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100 Financial Management models, diagrams and charts for powerful business presentations. Content: Financial Management, Finacial Market, Present Value, Perpetuity, Annuity, Compound Interest, Inflation, Bond Yield, Share Value, Free Cash Flow, IRR, Risk Valuation, Markowitz, SML, CAPM, Beta Risk, APT, Portfolio Theory, Economic Profit, Call Option, Straddle, Option Pricing, Theory, Leverage Ratio, Liquidity, Du Pont, Private Equity, Volatility, Working Capital, Valuation, Value Drivers, Risk/Return, Diversification, Corporate Finance, Yield, NPV, Cash Transfer, Accounting/nMore business diagrams to download on http://www.drawpack.com your visual business knowledge

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slide1

Cash

Raw materials

inventory

Receivables

Finished goods

inventory

Financial Management...

100 Slides

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slide2

Key Words...

Financial Market – Present Value – Perpetuity – Annuity – Compound Interest – Inflation – Bond Yield – Share Value – Free Cash Flow – IRR – Risk Valuation – Markowitz – SML – CAPM – Beta Risk – APT – Portfolio Theory – Economic Profit – CallOption – Straddle – Option Pricing Theory – Leverage Ratio – Liquidity – Du Pont – Private Equity – Volatility – Working Capital – Valuation – Value Drivers – Risk/Return – Diversification – Corporate Finance – Yield – NPV – Cash Transfer – Accounting

the dual functions of financial markets

The financial markets

The secondary market

The primary market

The firm

Investors

Investors

Investors

cash

cash

newly issued

securities

outstanding

securities

The Dual Functions of Financial Markets
present value

Present Value

Value today of a future cash flow.

Discount Factor

Present value of a $1 future payment.

Discount Rate

Interest rate used to compute present values of future cash flows.

Present

Value

=

PV

=

1

DF

t

(

1

)

r

+

´

PV

=

discount

factor

C

1

C

=

=

1

PV

DF

C

´

1

+

1

r

1

Present Value
net present value

required

investment

NPV

=

PV

-

C

+

1

NPV

=

C

0

+

1

r

Net Present Value
perpetuity

Perpetuity - Financial concept in which a cash flow is theoretically received forever.

cash

flow

cash

flow

=

=

PV

of

Cash

Flow

Return

present va

lue

discount

rate

C

C

=

1

PV

=

r

r

PV

Perpetuity
annuity

Annuity - An asset that pays a fixed sum each year for a specified number of years.

é

ù

1

1

=

´

-

PV

of

annuity

C

ê

ú

(

)

t

+

r

r

1

r

ë

û

Annuity
compound interest

18

16

10% Simple

14

10% Compound

12

10

FV of $1

8

6

4

2

0

0

3

6

9

12

15

18

21

24

27

30

Number of Years

Compound Interest
inflation

Inflation - Rate at which prices as a whole are increasing.

Nominal Interest Rate - Rate at which money invested grows.

Real Interest Rate - Rate at which the purchasing power of an investment increases.

1

+

nominal in

terest rat

e

+

1

real inter

est rate

=

1

+

inflation

rate

Inflation
bond prices and yields

1600

1400

1200

1000

800

Price

600

400

200

0

0

2

4

6

8

10

12

14

Yield

5 Year 9% Bond

1 Year 9% Bond

Bond Prices and Yields
valuing common stocks i

-

P

P

Div

1

0

Expected R

eturn

=

=

+

1

r

P

P

0

0

Div

=

=

1

Capitaliza

tion

Rate

P

0

-

r

g

Div

=

=

+

1

r

g

P

0

Valuing Common Stocks I
valuing common stocks ii

Return Measurements

Div

=

1

Dividend

Yield

P

0

=

Return

on

Equity

ROE

EPS

=

ROE

Book Equit

y Per

Share

Valuing Common Stocks II
valuing common stocks iii

If we forecast no growth, and plan to hold out stock indefinitely, we will then value the stock as a PERPETUITY.

Div

EPS

=

=

1

1

Perpetuity

P

or

0

r

r

Assumes all earnings are paid to shareholders.

