Value based management Chapter 3 & 12, SFM Value
Description: Value based management Chapter 3 12, SFM Value Measures Return on Invested Capital Economic Value Added Market Value Added Cash Flow Return On Investment Cash Value Added Market to Capital Ratio Total Shareholders Return Future
Related Topics
Download Presentation
"Value based management Chapter 3 & 12, SFM Value" is the property of its rightful owner. Permission is granted to download and print the materials on this website for personal, non-commercial use only, and to display it on your personal computer provided you do not modify the materials and that you retain all copyright notices contained in the materials. By downloading content from our website, you accept the terms of this agreement.
Presentation Transcript
slide1. Value based management Chapter 3 & 12, SFM<br>
slide3. Value Measures Return on Invested Capital
Economic Value Added
Market Value Added
Cash Flow Return On Investment
Cash Value Added
Market – to – Capital Ratio
Total Shareholders’ Return
Future Growth Value
Wealth Added Index ROIC
EVA
MVA
CFROI
CVA
MCR
TSR
FGV
WAI<br>
slide4. Return on Invested Capital (ROIC) ROIC is an indicator of Operating performance of the company.<br>
slide5. Return on Invested Capital (ROIC) ROIC is a indicator of Operating performance of the company.
ROIC = NOPLAT / Invested Capital
Where,
NOPLAT or NOPAT = Net EBIT – Taxes on Net EBIT
Net EBIT = EBIT – NOI* + NOE*
(*EBIT need to be adjusted for NOI/E if they are already included in EBIT)
‘Invested Capital’ is also called as ‘Operating Invested Capital’
OIC = Total Operating Assets
Or, OIC = Total Assets – Non Operating Assets – Excess Cash & Mktbl. Secs.
Or, OIC = NFA + NCA<br>
slide6. Return on Invested Capital (ROIC) ROIC = NOPLAT / Invested Capital
A company has an EBIT of Rs. 2 cr. It included interest income Rs. 0.1 cr. And non operating expenses of Rs. 0.2 cr. The total assets of the company is Rs. 5 cr. The company has capital work in progress worth Rs. 1 cr; Marketaable securities of Rs. 0.5 cr. and Cash worth Rs. 0.25 cr. In excess of working capital requirement. Tax 30%. Find out ROIC.
Net EBIT = 2 – 0.1 + 0.2 = Rs. 2.1 cr.
NOPLAT = 2.1 – (2.1*0.3) = Rs. 1.47 cr.
OIC = 5 – 1 – 0.5 – 0.25 = Rs. 3.25 cr.
ROIC = 1.47 / 3.25 = 45%<br>
slide7. A company has an ROIC of 16%, EBIT of RS. 100000 and interest income of Rs. 15000, WACC of 12%. What is the value of Invested capital, assuming the tax rate at 20%?
ANS: 4,25,000
If a company enjoys an ROIC of 20% with a capital investment of Rs. 5,00,000 and earns an EVA of Rs. 55,000 then find out it's cost of capital (WACC).
ANS: 9%
A company earns an EVA of Rs. 1,00,000 with an invested capital of rs. 4,00,000 sourced at a cost of 10%, then find out it's ROIC?
ANS: 35%<br>
slide8. A company earns an EVA of Rs. 1,00,000 with an invested capital of rs. 5,00,000 sourced at a cost of 10%, then find out it's NOPLAT?
ANS: 1,50,000
If NOPAT is Rs. 50,000, ROIC is 20% and accumulated depreciation is Rs. 2 lakh, then find out the value of gross investment.
ANS: 4,50,000
A company has an WACC of 12%. What should be the ROIC so that it can create value? ANS: more than 12%<br>
slide9. Economic Value Added (EVA) Economic Value Added is a measure of economic profit.<br>
slide10. Economic Value Added (EVA) Economic Value Added is a measure of economic profit.
It is calculated as the difference between the Net Operating Profit After Tax and the (opportunity) cost of invested Capital. This opportunity cost is determined by the weighted average cost of Debt and Equity Capital ("WACC") times to the amount of Capital employed.<br>
slide11. Economic Value Added (EVA) EVA
EVA = (ROIC – Kc) * OIC.
Or EVA = NOPAT – Capital Charge on Invested Capital
If EVA is +ve, the firm’s unlevered pool of profits (NOPAT) available for all investors is in excess of what the firm has to pay for employing funds in the business (Capital Charge).<br>
slide12. Economic Value Added (EVA) Say; EBIT = 1.5 Lakh, Tax rate = 30%, Net Fixed Assets = 5 lakh, Net Current Assets = 2 Lakh; WACC = 9%. Find out EVA.
NOPAT = EBIT (1-t) = 1.5 (1 – 0.3) = 1.05 Lakh
OIC or Invested Capital = NFA + NCA = 5 + 2 = 7 Lakh
EVA = 105000 – (0.09 * 700000) = 42000<br>
slide13. WACC = 15%
1. Find out the EVA of the Company.
2. Say the NOPAT in total is increased from 100000 to 110000 by utilizing the same investment. What happens to the EVA?
3. Decide which segment should be added between two mutually exclusive segments K and L.
Segment K which needs an investment of 50000 and can bring in additional NOPAT of 12000. While L needs an investment of 40000 and can generate a NOPAT of 7000.
4. Out of existing segments of A,B,C, and D, if any one segment needs to be dropped then which segment would be your choice and Why?<br>
slide14. The assumption is 1/2 of the invested capital is debt @ 10 interest. Tax rate is 50%
WACC = 11%
The Company has assumed EVA as its value creation measure. So needs to maximise EVA.
1. The marketing manager suggests segment B to be dropped as the return on sales is least in that segment. Give your views.
2. The CEO feels one more segment H can be added with following financials resulting in a ROS of 10%. Give your views.<br>
slide15. Say; EBIT = 1.5 Lakh, Tax rate = 30%, Net Fixed Assets = 5 lakh, Net Current Assets = 2 Lakh; WACC = 9%. Find out EVA.
ANS: 42,000
Given that the EVA is Rs.180 Cr; Invested Capital is Rs.700 Cr (equity 500 cr & Debt 200 cr); Market-Capitalisation Rs. 750 Cr and WACC of 12%. What is the current operation value of the firm?
ANS: 800 crores
If a company enjoys an ROIC of 25% with a capital investment of Rs. 10,00,000 at a WACC of 10%, then find out it's Economic Value added.
ANS: 1,50,000<br>
slide16. Market Value Added (MVA) MVA is the value addition through capital market operations.<br>
slide17. Market Value Added (MVA) Market Value Added measures the difference between the market value of the firm (Mkt Value of Debt and Equity) and the amount of Capital invested.
MVA is the excess of market value of capital over and above the book value of capital (as sourced from equity and debt providers). Equivalently, MVA equals the present value of future expected EVA when discounted @ wacc.<br>
slide18. Market Value Added (MVA) MVA = Market Value of Equity & Debt – Invested Capital
If MVA is +ve, Business has created a market value of firm more than what it sourced from the equity & debt holders
The Book Value of Equity and Debt are 5 Cr. And 4 Cr. respectively. The market price of equity is Rs. 2100 and there are 30,000 equities outstanding. Find out the MVA of the Company. MVE = 2100 * 30000= 6.3 Cr.
