7.00% 48,08448,084 00
7.50%7.50% 58,43658,436 10,35210,352
8.00%8.00% 68,78968,789 20,70520,705
8.50%8.50% 79,14179,141 31,05731,057
9.00%9.00% 89,49489,494 41,41041,410
Operating Profit Margin
Equity
Value
Change in
Base case of EV
Base case
Through sensitivity Analysis of different Value Divers
We can find the one affects firm’s value most !
Thousands of dollars
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Economic Value Road Map
Financing Decision
Investing Decision
Operating Decision
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EVA is based on something we have know for a long time: what
we call profit, the money left to service equity, is not profit at all.
Until a business returns a profit that is greater than its cost of
capital, it operates at a loss. Never mind that it pays taxes as if it
had a genuine profit. The enterprise still returns less to the
economy than it devours in resources…. Until then it does not
create wealth; it destroys it.
- Peter Drucker, The Information Executives Truly Need (1995)
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EVA Approach
Accounting profits v.s. Economic profits
Accounting profits
SalesCost of goods sold
Operating expenses
Interest expense
Taxes= - - - -
Economic profits
orResidual income
SalesCost of goods sold
Operating expenses
Taxes
Charge for all capital used
= -- - -
NOPATNet operating profits after taxes
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FirmValue
Present value of future free cash flow
InvestedCapital
=
+= Present value of future residual Income
Free Cash flow & Residual Income Approach
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Free Cash flow & Residual Income Approach
g=7.5% g=7.5%
1. Profit margin = 6.25%
2. Retention ratio = 60%
3. Investment (WC & real) = 0.5 per dollar of sales growth
4. Cost of capital = 10%
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Free Cash flow & Residual Income Approach
Residual Income: 1,250-10,000 × 10% = 250
g=7.5% g=7.5%
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Free cash flow or Residual Income?
Doesn’t provide readily apparent measure of
Annual Operating performance
When Free cash flow < 0
a) Investment is high in profitable firm
b) Operating is poor in unprofitable firm
e.g.Wal-Mart FCF -13% of capital, R is +8 % above its cost of capital
Kmart FCF +7% of capital, R is -3 % below its cost of capital
The weakness of free cash flow :
Residual Income provides better measure of period performance !
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EVA Approach
EVACash flow
from operations
AccrualsAfter-tax interest
Capital charges
Accounting adjustments= + + - +
Earnings
Operation profits
Economic profits
Economic Value Added (EVA)
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EVA DriversEVA Drivers
EVA = NOPAT- (k*Capital) = (r- k)*capital EVA = NOPAT- (k*Capital) = (r- k)*capital
NOPAT = operating profits after taxes but before financing NOPAT = operating profits after taxes but before financing costs and noncash bookkeeping entries except depreciationcosts and noncash bookkeeping entries except depreciation
Return on capital (r) = Return on capital (r) =
Return on capital =Return on capital =
NOPBT = firm’s net operating profits before taxesNOPBT = firm’s net operating profits before taxes
Cash taxNOPBT Sales1
Sales Capital NOPBT
NOPAT
Capital
Profit Margin
Capital Turnover Cash tax rate
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EVA DriversEVA Drivers
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EVA Calculation
1.Convert from accrual to cash accounting (LIFO, Bad debt reserves)2.Capitalize market-building expenditures that have been expensed in the past (R&D)3.Remove cumulative unusual losses or gains after taxes
Convert NOPAT and Capital form accounting book value to economic book value
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NOPATNOPAT
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CAPITALCAPITAL
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Example :Hobbs-Meyer Co.Example :Hobbs-Meyer Co.
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Example :Hobbs-Meyer Co.Example :Hobbs-Meyer Co.
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Example: Hobbs-Meyer coExample: Hobbs-Meyer co
Finance
Equity Equivalents
Tax
Equity Equivalents
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Example: Hobbs-Meyer coExample: Hobbs-Meyer co
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Example :Hobbs-Meyer Co.Example :Hobbs-Meyer Co.
法一法一 EVA=NOPAT-Cost of capital* CapitalEVA=NOPAT-Cost of capital* Capital =686000-10%*3984000=288000=686000-10%*3984000=288000 法二法二 EVA=(Return on capital-Cost of capital)EVA=(Return on capital-Cost of capital) *Capital*Capital =(686000/3984000-10%)*3984000=(686000/3984000-10%)*3984000 =288000=288000
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EVA V.S MVAEVA V.S MVA
Market Value AddedMarket Value Added
= Market Value of Equity - Book Value of = Market Value of Equity - Book Value of EquityEquity
= Present value of all future EVA= Present value of all future EVA
Market Value of Equity Market Value of Equity
== Book Value of Equity + Present value of Book Value of Equity + Present value of all future EVA all future EVA
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EVA V.S MVAEVA V.S MVA
Positive MVA
Negative MVA
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EVA VS Investment
Source: Stern Stewart Research “Special Report”,Apr,2002
相
反
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EVA is closely related to EVA is closely related to NPV.NPV.
It avoids the problems associates with It avoids the problems associates with approaches that focus on approaches that focus on percentage spreadspercentage spreads( ( rate of return- rate of cost)rate of return- rate of cost)
It makes top managers responsible for a It makes top managers responsible for a measure that they have measure that they have more control overmore control over
It is influenced by It is influenced by all of the decisionsall of the decisions that that managers have to make within a firm managers have to make within a firm
Advantages of EVAAdvantages of EVA
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increases in current EVA come at the increases in current EVA come at the expense of future EVAexpense of future EVA
higher EVA is accompanied by an higher EVA is accompanied by an increase in the cost of capital increase in the cost of capital
increase in EVA is increase in EVA is less than what the less than what the market expectedmarket expected it to be, leading to a it to be, leading to a drop in the market pricedrop in the market price
Side EffectsSide Effects of EVA with minimize riskof EVA with minimize risk