Valuing Common Stocks III
npv and cash transfers

Cash

Investment opportunity (real asset)

Investment opportunities (financial assets)

Firm

Shareholder

Invest

Alternative: pay dividend to shareholders

Shareholders invest for themselves

NPV and Cash Transfers
internal rate of return

2500

2000

1500

1000

500

NPV (,000s)

0

10

20

30

40

50

60

70

80

90

-500

100

-1000

-1500

Discount rate (%)

-2000

Internal Rate of Return
rate of return 1926 1997

60

40

20

Percentage Return

0

-20

Common Stocks

Long T-Bonds

-40

T-Bills

30

35

40

45

50

55

60

65

70

75

80

85

90

95

-60

26

Year

Rate of Return 1926 - 1997
measuring risk

Portfolio standard deviation

Unique

risk

Market risk

0

5

10

15

Number of Securities

Measuring Risk
portfolio risk i

The variance of a two stock portfolio is the sum of these four boxes:

Stock

1

Stock

2

=

x

x

σ

2

2

1

2

12

Stock

1

x

σ

1

1

x

x

ρ

σ

σ

1

2

12

1

2

=

x

x

σ

2

2

1

2

12

Stock

2

x

σ

2

2

x

x

ρ

σ

σ

1

2

12

1

2

Portfolio Risk I
portfolio risk ii

=

+

Expected

Portfolio

Return

(x

r

)

(

x

r

)

1

1

2

2

=

2

2

+

2

2

+

σ

x

σ

x

2

(

x

x

ρ

σ

σ

)

2

2

1

1

1

2

12

1

2

Portfolio

Variance

Portfolio Risk II
portfolio risk iii

The shaded boxes contain variance terms; the remainder contain covariance terms.

1

2

3

To calculate portfolio variance add up the boxes

4

STOCK

5

6

N

1

2

3

4

5

6

N

STOCK

Portfolio Risk III
beta and unique risk

Expected

s

stock

im

=

return

B

i

s

2

beta

m

+10%

Expected

-

10%

+

10%

market

return

-10%

Beta and Unique Risk
markowitz portfolio theory

Price changes vs. Normal distribution

600

500

400

# of Days (frequency)

300

200

100

0

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

Daily % Change

Markowitz Portfolio Theory
efficient frontier i

Return

Expected Return (%)

B

A

Risk

Standard deviation

Efficient Frontier I
efficient frontier ii

Expected Return (%)

T

Lending Borrowing

rf

S

Standard deviation

Efficient Frontier II
efficient frontier iii

Return

Low Risk

High Return

High Risk

High Return

Low Risk

Low Return

High Risk

Low Return

Risk

Efficient Frontier III
security market line i

Return

.

Market Return = rm

Efficient Portfolio

Risk FreeReturn =

rf

Risk

Security Market Line I
security market line ii

Return

.

Market Return = rm

Efficient Portfolio

Risk Free Return =

rf

BETA

1.0

Security Market Line II
security market line iii

Return

SML

rf

BETA

1.0

SML Equation = rf + B ( rm - rf )

Security Market Line III
capital asset pricing model capm

Expected return

Security market line

Market portfolio rate

Rm = 13.5%

Rf = 5%

Treasury bill rate

Beta

1

0

R = rf + B ( rm - rf )

Capital Asset Pricing Model (CAPM)
beta vs average risk premium

Avg Risk Premium

1966-91

30

20

10

0

SML

Investors

Market Portfolio

Portfolio Beta

1.0

Beta vs. Average Risk Premium
consumption betas vs market betas

Stocks

(and other risky assets)

Stocks

(and other risky assets)

Wealth is uncertain

Standard

CAPM

Consumption

CAPM

Market risk makes wealth uncertain.