MVA = (6.3 + 4) – (5 + 4) = 1.3 Cr<br>
slide19. Link between MVA and EVA Equivalently, MVA equals the present value of future expected EVA when discounted @ wacc.
MVA = EVA1/(1+wacc)1 + EVA2/(1+wacc)2 + …<br>
slide20. The Book Value of Equity and Debt are 5 Cr. And 4 Cr. respectively. The market price of equity is Rs. 2100 and there are 30,000 equities outstanding. Find out the MVA of the Company.
ANS: 1.3 crores.<br>
slide21. Cash Flow Return on Investment (CFROI) CFROI is a relative measure of sustainable value creation by the business.<br>
slide22. Cash Flow Return on Investment (CFROI) CFROI = (Operating Cash Flow – Economic Depreciation) / Cash Invested
Where, Operating Cash Flow = NOPAT + Accounting Depreciation
And Economic Depreciation is the amount of annual contribution to sinking fund earning cost of capital to replace the asset.
OR, Replacement fund Needed =
Eco Dep * FVIFA (Replacement time years, at cost of capital)<br>
slide23. Cash Flow Return on Investment (CFROI) If CFROI > Kc, the business is earning cash in excess of capital charge,
even after making provision for asset replacement at the end of asset life
i.e. Business seems to be sustainable for long time.<br>
slide24. A company earns operating cash flow worth Rs. 50,000 by investing cash of Rs. 8,00,000. If the economic depreciation is Rs. 10,000, then find out the cash flow return on investment (CFROI).
ANS: 5%
What shall be the value of cash flow return on investment (CFROI) for a firm with a cash value added (CVA) of Rs. 20,000, Operating cash flow of Rs. Rs. 1,00,000, Economic depreciation of Rs. 20,000 and WACC of 6%.
ANS: 8%<br>
slide25. Cash Value Added (CVA) CVA is an absolute measure of sustainable value creation by the business.<br>
slide26. Cash Value Added (CVA) CVA= Operating Cash Flow – Economic Depreciation – Capital charge on Gross Investment
Where,
Operating Cash Flow = NOPAT + Accounting Depreciation
Eco Dep * FVIFA (Replacement time years, at cost of capital) = Replacement fund Needed
Capital charge on Gross Investment = WACC * Cash Invested Originally.<br>
slide27. Cash Value Added (CVA) If CVA is +ve, the business is earning cash in excess of capital charge, even after making provision for asset replacement at the end of asset life i.e. Business seems to be sustainable for long time.
While CFROI is a relative measure, CVA is an absolute measure of Business sustainability.
EXAMPLE<br>
slide28. Illustration : 01
X Ltd is considering acquisition of a Machinery which would require an investment of Rs. 20 Lakh comprising of asset cost of Rs. 15 Lakh and a net working capital of Rs. 5 Lakh.
The Fixed asset has an economic life of 14 years and a salvage value of Rs. 1,00000. At the end of 14 years the asset is estimated to be replaced at Rs. 18,00000. The company follows SLM of depreciation for its accounting records. It is projected that the machine would generate a ROIC of 20%, measured by NOPAT on Invested capital. The cost of capital (Kc) is 10%.
(The FVIFA 14years 10% is 27.975)
You are required to calculate the CFROI, CVA and EVA of the company for first three years.<br>
slide29. Illustration: 02
A company has an investment of Rs.630 million (Rs.480 million in fixed assets and Rs.150 million in net working capital). The company assets have an economic life of 8 years and are expected to produce a NOPAT of Rs.80 million every year. After 8 years, the net working capital will be realised at par, but fixed assets will fetch nothing. The cost of capital for the project is 12 percent. Assume that the straight-line method of depreciation is used for tax as well as shareholder reporting purposes.
(i) What will be the ROIC for year 3? Assume that the capital employed is measured at the beginning of the year.
(ii) What will be the EVA (Rs. in million) for year 3?
(iii) What will be the ROGI for year 3?
(iv) What will be the CVA (Rs.in million) for year 3?
(v) What will be the CFROI for year 3?
(vi) Comment on value creation of the company.<br>
slide30. A company earns operating cash flow worth Rs. 10 lakh by investing cash of Rs. 80 lakh with a WACC of 10%. If the economic depreciation is Rs. 1 lakh, then find out the cash value added (CVA).
ANS: 1,00,000
What shall be the value of cash value added (CVA), when CFROI is 7%, operating cash flow is Rs. 2,00,000, Economic depreciation is Rs. 30,000 with a gross cash investment of Rs. 10 lakh at a WACC of 9%.
ANS: 80,000
Find out the value of 'capital charge on gross investment' when the CVA is Rs. 32,000, Operating cash flow is Rs. 50,000 and the economic depreciation is Rs. 8,000.
ANS: 10,000
Find out the value of cost of capital (WACC), when the CVA is Rs. 32,000, Operating cash flow is Rs. 50,000, the economic depreciation is Rs. 8,000 and the gross investment is Rs. 10 lakh.
ANS: 1%<br>
slide31. Market-to-Capital ratio (MCR or MBR) MCR measures value added to equity through capital market operations.<br>
slide32. Market-to-Capital ratio (MCR or MBR) MCR = Mkt Value of Equity / Book Value of Equity
If MCR > 1 , Business has created a market value of equity more than what it sourced from the equity holders.
The Shareholders Funds stands at Rs 5 Lakh. The market price of equity is Rs. 250 and there are 1,000 equities outstanding. Find out the MCR of the Company. MVE = 250 * 1000= 2.5 Lakh.
MCR = 2.5 / 5 = 0.5<br>
slide33. The Shareholders Funds stands at Rs 5 Lakh. The market price of equity is Rs. 1000 and there are 1,000 equities outstanding. Find out the MCR of the Company.
ANS: 2 Times.
Find out the value of 'market to capital ratio (MCR)' when the net worth of the company is Rs. 15 lakh, there are 10,000 equities outstanding and the market value of each equity is Rs. 1,500.
ANS: 10<br>
slide34. Total Return to Shareholders (TRS) TRS is a comprehensive measure of returns earned by the shareholders.<br>
slide35. Total Return to Shareholders (TRS) TRS = (End Mkt Value of Equity - Beginning Mkt Vlaue of Equity) + Dividends & Share Buybacks During the Year Begng Mkt Value of Equity + Additional equity raised during the year If TRS ≥ Ke,
than a business could live up to the equity holders’ expectations.<br>
slide36. Total Return to Shareholders (TRS) What would have been the total return to the shareholder having 1000 shares in a company if the DPR of the company is 40% having a face value of Rs.10 with earnings per share of Rs.7.50 . The Opening price is Rs.141 and the closing is Rs.150.
PAT= 7.5*1000 = 7500
Dividend = 7500*40% = 3000
Capital Appreciation = 150*1000 – 141*1000 = 9000
TRS = (9000 + 3000) / (141*1000) = 8.51%<br>
slide37. What would have been the total return to the shareholder having 1000 shares in a company if the DPR of the company is 40% having a face value of Rs.10 with earnings per share of Rs.7.50 . The Opening price is Rs.141 and the closing is Rs.150.
ANS:8.50%
A company distributes Rs. 2,00,000 as dividend during a year and its year opening market value was Rs. 200 lakh against a year closing market value of Rs. 248 lakh. Find out it's total return to sharehoders (TRS).
ANS: 25%<br>
slide38. Future Growth Value (FGV) FGV measures the portion of market value attributed to EVA growth.<br>
slide39. Future Growth Value (FGV) FGV = Mkt Value of Firm – Current Operation Value of Firm
Where,
Crnt. Oprn. Value of Firm = Capitalised Value of Equity – Invested Capital
OR, Crnt. Oprn. Value of Firm = (EVA/WACC) – Invested Capital<br>
slide40. Future Growth Value (FGV) Calculate the Future Growth Value of a company given that the EVA is Rs.180 Cr; Invested Capital is Rs.700 Cr (equity 500 cr & Debt 200 cr); Market Capitalisation Rs. 750 Cr and WACC of 12%.
Crnt. Oprn. Value of Firm = (EVA/WACC) – Invested Capital = (180/0.12) – 700 = 800 Cr.
FGV = Mkt Value of Firm – Current Operation Value of Firm = (750 + 200) – 800 = 150 Cr.<br>
slide41. FGV_Future Growth Value Future Growth Value measures the portion of market value attributed to EVA growth.
FGV can be driven by market expectations of productivity improvements, organic growth, and value-creating acquisitions.
FGV component can be a useful tool in evaluating investors' assessment of the wealth creation potential of new strategies and opportunities.<br>
slide42. Given that the EVA is Rs.180 Cr; Invested Capital is Rs.700 Cr (equity 500 cr & Debt 200 cr); Market-Capitalisation Rs. 750 Cr and WACC of 12%. Find out the Future Growth Value (FGV).
ANS: 150 crores<br>
slide43. Wealth Added Index (WAI) WAI measures the excess wealth generated above expectations<br>
slide44. Wealth Added Index_ WAI WAI is the excess wealth generated above expectations based on the perceived risk of the shares.
It is important to recognize that Wealth Added reflects returns for all equity investors, no matter when they bought their shares.
WAI = (Total Shareholder Return - Required Return) x Opening Market Cap<br>
slide45. Wealth Added Index_ WAI What would have been the Wealth Added Index in a company if the DPR of the company is 60% with earnings of Rs.75000. The Opening Market Capitalisation is Rs.2 Lakh and the closing is Rs.2.5 Lakh. Assume Ke @ 9%.
WAI = (Total Shareholder Return - Required Return) x Opening Market Cap
TSR = [(250000 – 200000) + (75000*0.60)] / 200000
TSR = 47.5%
WAI = (47.5 – 9)% * 200000 = 77000<br>
slide46. A company distributes Rs. 2,00,000 as dividend during a year and its year opening market value was Rs. 200 lakh against a year closing market value of Rs. 248 lakh. Find out it's wealth added index (WAI) if the required return on equity is 15%.
ANS: 20 lakh<br>
slide47. Approaches to vbm<br>
slide48. Value Based Management : Stimulants Pressure from Institutional Investors.
Peer Pressure.
Performance Rating Pressure.
Abolition of Agency Cost (linking top mgmt. compensation to shareholder return)<br>
slide49. The Consulting Companies and Their Anchor VBM Measures<br>
slide50. Various Approaches to VBM Marakon approach
Alkar approach
Mckinsey approach
Stern Stewart or EVA approach
BCG approach<br>
slide51. Marakon Approach<br>
slide52. Marakon approach Marakon associates – a management consulting firm
Specify the financial determinants of value
Understand the strategic drivers of value
Formulate higher value strategies
Develop superior organizational capabilities<br>
slide53. Marakon approach….contd 1. Specify financial determinants of value
Based on market to book ratio model
Shareholder wealth creation is the difference between market value (M) and book value (B) of a firms equity<br>
slide54. Marakon approach….contd The Book value of equity, measures approximately the capital contributed by the shareholders
The Market value of equity reflects how productively the firm has employed the capital contributed by the shareholders, as assessed by the stock market
Hence if M > B value is created and
if M < B value is destroyed<br>
slide55. Marakon approach….contd M to B is a function of
Return on equity (r )
Growth rate of dividends (and earnings)(g)
Cost of equity(k)
M/B = (r-g)/(k-g)
M/B > 1 if and only if r > k i.e. only if return on equity is > cost of equity
Also when r > k, higher the g, higher is M/B
When the spread is positive, a higher growth rate contributes more to value creation<br>
slide56. Marakon approach….contd (illustration) 1. If the ROE is 20%, cost of equity is 12% and growth rate of dividends is 7% then find out the M/B.
i. If the ROE increases to 25% what would be the new M/B?
ii. If the growth rate of dividend increases to 10%, what would be the new M/B?
iii. How does the cost of equity and Growth rate of dividends affect the Value of the firm?<br>
slide57. Marakon approach….contd (illustration) r =20%; k =12%; g =7%
M/B = (20-7) / (12-7)= 2.6
Iff r =25%;
M/B = (25-7) / (12-7)= 3.6
Value of the firm increased from 2.6 to 3.6 as measured by M/B.
Hence;
if the firm can increase the positive spread between r & k then the Value of firm will also increase & vice versa.<br>
slide58. Marakon approach….contd (illustration) When r =20%; k =12% and g =7%, Value of firm was (M?B)= 2.6
If g =10%; M/B =(20-10) / (12-10) = 5
Value of the firm increased from 2.6 to 5 as measured by M/B.
Hence;
With a positive spread between r and k; if the firm can increase the value of g then the Value of firm also increases & vice versa.<br>
slide59. Marakon approach….contd 2. Understand the strategic drivers of value
HOW to Increase the +ve Spread b/w r and k; and How to Increase g
Market economics or Profitability
Refers to structural factors which determine the average equity spread as well as the growth rate applicable to all competitors in a particular market segment
Intensity of direct / indirect competition
Threat of entry
Supplier pressures
Regulatory pressures
Customer pressures<br>
slide60. Marakon approach….contd Competitive position
Product differentiation (customers willing to pay a premium)
Economic cost position (lower total economic costs per unit than the market average)
Economic cost = operating cost + charge for capital employed
Access to cheaper raw materials
Efficient process technology
Access to low cost distribution channels
Superior management
Economies of scale in some markets<br>
slide61. Marakon approach….contd 3. Formulate higher value strategies
Participation strategy
Corporate level
Which new business the firm will enter
Which existing business the firm will exit
Business unit level
Which unserved market/ segment will the firm enter
Which served market/ segment will the firm exit
Competitive Strategy
Differentiate the products
Manage the business unit costs
Pricing the product<br>
slide62. Marakon approach….contd 4. Develop superior organizational capabilities by overcoming internal barriers
Top management team fully committed to the goal of Value maximization
Corporate governance that promotes highest degree of accountability for creation or destruction of value
Top management compensation plan guided by the principle of ‘relative pay for relative performance’
Proper Resource allocation system
Well laid out performance management system which is founded on two basic principles of
Performance targets driven by plans
Performance contracts should be fully honored by both sides<br>
slide63. Marakon approach….contd Limitations of Marakon approach
The spread between ROE and Ke are not comparable as one is an accounting measure and the other is market based.
The positive spread may be due to accounting policies.
Advantages of Marakon approach
ROE, Ke are widely used parameters.
Intuitively appealing valuation theory
MV of the firm is an external scorecard<br>
slide64. Marakon Approach_Problems 2. The return on equity is 20% and cost of equity is 14%. If the retention ratio is 60% and the book value per share is Rs. 50, then
What is the growth rate of the firm?