Wealth

Consumption is uncertain

Wealth = market

portfolio

Consumption

Consumption Betas vs. Market Betas
arbitrage pricing theory

Alternative to CAPM

Expected Risk

Premium = r - rf

= Bfactor1(rfactor1 - rf) + Bf2(rf2 - rf) + …

Return = a + bfactor1(rfactor1) + bf2(rf2) + …

Arbitrage Pricing Theory
capital structure coc

Expected Returns and Betas prior to refinancing

Expected return (%)

20

Requity= 15

Rassets= 12.2

Rdebt= 8

0

0

0.2

0.8

1.2

Bdebt

Bassets

Bequity

Capital Structure & COC
risidual income eva

=

EVA

Residual

Income

=

Income

earned

-

Income

required

=

´

[

]

Income

earned

-

Cost

of

Capital

Investment

Risidual Income & EVA

Residual Income or EVA = Net Dollar return after deducting the cost of capital.

economic profit

Economic Profit = capital invested multiplied by the spread between return on investment and the cost of capital.

=

EP

Economic

Profit

=

-

´

(

ROI

r

)

Capital

Invested

Economic Profit
accounting measurement

ECONOMICACCOUNTING

Cash flow + Cash flow +

change in PV = change in book value =

Cash flow - Cash flow -

economic depreciation accounting depreciation

Economic income Accounting income

PV at start of year BV at start of year

INCOME

RETURN

Accounting Measurement
m m proposition

r

rE

rA

rD

D

E

Risk free debt

Risky debt

M&M Proposition
wacc traditional and m m view

r

r

rE

rE

WACC

rE =WACC

rD

rD

D

V

D

V

r

rE

WACC

rD

D

V

WACC (traditional and M&M view)
financial distress

Maximum value of firm

Costs of

financial distress

PV of interest

tax shields

Value of levered firm

Value of

unlevered

firm

Optimal amount

of debt

Debt

Financial Distress
protective put

Long stock and long put

Long Stock

Protective Put

Position Value

Long Put

Share Price

Protective Put
straddle

Long call and long put

- Strategy for profiting from high volatility

Straddle

Position Value

Share Price

Straddle
black scholes option pricing model

Ps

S

v2

2

ln + ( r + ) t

(d1) =

v t

N(d1)=

32 34 36 38 40

Black-Scholes Option Pricing Model
binomial vs black scholes

Expanding the binomial model to allow more possible price changes

1 step 2 steps 4 steps

(2 outcomes) (3 outcomes) (5 outcomes)

etc. etc.

Binomial vs. Black Scholes
straight bond vs callable bond

Value of

Straight bond

bond

100

Bond Callable

at 100

75

50

25

Value of

straight bond

25

50

75

100

125

150

Straight Bond vs. Callable Bond
exchange rate relationship

1

+

r

1

+

i

foreign

foreign

equals

1

+

r

1

+

i

$

$

equals

equals

f

E(s

)

foreign

/

$

foreign

/

$

equals

S

S

foreign

/

$

foreign

/

$

Exchange Rate Relationship
leverage ratios i

long term

debt

Long term

debt ratio

=

long term

debt

+

equity

long term

debt

+

value of

leases

Debt equity

ratio

=

equity

Leverage Ratios I
leverage ratios ii

total liabilities

Total debt

ratio

=

total assets

EBIT

=

Times interest earned

interest payments

EBIT

+

depreciation

Cash coverage

ratio

=

interest payments

Leverage Ratios II
liquidity ratios i

Net working

capital

net working

capital

=

to total

assets ratio

total assets

current

assets

Current ratio

=

current

liabilities

Liquidity Ratios I
liquidity ratios ii

cash

+

marketable

securities

+

receivables

Quick ratio

=

current

liabilities

cash

+

marketable

securities

Cash ratio

=

current

liabilities

cash

+

marketable

securities

+

receivables

Interval

measure

=

average daily

expenditures

from

operations

Liquidity Ratios II
efficiency ratios i

sales

=

Asset turnover

ratio

average

total assets

sales

NWC

turnover

=

average

net working

capital

Efficiency Ratios I
efficiency ratios ii

cost of

goods sold

Inventory

turnover

ratio

=

average

inventory

average

inventory

Days\'