What is the Market value of equity as per marakon model?
What is the value creation index of the firm?<br>
slide65. Marakon Approach_Problems r =20%, k =14%, (1-b) =60%, B =Rs. 50.
g =(1-b)r = 0.6 * 0.2= 0.12 or 12%
M/B = (20-12)/(14-12) = 4
So, M/50 = 4; hence; M = Rs. 200
The value creation index is 4.<br>
slide66. Marakon Approach_Problems 3. The return on equity is 18% and the equity capitalisation rate is 10%. If the payout ratio is 55% and the market price of share is Rs. 200, then what should be the book value per share as per marakon model? (The actual BV is Rs. 25)<br>
slide67. Marakon Approach_Problems r =18%, k =10%, b =55%, M =Rs. 200
g = (1-b)r = 0.45 * 0.18 = 8.1%
M/B = (18-8.1)/(10-8.1) = 5.21
200/B = 5.21
B = 200/5.21 = Rs. 38.38<br>
slide68. Marakon Approach_Problems 4. The equity value of X ltd. Is Rs. 2 Lakh and the profit after taxes is Rs. 30000. the company has paid a dividend of Rs.10000 for the year. If the risk free rate is 10%, market return is 12% and Beta value is 5, then find out whether the company has created the value or destroyed as per marakon model.<br>
slide69. The value based management measure adopted by Marakon is Market to book ratio
In market to book ratio 'm' can be greater than 'b' if and only if r > k.
With a positive spread between return on equity and cost of equity, the value of will increase if g' increases but limited to the value of 'k'.
If the ROE is 25%, cost of equity is 12% and growth rate of dividends is 7% then find out the M/B.
ANS: 3.6
If the ROE is 20%, cost of equity is 12% and growth rate of dividends is 10% then find out the M/B.
ANS: 5
As per marakon model if a firm can increase the positive spread between return on equity and cost of equity then the value of firm will increase.<br>
slide70. The return on equity is 20% and cost of equity is 14%. If the retention ratio is 60% and the book value per share is Rs. 50, then what is the growth rate (g)?
ANS: 12%
The return on equity is 20% and cost of equity is 14%. If the retention ratio is 60% and the book value per share is Rs. 50, then what would be the expected market value of equity as per marakon model?
ANS: 200
The return on equity is 20% and cost of equity is 14%. If the retention ratio is 60% and the book value per share is Rs. 50, then what would be the value of M/B ratio as per marakon model?
ANS: 4
The return on equity is 18% and the equity capitalisation rate is 10%. If the payout ratio is 55% and the market price of share is Rs. 200, then what should be the book value per share as per marakon model?
ANS: 38.38<br>
slide71. Mckinsey Approach<br>
slide72. Mckinsey Approach A company can maximize its value by focusing decision making on the key drivers of value.
Value Thinking: to make value happen, a company’s actions should be based on a foundation of value thinking. It has two dimensions;
Value metrics: The value metrics that reflects the economic results of the company and not that of accounting results. The metrics should consider the stock market valuation of the company and the opportunity cost.
Value Mindset: The management must care about shareholder value creation above others.<br>
slide73. Mckinsey Approach: Creating SHARE HOLDERS VALUE Aspirations and targets SHAREHOLDER
VALUE<br>
slide74. 4. Stern stewart approach EVA® Approach<br>
slide75. Stern Stewart (EVA®) approach First proposed by Stern Stewart & Co., EVA is now a very popular idea.
Fortune Magazine- “Today’s hottest financial idea and getting hotter”
Peter Ducker – “it is a measure of total factor productivity”
EVA is essentially surplus left after making an appropriate charge for the capital employed in business.
EVA = NOPAT – WACC * CAPITAL
EVA = CAPITAL (ROC – WACC)
EVA = [PAT + INT(1 - t)] – WACC * CAPITAL
EVA = PAT – COE * EQUITY<br>
slide76. Stern Stewart (EVA®) approach: Drivers of EVA Increasing efficiency (or productivity)- increasing operating profit from the same investment in operating assets. (better asset utilization, turning idle asset into earning assets)
Profitable Growth - marginal growth in operating profit should be higher than marginal growth in investment in operating assets. (Additional investment in assets only if New ROIC is more than current ROIC)
Wiping out unproductive capital – disinvest from segments where ROIC and WACC spread is negative or fragile than overall average.
Reducing WACC – altering financing strategy to reduce WACC.<br>
slide77. The Two Financial Paradigms: EPS based Financial Management vs. EVA based Financial Management EPS based FM
Management tries to… Report steady increase in EPS
Diversify to achieve stability
Tightly control the allocation of capital
Balance the claim of various stakeholders
Buy companies with low P/E to bootstrap EPS
Negotiate divisional profit targets EVA based FM
Management tries to… Achieve improvement in EVA
Strive for focus
Decentralize the investment decisions
Accord primacy to shareholder welfare
Acquire companies that augment value
Define EVA targets by formula<br>
slide78. 5. BCG Approach<br>
slide79. BCG Approach Two Corner concepts;
Total Return to Shareholder(TRS)
Total Business Return (TBR)
For applying these concepts Two performance matrices are developed;
Cash Flow Return on Investment (CFROI)
Cash Value Added (CVA)<br>
slide80. Total Return to Shareholders If it is a single holding period
TRS = [Dividend & Share Buyback + (Ending Mkt Value – Beginning Mkt Value)] / [Beginning Mkt Value + Additional equity raised during the period]
If it is a multiple holding period;
Beginning Market Value = D1/(1+TRS)1 + D2/(1+TRS)2 +….+ End Mkt Value/ (1+TRS)n<br>
slide81. TRS: Credibility It is comprehensive as it includes both dividends and capital gain.
It is widely used by investment community and also required by SEC.
TSR can be easily benchmarked against the mkt or peer groups
TSR is not biased by size
TSR is difficult to manipulate<br>
slide82. BCG approach…contd. Drivers of TRS
Profitability, growth and free cash flow
Capital gains is driven by the first two
Free cash flow drives the dividend payout, buyback of shares.
A TRS > Ke, is a proxy for Return, Earnings and Value added measures for equity holders.<br>
slide83. Total Business Return What TRS is to investors, TBR is to internal management.
If it is a single holding period
TBR = (Free Cash Flow / Begn. Value) + (Endg Value – Begn Value) / Begn Value]
If it is a multiple holding period;
Begn Mkt Value = FCF1/(1+TBR)1 + FCF2/(1+TBR)2 +….+ End Value/ (1+TBR)n<br>
slide84. BCG approach…contd. CFROI and CVA
CFROI = (Operating Cash Flow – Economic Depreciation) / Cash Invested
If CFROI > Kc, the business is earning cash in excess of capital charge, even after making provision for asset replacement at the end of asset life i.e. Business seems to be sustainable for long time.
Drivers of CFROI- Efficiency, Profitable growth and wiping out unproductive capital.<br>
slide85. BCG approach…contd. CVA= Operating Cash Flow – Economic Depreciation – Capital charge on Gross Investment
While CFROI is a relative measure, CVA is an absolute measure of Business sustainability.
If CVA is +ve, the business is earning cash in excess of capital charge, even after making provision for asset replacement at the end of asset life i.e. Business seems to be sustainable for long time.
BCG advocates Cash Value Added as superior to EVA.
Drivers of CVA - Efficiency, Profitable growth and wiping out unproductive capital.<br>
slide86. BCG approach: Resource Allocation decision<br>
slide87. Drivers of Value BUT it is interesting to note that drivers of CFROI/ CVA / EVA are same and they are;
Efficiency,
Profitable growth and
Wiping out unproductive capital.<br>
slide3. Value Measures Return on Invested Capital
Economic Value Added
Market Value Added
Cash Flow Return On Investment
Cash Value Added
Market – to – Capital Ratio
Total Shareholders’ Return
Future Growth Value
Wealth Added Index ROIC
EVA
MVA
CFROI
CVA
MCR
TSR
FGV
WAI<br>
slide4. Return on Invested Capital (ROIC) ROIC is an indicator of Operating performance of the company.<br>
slide5. Return on Invested Capital (ROIC) ROIC is a indicator of Operating performance of the company.
ROIC = NOPLAT / Invested Capital
Where,
NOPLAT or NOPAT = Net EBIT – Taxes on Net EBIT
Net EBIT = EBIT – NOI* + NOE*
(*EBIT need to be adjusted for NOI/E if they are already included in EBIT)
‘Invested Capital’ is also called as ‘Operating Invested Capital’
OIC = Total Operating Assets
Or, OIC = Total Assets – Non Operating Assets – Excess Cash & Mktbl. Secs.
Or, OIC = NFA + NCA<br>
slide6. Return on Invested Capital (ROIC) ROIC = NOPLAT / Invested Capital
A company has an EBIT of Rs. 2 cr. It included interest income Rs. 0.1 cr. And non operating expenses of Rs. 0.2 cr. The total assets of the company is Rs. 5 cr. The company has capital work in progress worth Rs. 1 cr; Marketaable securities of Rs. 0.5 cr. and Cash worth Rs. 0.25 cr. In excess of working capital requirement. Tax 30%. Find out ROIC.
Net EBIT = 2 – 0.1 + 0.2 = Rs. 2.1 cr.
NOPLAT = 2.1 – (2.1*0.3) = Rs. 1.47 cr.
OIC = 5 – 1 – 0.5 – 0.25 = Rs. 3.25 cr.
ROIC = 1.47 / 3.25 = 45%<br>
slide7. A company has an ROIC of 16%, EBIT of RS. 100000 and interest income of Rs. 15000, WACC of 12%. What is the value of Invested capital, assuming the tax rate at 20%?
ANS: 4,25,000
If a company enjoys an ROIC of 20% with a capital investment of Rs. 5,00,000 and earns an EVA of Rs. 55,000 then find out it's cost of capital (WACC).
ANS: 9%
A company earns an EVA of Rs. 1,00,000 with an invested capital of rs. 4,00,000 sourced at a cost of 10%, then find out it's ROIC?
ANS: 35%<br>
slide8. A company earns an EVA of Rs. 1,00,000 with an invested capital of rs. 5,00,000 sourced at a cost of 10%, then find out it's NOPLAT?
ANS: 1,50,000
If NOPAT is Rs. 50,000, ROIC is 20% and accumulated depreciation is Rs. 2 lakh, then find out the value of gross investment.
ANS: 4,50,000
A company has an WACC of 12%. What should be the ROIC so that it can create value? ANS: more than 12%<br>
slide9. Economic Value Added (EVA) Economic Value Added is a measure of economic profit.<br>
slide10. Economic Value Added (EVA) Economic Value Added is a measure of economic profit.
It is calculated as the difference between the Net Operating Profit After Tax and the (opportunity) cost of invested Capital. This opportunity cost is determined by the weighted average cost of Debt and Equity Capital ("WACC") times to the amount of Capital employed.<br>
slide11. Economic Value Added (EVA) EVA
EVA = (ROIC – Kc) * OIC.
Or EVA = NOPAT – Capital Charge on Invested Capital
If EVA is +ve, the firm’s unlevered pool of profits (NOPAT) available for all investors is in excess of what the firm has to pay for employing funds in the business (Capital Charge).<br>
slide12. Economic Value Added (EVA) Say; EBIT = 1.5 Lakh, Tax rate = 30%, Net Fixed Assets = 5 lakh, Net Current Assets = 2 Lakh; WACC = 9%. Find out EVA.
NOPAT = EBIT (1-t) = 1.5 (1 – 0.3) = 1.05 Lakh
OIC or Invested Capital = NFA + NCA = 5 + 2 = 7 Lakh
EVA = 105000 – (0.09 * 700000) = 42000<br>
slide13. WACC = 15%
1. Find out the EVA of the Company.
2. Say the NOPAT in total is increased from 100000 to 110000 by utilizing the same investment. What happens to the EVA?
3. Decide which segment should be added between two mutually exclusive segments K and L.
Segment K which needs an investment of 50000 and can bring in additional NOPAT of 12000. While L needs an investment of 40000 and can generate a NOPAT of 7000.
4. Out of existing segments of A,B,C, and D, if any one segment needs to be dropped then which segment would be your choice and Why?<br>
slide14. The assumption is 1/2 of the invested capital is debt @ 10 interest. Tax rate is 50%
WACC = 11%
The Company has assumed EVA as its value creation measure. So needs to maximise EVA.
1. The marketing manager suggests segment B to be dropped as the return on sales is least in that segment. Give your views.
2. The CEO feels one more segment H can be added with following financials resulting in a ROS of 10%. Give your views.<br>
slide15. Say; EBIT = 1.5 Lakh, Tax rate = 30%, Net Fixed Assets = 5 lakh, Net Current Assets = 2 Lakh; WACC = 9%. Find out EVA.
ANS: 42,000
Given that the EVA is Rs.180 Cr; Invested Capital is Rs.700 Cr (equity 500 cr & Debt 200 cr); Market-Capitalisation Rs. 750 Cr and WACC of 12%. What is the current operation value of the firm?
ANS: 800 crores
If a company enjoys an ROIC of 25% with a capital investment of Rs. 10,00,000 at a WACC of 10%, then find out it's Economic Value added.
ANS: 1,50,000<br>
slide16. Market Value Added (MVA) MVA is the value addition through capital market operations.<br>
slide17. Market Value Added (MVA) Market Value Added measures the difference between the market value of the firm (Mkt Value of Debt and Equity) and the amount of Capital invested.
MVA is the excess of market value of capital over and above the book value of capital (as sourced from equity and debt providers). Equivalently, MVA equals the present value of future expected EVA when discounted @ wacc.<br>
slide18. Market Value Added (MVA) MVA = Market Value of Equity & Debt – Invested Capital
If MVA is +ve, Business has created a market value of firm more than what it sourced from the equity & debt holders
The Book Value of Equity and Debt are 5 Cr. And 4 Cr. respectively. The market price of equity is Rs. 2100 and there are 30,000 equities outstanding. Find out the MVA of the Company. MVE = 2100 * 30000= 6.3 Cr.
MVA = (6.3 + 4) – (5 + 4) = 1.3 Cr<br>
slide19. Link between MVA and EVA Equivalently, MVA equals the present value of future expected EVA when discounted @ wacc.
MVA = EVA1/(1+wacc)1 + EVA2/(1+wacc)2 + …<br>
slide20. The Book Value of Equity and Debt are 5 Cr. And 4 Cr. respectively. The market price of equity is Rs. 2100 and there are 30,000 equities outstanding. Find out the MVA of the Company.