sales in

inventory

=

cost of

goods sold

/

365

average

receivables

Average

collection

period

=

average

daily sales

Efficiency Ratios II
profitability ratios i

EBIT

-

tax

Net profit

margin

=

sales

EBIT

-

tax

Return on

assets

=

average

total assets

earnings

available

for common

stock

Return on

equity

=

average

equity

Profitability Ratios I
profitability ratios ii

dividends

Payout

ratio

=

earnings

earnings

-

dividends

Plowback

ratio

=

earnings

=

1

-

payout

ratio

earnings

-

dividends

Growth in

equity

from plowback

=

earnings

Profitability Ratios II
market value ratios i

stock price

PE

Ratio

=

earnings per share

P

1

Div

1

0

Forecasted PE

ratio

=

=

x

r

-

g

EPS

aveEPS

1

1

per share

dividend

=

Dividend yield

stock price

Market Value Ratios I
market value ratios ii

Div

1

P

Price per

share

=

=

0

r

-

g

stock price

Market to

book ratio

=

book value

per share

market value

of assets

Tobins Q

=

estimated

replcement

cost

Market Value Ratios II
du pont system i

sales

EBIT

-

taxes

ROA

=

x

assets

sales

asset

turnover

profit

margin

Du Pont System I
du pont system ii

assets

sales

EBIT

-

taxes

EBIT

-

taxes

-

interest

ROE

=

x

x

x

equity

assets

sales

EBIT

-

taxes

leverage

ratio

asset

turnover

profit

margin

debt

burden

Du Pont System II
firm s cumulative capital requirement

Dollars

A

B

C

Cumulative capital requirement

Year 1

Year 2

Time

Strategy A: A permanent cash surplus

Strategy B: Short-term lender for part of year and borrower for remainder

Strategy C: A permanent short-term borrower

Firm‘s Cumulative Capital Requirement
working capital

Simple Cycle of operations

Cash

Raw materials

inventory

Receivables

Finished goods

inventory

Working Capital
inventories cash balances i

Total costs

Carrying costs

Total order costs

Order size

Optimal

order size

Inventories & Cash Balances I
inventories cash balances ii

Cash balance ($000)

25

Average inventory

12.5

Weeks

0

1

2

3

4

5

Value of bills sold = Q =

2 x annual cash disbursement x cost per sale

interest rate

Inventories & Cash Balances II
private equity partnership

Investment Phase

Payout Phase

General Partner put up 1% of capital

General Partner get carried interest in 20% of profits

Mgmt fees

Limited partners get investment back, then 80% of profits

Limited partners put in 99% of capital

Partnership

Partnership

Company 1

Company 2

Sale or IPO of companies

Investment in diversified portfolio of companies

Company N

Private Equity Partnership
increase in the cash flows from assets

Assets

Debtholders

They have fixed claims on

these cash flows

Cash flows form assets

Shareholders

They have residual claims on

these cash flows so that the

larger the cash flows, the

more value created

Increase in the Cash Flows from Assets
a simplified view of the financial accounting process

The firm

The rest

of the world

Financial transactions

Financial accounting process

The balance sheet

Records assets and liabilities

at the date of the balance sheet.

Their difference is the book value

of equity at that date.

The income statement

Records revenues and expenses

over a period of time. Their

difference, which represents an

increase or a decrease in the book

value of equity, is the profit or

loss for the period.

A Simplified View of the Financial Accounting Process
sources of risk that increase profit volatility

Economic conditions

  • Political & social environment

+ 31%

+ 26%

+ 10%

Less fixed

interest

expenses

and variable

tax expenses

SALES

Earnings

before interest

and taxes

Earnings

after taxes

Less variable

and

fixed

expenses

- 10%

  • Market structure
  • Firm‘s competitive position

- 26%

- 31%

OPERATIONAL RISK

ECONOMIC RISK

BUSINESS RISK

FINANCIAL RISK

Sources of Risk That Increase Profit Volatility
the link between the balance sheets and the income statement

Balance Sheet

December 31, 2001

Income Statement

Year 2002

Balance Sheet

December 31, 2002

Assets

$170

Liabilities

$100

Revenues

$480

Expenses

$469.8

Assets

$190

Liabilities

$113

Owner‘s equity

$70

Owner‘s equity

$77

Net Profit

$10.2

Retained earnings

$7

Dividends

$3.2

The Link Between the Balance Sheets and the Income Statement
the managerial balance sheet versus the standard balance sheet

The Managerial Balance Sheet

The Standard Balance Sheet

Invested capital

or net assets

Liabilities

and owner‘s equity

Capital employed

Total assets

Cash

Short-term debt

Cash

Short-term debt

Working capital

requirement

(WCR)

Operating assets

less

Operating liabilities

Operating assets

Accounts receivable

plus

Inventories

plus

Prepaid expenses

Long-term financing

Long-term debt

plus

Owner‘s equity

Operating liabilities

Accounts payable

plus

Accrued expenses

Long-term financing

Long-term debt

plus

Owner‘s equity

Net fixed assets

Net fixed assets

The Managerial Balance Sheet Versus the Standard Balance Sheet
the firm s operating cycle and its impact on the firm s balance sheet

Payments for nonoperating

activities

Cash

  • Impact on the balance sheet:
  • Accounts receivable
  • Finished goods inventory
  • Impact on the balance sheet:
  • Accounts payable
  • Raw material inventory

Sales

Procurement

Production

  • Impact on the balance sheet:
  • Raw materials inventory
  • Work in progress inventory
  • Finished goods inventory
The Firm‘s Operating Cycle and Its Impact on the Firm‘s Balance Sheet
sources of cash inflow and cash outflow

Operating activities

Investing activities

Financial activities

  • Sale of goods and services
  • Sale of fixed assets
  • Sale of long-term financial assets
  • Collection of interest and
  • dividend income
  • Collection of loans mad
  • Issuance of stocks and bonds
  • Long-term borrowings
  • Short-term borrowings

Sources of cash inflow

$2

CASH

$472

$13

$18.2

$460.8

$12

Operating activities

Investing activities

Financial activities

  • Purchase of supplies
  • Selling, general, and administrative
  • expenses
  • Tax expense
  • Capital expenditures and
  • acquisitions
  • Long-term financial investments
  • Repurchase of stocks and bonds
  • Repayment of long-term debt
  • Repayment of short-term debt
  • Interest payment
  • Dividend payment

Sources of cash outflow

New cash flow from financing

activities

($5.2)

Net cash flow from operating

activities

$11.2

New cash flow from investing

activities

($10)

Sources of Cash Inflow and Cash Outflow
the drivers of return on equity

Return on equity

Earnings after tax

Owner‘s equity

ROE =

Financial leverage multiplier

Tax effects

Return on invested capital

Earnings before interest and tax

Invested capital

ROIC =

Operating profit margin

Capital turnover

Financial structure ratio

Financial cost ratio

Tax effect ratio

Earnings before interest and tax

Sales

Sales

Invested capital

Invested capital

Owner‘s equity

Earnings before tax

Earnings before interest and tax

Earnings after tax

Earnings before tax

Sales

Invested capital

Owner‘s equity

Cost of debt

Tax rate

Operating costs

Cash

Working Capital

requirement

Fixed assets

The Drivers of Return on Equity
the financial system

Intermediation via

institutional investors

Insurance companies, pension funds,

Investment funds & venture capitalists

CASH

PRIVATE

PLACEMENT

Insurance policies

Retirement plans

Shares in funds

S

U

P

P

L

I

E

R

S

OF

F

U

N

D

S

F

I

R

M

S

CASH

CASH

CASH

Money Market

Instruments

SHARES

BONDS

CASH

CASH

The equity market

(Trading in shares of common stocks)

SHARES

SHARES

CASH

CASH

The corporate market

(Trading in corporate bonds)

BONDS

BONDS

CASH

CASH

The money market

(Trading in money market instruments)

Commercial

paper

Commercial

paper

Bank certificates

of deposit (CD)