ANS: 1.3 crores.<br>
slide21. Cash Flow Return on Investment (CFROI) CFROI is a relative measure of sustainable value creation by the business.<br>
slide22. Cash Flow Return on Investment (CFROI) CFROI = (Operating Cash Flow – Economic Depreciation) / Cash Invested
Where, Operating Cash Flow = NOPAT + Accounting Depreciation
And Economic Depreciation is the amount of annual contribution to sinking fund earning cost of capital to replace the asset.
OR, Replacement fund Needed =
Eco Dep * FVIFA (Replacement time years, at cost of capital)<br>
slide23. Cash Flow Return on Investment (CFROI) If CFROI > Kc, the business is earning cash in excess of capital charge,
even after making provision for asset replacement at the end of asset life
i.e. Business seems to be sustainable for long time.<br>
slide24. A company earns operating cash flow worth Rs. 50,000 by investing cash of Rs. 8,00,000. If the economic depreciation is Rs. 10,000, then find out the cash flow return on investment (CFROI).
ANS: 5%
What shall be the value of cash flow return on investment (CFROI) for a firm with a cash value added (CVA) of Rs. 20,000, Operating cash flow of Rs. Rs. 1,00,000, Economic depreciation of Rs. 20,000 and WACC of 6%.
ANS: 8%<br>
slide25. Cash Value Added (CVA) CVA is an absolute measure of sustainable value creation by the business.<br>
slide26. Cash Value Added (CVA) CVA= Operating Cash Flow – Economic Depreciation – Capital charge on Gross Investment
Where,
Operating Cash Flow = NOPAT + Accounting Depreciation
Eco Dep * FVIFA (Replacement time years, at cost of capital) = Replacement fund Needed
Capital charge on Gross Investment = WACC * Cash Invested Originally.<br>
slide27. Cash Value Added (CVA) If CVA is +ve, the business is earning cash in excess of capital charge, even after making provision for asset replacement at the end of asset life i.e. Business seems to be sustainable for long time.
While CFROI is a relative measure, CVA is an absolute measure of Business sustainability.
EXAMPLE<br>
slide28. Illustration : 01
X Ltd is considering acquisition of a Machinery which would require an investment of Rs. 20 Lakh comprising of asset cost of Rs. 15 Lakh and a net working capital of Rs. 5 Lakh.
The Fixed asset has an economic life of 14 years and a salvage value of Rs. 1,00000. At the end of 14 years the asset is estimated to be replaced at Rs. 18,00000. The company follows SLM of depreciation for its accounting records. It is projected that the machine would generate a ROIC of 20%, measured by NOPAT on Invested capital. The cost of capital (Kc) is 10%.
(The FVIFA 14years 10% is 27.975)
You are required to calculate the CFROI, CVA and EVA of the company for first three years.<br>
slide29. Illustration: 02
A company has an investment of Rs.630 million (Rs.480 million in fixed assets and Rs.150 million in net working capital). The company assets have an economic life of 8 years and are expected to produce a NOPAT of Rs.80 million every year. After 8 years, the net working capital will be realised at par, but fixed assets will fetch nothing. The cost of capital for the project is 12 percent. Assume that the straight-line method of depreciation is used for tax as well as shareholder reporting purposes.
(i) What will be the ROIC for year 3? Assume that the capital employed is measured at the beginning of the year.
(ii) What will be the EVA (Rs. in million) for year 3?
(iii) What will be the ROGI for year 3?
(iv) What will be the CVA (Rs.in million) for year 3?
(v) What will be the CFROI for year 3?
(vi) Comment on value creation of the company.<br>
slide30. A company earns operating cash flow worth Rs. 10 lakh by investing cash of Rs. 80 lakh with a WACC of 10%. If the economic depreciation is Rs. 1 lakh, then find out the cash value added (CVA).
ANS: 1,00,000
What shall be the value of cash value added (CVA), when CFROI is 7%, operating cash flow is Rs. 2,00,000, Economic depreciation is Rs. 30,000 with a gross cash investment of Rs. 10 lakh at a WACC of 9%.
ANS: 80,000
Find out the value of 'capital charge on gross investment' when the CVA is Rs. 32,000, Operating cash flow is Rs. 50,000 and the economic depreciation is Rs. 8,000.
ANS: 10,000
Find out the value of cost of capital (WACC), when the CVA is Rs. 32,000, Operating cash flow is Rs. 50,000, the economic depreciation is Rs. 8,000 and the gross investment is Rs. 10 lakh.
ANS: 1%<br>
slide31. Market-to-Capital ratio (MCR or MBR) MCR measures value added to equity through capital market operations.<br>
slide32. Market-to-Capital ratio (MCR or MBR) MCR = Mkt Value of Equity / Book Value of Equity
If MCR > 1 , Business has created a market value of equity more than what it sourced from the equity holders.
The Shareholders Funds stands at Rs 5 Lakh. The market price of equity is Rs. 250 and there are 1,000 equities outstanding. Find out the MCR of the Company. MVE = 250 * 1000= 2.5 Lakh.
MCR = 2.5 / 5 = 0.5<br>
slide33. The Shareholders Funds stands at Rs 5 Lakh. The market price of equity is Rs. 1000 and there are 1,000 equities outstanding. Find out the MCR of the Company.
ANS: 2 Times.
Find out the value of 'market to capital ratio (MCR)' when the net worth of the company is Rs. 15 lakh, there are 10,000 equities outstanding and the market value of each equity is Rs. 1,500.
ANS: 10<br>
slide34. Total Return to Shareholders (TRS) TRS is a comprehensive measure of returns earned by the shareholders.<br>
slide35. Total Return to Shareholders (TRS) TRS = (End Mkt Value of Equity - Beginning Mkt Vlaue of Equity) + Dividends & Share Buybacks During the Year Begng Mkt Value of Equity + Additional equity raised during the year If TRS ≥ Ke,
than a business could live up to the equity holders’ expectations.<br>
slide36. Total Return to Shareholders (TRS) What would have been the total return to the shareholder having 1000 shares in a company if the DPR of the company is 40% having a face value of Rs.10 with earnings per share of Rs.7.50 . The Opening price is Rs.141 and the closing is Rs.150.
PAT= 7.5*1000 = 7500
Dividend = 7500*40% = 3000
Capital Appreciation = 150*1000 – 141*1000 = 9000
TRS = (9000 + 3000) / (141*1000) = 8.51%<br>
slide37. What would have been the total return to the shareholder having 1000 shares in a company if the DPR of the company is 40% having a face value of Rs.10 with earnings per share of Rs.7.50 . The Opening price is Rs.141 and the closing is Rs.150.
ANS:8.50%
A company distributes Rs. 2,00,000 as dividend during a year and its year opening market value was Rs. 200 lakh against a year closing market value of Rs. 248 lakh. Find out it's total return to sharehoders (TRS).
ANS: 25%<br>
slide38. Future Growth Value (FGV) FGV measures the portion of market value attributed to EVA growth.<br>
slide39. Future Growth Value (FGV) FGV = Mkt Value of Firm – Current Operation Value of Firm
Where,
Crnt. Oprn. Value of Firm = Capitalised Value of Equity – Invested Capital
OR, Crnt. Oprn. Value of Firm = (EVA/WACC) – Invested Capital<br>
slide40. Future Growth Value (FGV) Calculate the Future Growth Value of a company given that the EVA is Rs.180 Cr; Invested Capital is Rs.700 Cr (equity 500 cr & Debt 200 cr); Market Capitalisation Rs. 750 Cr and WACC of 12%.