CASH

Intermediation via

banks

and other lending institutions

BANK

DEPOSITS

DEBT OWED

TO BANKS

CASH

CASH

The Financial System
alternative equity valuation models

Market multiples model

Dividend valuation model

Firm‘s earnings, cash

flows, or book value

Future expected

dividends

Equity

value

multiplied by the

discounted at the

Corresponding

market multiple

Cost of equity

equals

Present value

of debt

Discounted cash flow model

Adjusted present value model

Cash flows

from assets

Unlevered

asset value

less the

Firm‘s earnings, cash

flows, or book value

discounted at the

Unlevered

cost of equity

Levered

asset value

discounted at the

Corresponding

market multiple

Tax

savings

Present value

of tax savings

discounted at the

Cost of debt

Alternative Equity Valuation Models
the drivers of value creation

EBIT

Sales

Operating margin =

EBIT

Invested capital

(pretax ROIC)

Sales

Invested capital

Capital turnover =

Expected aftertax

ROIC

Tax effect = (1 – Taxe rate)

Return spread

(ROIC – WACC)

Percent of

debt financing

Market Value Added (MVA)

If the present value of the future stream of

expected return spreads is positive, MVA is

positive and the higher the growth, the more

value created.

If the present value of the future stream of

expected return spreads is negative, MVA is

negative and the higher the growth, the more

value destroyed.

Aftertax cost of debt

Weighted average

cost of capital

WACC

Estimated cost of equity

Percent of

equity financing

Economic, political, and

social environments

Market structure

Sustainability

of growth

Competitive advantages and

core competencies

EBIT = Earnings before interest and taxes (operating profit before tax);

Invested capital = Cash + Working capital requirement + net fixed assets;

WACC = (%Debt)(Aftertax cost of debt) + (%Equity)(Cost of equity).

The Drivers of Value Creation
capital budgeting simulation

Step 1: Develop probability distributions for key factors.

Step 2: Randomly select values from these distributions.

Market

size

Selling

price

Fixed

costs

Probability

Value range

Market

growth

rate

Investment

required

Residual

value of

investment

Share

of market

Operating

costs

Useful life

of facilities

Step 3: Combine these factors and determine a net present value.

Step 4: Continue to repeat this process until a clear portrait of

the results is obtained.

Probability

Net present value

Step 5: Evaluate the resultant probability distribution.

Capital-Budgeting Simulation
cash flow diagram

Supplies

and

materials

purchased

using trade

credit

Saleable

product

(inventory)

Credit sales

(accounts

receivable)

Suppliers

Payment

for fixed

asset

purchases

Payment

for wages

and salaries

Payment

for heat

and power

Bad

debts

Payments

for credit

purchases

Cash

dividends

Collections

from

credit

sales

Cash

Cash

sales

Proceeds from

sale or issuance

of stock

Proceeds from

sale or issuance

of notes and

bonds

Payment

of taxes

Interest

and

principal

Stockholders

Creditors

Government

Cash Flow Diagram
aggressive financing strategy permanent reliance on short term financing

Permanent dependence

on short-term financing

Temporary (short-term)

financing

Permanent

current assets

DOLLAR

AMOUNT

Current

assets

Permanent plus

spontaneous financing

Fixed

assets

TIME

Aggressive Financing Strategy: Permanent Reliance on Short-Term Financing
cash and marketable securities management

Irregular cash inflows

Bond sales

Other debt contracts

Preferred stock sales

Common stock sales

In

Irregular outflows

Dividends

Interest

Principal on

debt

Share repurchase

Taxes

Out

Cash

balance

Purchase

Marketable

securities

Sale

Purchase

Labor and material

Credit

sales

Fixed assets

Inventory

Receivables

Depreciation

Sale

Cash sales

Collections

Cash and Marketable Securities Management
three ways to transfer financial capital in the economy

(1)

Direct transfer

of funds

(2)

Indirect transfer

using the investment

banker

(3)

Indirect transfer

using the financial

intermediary

The business

firm (a savings

deficit unit)

The business

firm (a savings

deficit unit)

The business

firm (a savings

deficit unit)

Firm‘s

securities

Securities

Funds

Funds

Firm‘s

securities

(stocks,

bonds)

Marketable

securities

Marketable

securities

Funds

(dollars of

savings)