Crnt. Oprn. Value of Firm = (EVA/WACC) – Invested Capital = (180/0.12) – 700 = 800 Cr.
FGV = Mkt Value of Firm – Current Operation Value of Firm = (750 + 200) – 800 = 150 Cr.<br>
slide41. FGV_Future Growth Value Future Growth Value measures the portion of market value attributed to EVA growth.
FGV can be driven by market expectations of productivity improvements, organic growth, and value-creating acquisitions.
FGV component can be a useful tool in evaluating investors' assessment of the wealth creation potential of new strategies and opportunities.<br>
slide42. Given that the EVA is Rs.180 Cr; Invested Capital is Rs.700 Cr (equity 500 cr & Debt 200 cr); Market-Capitalisation Rs. 750 Cr and WACC of 12%. Find out the Future Growth Value (FGV).
ANS: 150 crores<br>
slide43. Wealth Added Index (WAI) WAI measures the excess wealth generated above expectations<br>
slide44. Wealth Added Index_ WAI WAI is the excess wealth generated above expectations based on the perceived risk of the shares.
It is important to recognize that Wealth Added reflects returns for all equity investors, no matter when they bought their shares.
WAI = (Total Shareholder Return - Required Return) x Opening Market Cap<br>
slide45. Wealth Added Index_ WAI What would have been the Wealth Added Index in a company if the DPR of the company is 60% with earnings of Rs.75000. The Opening Market Capitalisation is Rs.2 Lakh and the closing is Rs.2.5 Lakh. Assume Ke @ 9%.
WAI = (Total Shareholder Return - Required Return) x Opening Market Cap
TSR = [(250000 – 200000) + (75000*0.60)] / 200000
TSR = 47.5%
WAI = (47.5 – 9)% * 200000 = 77000<br>
slide46. A company distributes Rs. 2,00,000 as dividend during a year and its year opening market value was Rs. 200 lakh against a year closing market value of Rs. 248 lakh. Find out it's wealth added index (WAI) if the required return on equity is 15%.
ANS: 20 lakh<br>
slide47. Approaches to vbm<br>
slide48. Value Based Management : Stimulants Pressure from Institutional Investors.
Peer Pressure.
Performance Rating Pressure.
Abolition of Agency Cost (linking top mgmt. compensation to shareholder return)<br>
slide49. The Consulting Companies and Their Anchor VBM Measures<br>
slide50. Various Approaches to VBM Marakon approach
Alkar approach
Mckinsey approach
Stern Stewart or EVA approach
BCG approach<br>
slide51. Marakon Approach<br>
slide52. Marakon approach Marakon associates – a management consulting firm
Specify the financial determinants of value
Understand the strategic drivers of value
Formulate higher value strategies
Develop superior organizational capabilities<br>
slide53. Marakon approach….contd 1. Specify financial determinants of value
Based on market to book ratio model
Shareholder wealth creation is the difference between market value (M) and book value (B) of a firms equity<br>
slide54. Marakon approach….contd The Book value of equity, measures approximately the capital contributed by the shareholders
The Market value of equity reflects how productively the firm has employed the capital contributed by the shareholders, as assessed by the stock market
Hence if M > B value is created and
if M < B value is destroyed<br>
slide55. Marakon approach….contd M to B is a function of
Return on equity (r )
Growth rate of dividends (and earnings)(g)
Cost of equity(k)
M/B = (r-g)/(k-g)
M/B > 1 if and only if r > k i.e. only if return on equity is > cost of equity
Also when r > k, higher the g, higher is M/B
When the spread is positive, a higher growth rate contributes more to value creation<br>
slide56. Marakon approach….contd (illustration) 1. If the ROE is 20%, cost of equity is 12% and growth rate of dividends is 7% then find out the M/B.
i. If the ROE increases to 25% what would be the new M/B?
ii. If the growth rate of dividend increases to 10%, what would be the new M/B?
iii. How does the cost of equity and Growth rate of dividends affect the Value of the firm?<br>
slide57. Marakon approach….contd (illustration) r =20%; k =12%; g =7%
M/B = (20-7) / (12-7)= 2.6
Iff r =25%;
M/B = (25-7) / (12-7)= 3.6
Value of the firm increased from 2.6 to 3.6 as measured by M/B.
Hence;
if the firm can increase the positive spread between r & k then the Value of firm will also increase & vice versa.<br>
slide58. Marakon approach….contd (illustration) When r =20%; k =12% and g =7%, Value of firm was (M?B)= 2.6
If g =10%; M/B =(20-10) / (12-10) = 5
Value of the firm increased from 2.6 to 5 as measured by M/B.
Hence;
With a positive spread between r and k; if the firm can increase the value of g then the Value of firm also increases & vice versa.<br>
slide59. Marakon approach….contd 2. Understand the strategic drivers of value
HOW to Increase the +ve Spread b/w r and k; and How to Increase g
Market economics or Profitability
Refers to structural factors which determine the average equity spread as well as the growth rate applicable to all competitors in a particular market segment
Intensity of direct / indirect competition
Threat of entry
Supplier pressures
Regulatory pressures
Customer pressures<br>
slide60. Marakon approach….contd Competitive position
Product differentiation (customers willing to pay a premium)
Economic cost position (lower total economic costs per unit than the market average)
Economic cost = operating cost + charge for capital employed
Access to cheaper raw materials
Efficient process technology
Access to low cost distribution channels
Superior management
Economies of scale in some markets<br>
slide61. Marakon approach….contd 3. Formulate higher value strategies
Participation strategy
Corporate level
Which new business the firm will enter
Which existing business the firm will exit
Business unit level
Which unserved market/ segment will the firm enter
Which served market/ segment will the firm exit
Competitive Strategy
Differentiate the products
Manage the business unit costs
Pricing the product<br>
slide62. Marakon approach….contd 4. Develop superior organizational capabilities by overcoming internal barriers
Top management team fully committed to the goal of Value maximization
Corporate governance that promotes highest degree of accountability for creation or destruction of value
Top management compensation plan guided by the principle of ‘relative pay for relative performance’
Proper Resource allocation system
Well laid out performance management system which is founded on two basic principles of
Performance targets driven by plans
Performance contracts should be fully honored by both sides<br>
slide63. Marakon approach….contd Limitations of Marakon approach
The spread between ROE and Ke are not comparable as one is an accounting measure and the other is market based.
The positive spread may be due to accounting policies.
Advantages of Marakon approach
ROE, Ke are widely used parameters.
Intuitively appealing valuation theory
MV of the firm is an external scorecard<br>
slide64. Marakon Approach_Problems 2. The return on equity is 20% and cost of equity is 14%. If the retention ratio is 60% and the book value per share is Rs. 50, then
What is the growth rate of the firm?
What is the Market value of equity as per marakon model?