Intermediary‘s

securities

Securities

Funds

Funds

Savers

(savings

surplus units)

Savers

(savings

surplus units)

Savers

(savings

surplus units)

Three Ways to Transfer Financial Capital in the Economy
key metrics required for different company situations

High

Growth of

net

income

Multiyear

DCF of

economic

profit

  • Need for long-term view
  • High probability of significant change of
  • - Technology
  • - Regulation
  • - Competition
  • Long life of investments
  • Complexity of business portfolio

Operating

value drivers

Net

income,

return on

sales

ROIC-WACC,

economic

profit (one year)

Low

Low

High

  • Capital intensity (need for
  • balance sheet focus)
  • Working capital
  • Property, plant, and equipment
Key Metrics Required for Different Company Situations
various levels of value driver identification

LEVEL 2

LEVEL 3

LEVEL 1

  • Examples
  • Percent
  • accounts
  • revolving
  • Dollars per
  • visit
  • Unit revenues
  • Billable hours
  • to total payroll
  • hours
  • Percent capacity
  • utilized
  • Cost per
  • delivery
  • Accounts
  • receivable
  • terms & timing
  • Accounts
  • payable terms
  • & timing
  • Examples
  • Customer mix
  • Sales force
  • productivity
  • (expense:
  • revenue)
  • Fixed cost/
  • allocations
  • Capacity
  • management
  • Operational
  • yield

Margin

Margin

Invested

capital

ROIC

Margin

Invested

capital

Invested

capital

Generic

Business-unit

specific

Operating

value drivers

Various Levels of Value Driver Identification
customer servicing human expense flowchart

% time on board

Call volume

% time in training

Number of

people

% time on breaks

Percent occupancy

% time on vacation

Personal

cost

% time paid

Average work

time per call

Cost per person

Absence/other

Number of

stations per SDC

Hourly rate

Number of

SDCs

Benefits

Equipment

cost per station

Service

Delivery

Center

expense

Station

cost

Equipment,

maintenance

experse per

station

Annual salary

Cost per SDC

Benefits

Total

CS-

human

expense

Other equipment

expense

Span of control

Headquaters

expense

Number of employees

Overhead

expense

Regional

center

expenses

Salary expense

Supervisory

cost

Utilities

Number of

supervisors

Other

Area staff

center

expense

Building operating

expense

Number of employees

Allocated

G&A

Overhead

cost

Building

maintanance

expense

Equipment

Materials

Other

Customer Servicing – Human Expense Flowchart
six conditions for excellent value based management

Performance

Driven

5

4

3

Low cost

Value-based

2

1

Strong

self-reinforcement

process

Managed

bottom up

as well as

top down

Highest level

Good

Two-way

communications

Medium

Sup par

Lowest

Six Conditions for Excellent Value-Based Management
simple entity valuation of a single business company

Operating

free cash flow

160

150

140

130

100

90

70

Operating

value

Cash flow

to debtholders

85

80

Debt

value

74

69

43

36

20

Equity

value

Cash flow

to equity owners

75

70

66

61

57

54

50

Simple Entity Valuation of a Single-Business Company
entity valuation of a multibusiness company

1,750

Excess

marketable

securities

Corporate

overhead

150

250

  • Market value:
  • Of debt
  • Of preferred stock

200

Unit D

1,500

300

300

Unit C

100

400

1,100

Unit B

700

Unit A

Common

equity

value

Total value

before

subtracting

corporate

overhead

Total

company

value

Entity Valuation of a Multibusiness Company
steps in valuation

Calculate NOPLAT and invested capital

  • Calculate value drivers
  • Develop an integrated historical perspective
  • Analyze financial health

(1)

Analyze

historical

performance

  • Understand strategic position
  • Develop performance scenarios
  • Forecast individual line items
  • Check overall forecast for reasonableness

(2)

Forecast

performance

  • Develop target market value weights
  • Estimate cost of noequity financing
  • Estimate cost of equity financing

(3)

Estimate

cost of capital

  • Select appropriate technique
  • Select forecast horizon
  • Estimate the parameters
  • Discount continuing value to present

(4)

Estimate

continuing

value

(5)

Calculate

and interpret

results

  • Calculate and test results
  • Interpret results within decision context
Steps in Valuation
business system analysis

Product

Design and

Development

Procurement

Manufacturing

Marketing

Sales and

Distribution

Issues

  • Access to
  • sources
  • Costs
  • Outsourcing
  • Costs
  • Cycle time
  • Quality
  • Pricing
  • Advertising/
  • promotion
  • Packaging
  • Brands
  • Sales
  • effectiveness
  • Costs
  • Channels
  • Transportation
  • Product
  • attributes
  • Quality
  • Time to
  • market
  • Proprietary
  • technology
Business System Analysis
structure conduct performance model

Industry

Producers

External

Shocks

STRUCTURE

CONDUCT

PERFORMANCE

Feedback

Feedback

Cooperation vs. Rivalry

Structure-Conduct-Performance Model
rates of return implied by alternative continuing value formulas

Average ROIC

NOPLAT

WACC - g

CV =

Aggressive

formula

Convergence

formula

NOPLAT

WACC

CV =

WACC

Time

Forecast

period

Continuing-value period

Rates of Return Implied by Alternative Continuing-Value Formulas
impact of continuing value assumptions

g = 8%

$3,000

$2,000

g = 6%

CONTINUING

VALUE ($)

g = 4%

g = 2%

g = 0%

$1,000

0

12

14

16

18

20

10%

RETURN ON NET NEW INVESTED CAPITAL

Impact of Continuing-Value Assumptions
relative positions of selected industries along continuing value parameters

> Inflation

Not economic

Growing

Entertainment

Sporting

goods

Most

firms

Information

processing

Soft

drinks

EARNINGS

GROWTH

= Inflation

CONSUMPTION

Not economic

Tobacco

Defense

Steel

< Inflation

Declining

= WACC

> WACC

< WACC

RETURN ON NEW CAPITAL

Low Entry costs High

Many Substitutes Few

Short Life cycle Long

High Price elasticity Low

Factors

affecting

returns

Relative Positions of Selected Industries Along Continuing-Value Parameters
a forecast period that will result in a poor valuation of a cyclical business

NOPLAT

End of

forecast period

Date of

valuation

TIME

A Forecast Period that Will Result in a Poor Valuation of a Cyclical Business
risk return trade offs of hedging programs

E (Return)

E (Return)

A

Beta

unchanged

Beta

unchanged

A

B

Beta

decreased

Rf

Rf

B

Beta

decreased

Total risk

Beta (undiversifiable risk)

Risk/Return Trade-Offs of Hedging Programs
framework for evaluating the value of an acquisition

Stand-alone

value of

target

(without

any

takeover

premium)

Combined

value

Stand-

alone

value of

acquiror

(pre-merger)

Value

of

synergies

Transaction

costs

Value of

next best

alternative

Value of

target to

acquiror

Price paid

including

premium

Net value

gained

from

acquisition

Framework for Evaluating the Value of an Acquisition
patent valuation dcf method overview

Value (NPV) of technology/project/product

NPV = Estimation of present value of a

business using discounted cash flows

Maximal value of technology =

NPV x Max Protection Factor

Max Protection Factor = Empirical

factor indicating maximal impact of

patents on NPV

Value of patents =

NPV x Pfmax x PPF

Patent Protection Factor = Measure of

the quality of the patent protection

Patent Valuation: DCF Method Overview
patent valuation maximal protection factor

Maximal

Protection

Factor

30%

Empirical curve

5%

Age of

Technology

Technology

under R&D

Mature

Technology

Patent-Value = Maximal-Protection-Factor x Patent-Protection-Factor x NPVtec

Pval = Pmax x PPF x NPVtec

Patent Valuation: Maximal Protection Factor
acquisition of real options

Big bets

Alliance

leverage

High

LEVEL OF INVESTMENT

(OPTION PRICE)

Entry

stakes

Risk

pooling

Low

Internal

External

SOURCE OF OPTIONS

Acquisition of Real Options
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