What is the value creation index of the firm?<br>
slide65. Marakon Approach_Problems r =20%, k =14%, (1-b) =60%, B =Rs. 50.
g =(1-b)r = 0.6 * 0.2= 0.12 or 12%
M/B = (20-12)/(14-12) = 4
So, M/50 = 4; hence; M = Rs. 200
The value creation index is 4.<br>
slide66. Marakon Approach_Problems 3. The return on equity is 18% and the equity capitalisation rate is 10%. If the payout ratio is 55% and the market price of share is Rs. 200, then what should be the book value per share as per marakon model? (The actual BV is Rs. 25)<br>
slide67. Marakon Approach_Problems r =18%, k =10%, b =55%, M =Rs. 200
g = (1-b)r = 0.45 * 0.18 = 8.1%
M/B = (18-8.1)/(10-8.1) = 5.21
200/B = 5.21
B = 200/5.21 = Rs. 38.38<br>
slide68. Marakon Approach_Problems 4. The equity value of X ltd. Is Rs. 2 Lakh and the profit after taxes is Rs. 30000. the company has paid a dividend of Rs.10000 for the year. If the risk free rate is 10%, market return is 12% and Beta value is 5, then find out whether the company has created the value or destroyed as per marakon model.<br>
slide69. The value based management measure adopted by Marakon is Market to book ratio
In market to book ratio 'm' can be greater than 'b' if and only if r > k.
With a positive spread between return on equity and cost of equity, the value of will increase if g' increases but limited to the value of 'k'.
If the ROE is 25%, cost of equity is 12% and growth rate of dividends is 7% then find out the M/B.
ANS: 3.6
If the ROE is 20%, cost of equity is 12% and growth rate of dividends is 10% then find out the M/B.
ANS: 5
As per marakon model if a firm can increase the positive spread between return on equity and cost of equity then the value of firm will increase.<br>
slide70. The return on equity is 20% and cost of equity is 14%. If the retention ratio is 60% and the book value per share is Rs. 50, then what is the growth rate (g)?
ANS: 12%
The return on equity is 20% and cost of equity is 14%. If the retention ratio is 60% and the book value per share is Rs. 50, then what would be the expected market value of equity as per marakon model?
ANS: 200
The return on equity is 20% and cost of equity is 14%. If the retention ratio is 60% and the book value per share is Rs. 50, then what would be the value of M/B ratio as per marakon model?
ANS: 4
The return on equity is 18% and the equity capitalisation rate is 10%. If the payout ratio is 55% and the market price of share is Rs. 200, then what should be the book value per share as per marakon model?
ANS: 38.38<br>
slide71. Mckinsey Approach<br>
slide72. Mckinsey Approach A company can maximize its value by focusing decision making on the key drivers of value.
Value Thinking: to make value happen, a company’s actions should be based on a foundation of value thinking. It has two dimensions;
Value metrics: The value metrics that reflects the economic results of the company and not that of accounting results. The metrics should consider the stock market valuation of the company and the opportunity cost.
Value Mindset: The management must care about shareholder value creation above others.<br>
slide73. Mckinsey Approach: Creating SHARE HOLDERS VALUE Aspirations and targets SHAREHOLDER
VALUE<br>
slide74. 4. Stern stewart approach EVA® Approach<br>
slide75. Stern Stewart (EVA®) approach First proposed by Stern Stewart & Co., EVA is now a very popular idea.
Fortune Magazine- “Today’s hottest financial idea and getting hotter”
Peter Ducker – “it is a measure of total factor productivity”
EVA is essentially surplus left after making an appropriate charge for the capital employed in business.
EVA = NOPAT – WACC * CAPITAL
EVA = CAPITAL (ROC – WACC)
EVA = [PAT + INT(1 - t)] – WACC * CAPITAL
EVA = PAT – COE * EQUITY<br>
slide76. Stern Stewart (EVA®) approach: Drivers of EVA Increasing efficiency (or productivity)- increasing operating profit from the same investment in operating assets. (better asset utilization, turning idle asset into earning assets)
Profitable Growth - marginal growth in operating profit should be higher than marginal growth in investment in operating assets. (Additional investment in assets only if New ROIC is more than current ROIC)
Wiping out unproductive capital – disinvest from segments where ROIC and WACC spread is negative or fragile than overall average.
Reducing WACC – altering financing strategy to reduce WACC.<br>
slide77. The Two Financial Paradigms: EPS based Financial Management vs. EVA based Financial Management EPS based FM
Management tries to… Report steady increase in EPS
Diversify to achieve stability
Tightly control the allocation of capital
Balance the claim of various stakeholders
Buy companies with low P/E to bootstrap EPS
Negotiate divisional profit targets EVA based FM
Management tries to… Achieve improvement in EVA
Strive for focus
Decentralize the investment decisions
Accord primacy to shareholder welfare
Acquire companies that augment value
Define EVA targets by formula<br>
slide78. 5. BCG Approach<br>
slide79. BCG Approach Two Corner concepts;
Total Return to Shareholder(TRS)
Total Business Return (TBR)
For applying these concepts Two performance matrices are developed;
Cash Flow Return on Investment (CFROI)
Cash Value Added (CVA)<br>
slide80. Total Return to Shareholders If it is a single holding period
TRS = [Dividend & Share Buyback + (Ending Mkt Value – Beginning Mkt Value)] / [Beginning Mkt Value + Additional equity raised during the period]
If it is a multiple holding period;
Beginning Market Value = D1/(1+TRS)1 + D2/(1+TRS)2 +….+ End Mkt Value/ (1+TRS)n<br>
slide81. TRS: Credibility It is comprehensive as it includes both dividends and capital gain.
It is widely used by investment community and also required by SEC.
TSR can be easily benchmarked against the mkt or peer groups
TSR is not biased by size
TSR is difficult to manipulate<br>
slide82. BCG approach…contd. Drivers of TRS
Profitability, growth and free cash flow
Capital gains is driven by the first two
Free cash flow drives the dividend payout, buyback of shares.
A TRS > Ke, is a proxy for Return, Earnings and Value added measures for equity holders.<br>
slide83. Total Business Return What TRS is to investors, TBR is to internal management.
If it is a single holding period
TBR = (Free Cash Flow / Begn. Value) + (Endg Value – Begn Value) / Begn Value]
If it is a multiple holding period;
Begn Mkt Value = FCF1/(1+TBR)1 + FCF2/(1+TBR)2 +….+ End Value/ (1+TBR)n<br>
slide84. BCG approach…contd. CFROI and CVA
CFROI = (Operating Cash Flow – Economic Depreciation) / Cash Invested
If CFROI > Kc, the business is earning cash in excess of capital charge, even after making provision for asset replacement at the end of asset life i.e. Business seems to be sustainable for long time.
Drivers of CFROI- Efficiency, Profitable growth and wiping out unproductive capital.<br>
slide85. BCG approach…contd. CVA= Operating Cash Flow – Economic Depreciation – Capital charge on Gross Investment
While CFROI is a relative measure, CVA is an absolute measure of Business sustainability.
If CVA is +ve, the business is earning cash in excess of capital charge, even after making provision for asset replacement at the end of asset life i.e. Business seems to be sustainable for long time.
BCG advocates Cash Value Added as superior to EVA.
Drivers of CVA - Efficiency, Profitable growth and wiping out unproductive capital.<br>
slide86. BCG approach: Resource Allocation decision<br>
slide87. Drivers of Value BUT it is interesting to note that drivers of CFROI/ CVA / EVA are same and they are;
Efficiency,
Profitable growth and
Wiping out unproductive capital.<br>