Value drivers
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Value Drivers. The Context of Business Valuation. Mergers and acquisitions Fundamental analysis for share valuation Evaluation of a business strategy. Fundamental Principles.

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Value Drivers

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Value drivers

Value Drivers


The context of business valuation

The Context of Business Valuation

  • Mergers and acquisitions

  • Fundamental analysis for share valuation

  • Evaluation of a business strategy


Fundamental principles

Fundamental Principles

  • In the real market, a firm creates value by earning a return on invested capital greater than the opportunity cost of capital.

  • The more a firm invest at returns above the cost of capital, the more value it creates


Fundamental principles contd

Fundamental Principles (Contd.)

  • Afirm selects strategies that maximize the present value of expected cash flows or economic benefits

  • The value of a company’s shares in the stock market is based on the market’s expectations of future performance of the company.


Fundamental principles contd1

Fundamental Principles (Contd.)

  • After an initial price is set, the return that shareholders earn depends more on the changes in expectations about the company’s future performance than its actual performance.


Noplat

NOPLAT

  • NOPLAT (Net operating profits less adjusted taxes) represents the profits generated from the company’s core operations after subtracting the income taxes related to the core operations.


Invested capital

Invested Capital

  • Invested capital represents the cumulative amount the business has invested in its core operations – primarily property, plan and equipment and working capital.

  • Invested capital is the total of equity and total borrowings in the balance sheet of a company, reduced by the amount of non-operating assets.


Net investment

Net Investment

  • Net investment is the increase in invested capital from one year to the next

  • Net Investment =

    Invested capitalt+1 - Invested capitalt


Free cash flow fcf

Free Cash Flow (FCF)

  • FCF is the cash flow generated by the core operations of the business after deducting investments in new capital.

  • FCF = NOPLAT – Net Investment


Return on invested capital roic

Return on Invested Capital (ROIC)

  • ROIC is the return the company earns on each rupee invested in the business

  • ROIC = NOPLAT /Invested capital


Investment rate ir

Investment Rate (IR)

  • IR is the portion of NOPLAT invested back into the business.

  • IR = Net investment/NOPLAT


Weighted average cost of capital wacc

Weighted Average Cost of Capital (WACC)

  • WACC is the rate of return that investors expect to earn from investing in the company and therefore, the appropriate discount rate for the free cash flow


Growth g

Growth (g)

  • ‘g’ is the rate at which the company’s NOPLAT and cash flow grows each year

  • If the company’s revenue and NOPLAT grow at a constant rate and the company’s IR is also constant, its FCF will grow a constant rate


Perpetuity formula

Perpetuity Formula

  • Enterprise Value =

    FCFt+1 /(WACC-g)


Free cash flow

Free Cash Flow

  • FCF =

    NOPLAT – Net Investment

  • FCF =

    NOPLAT – (NOPLAT x IR)

  • FCF =

    NOPLAT x (1-IR)


Growth

Growth

  • g = ROIC x IR

  • IR = g/ROIC

  • Technically one should use the return on new or incremental capital


Fcf in terms of growth

FCF in Terms of Growth

  • FCF = NOPLAT x (1 – IR)

  • FCF = NOPLAT x (1-g/ROIC)


Key value drivers

Key Value Drivers

  • Value = [NOPLATt=1×(1-g/ROIC)]

    WACC – g

  • Value drivers : Growth; ROIC; and Cost of capital


Economic profit model

Economic Profit Model

  • The value of a company equals the amount of capital invested, plus a premium equal to the present value of the value created each year.


Economic profit eva

Economic Profit (EVA)

  • Economic Profit =

    Invested capital x (ROIC – WACC)

  • PV of economic profit =

    EP/(WACC-g)


Enterprise value

Enterprise Value

  • Value =

    Invested capital + PV of projected EVA


Drivers of earnings multiple

Drivers of Earnings Multiple

  • Value = NOPLATT=1 x (1-g/ROIC)

    WACC – g

  • Value = (1-g/ROIC)

    NOPLATt=1 WACC - g


Drivers of earnings multiple contd

Drivers of earnings multiple (Contd.)

  • A Company’s earnings multiple is driven by both its expected growth and its return on capital


Drivers of market value book value multiple

Drivers of Market Value/ Book Value Multiple

  • NOPLAT =

    Invested Capital x ROIC

  • Value =

    Invested CapitalxROICx(1-g/ROIC)

    WACC - g


Drivers of market value book value multiple1

Drivers of Market Value/Book Value Multiple

  • Value= ROICx(1-g/RONIC)

    Invested Capital WACC – g

    Drivers are : WACC;ROIC; and g


Value drivers1

Value Drivers

  • Revenue growth

  • Profit margin (per cent)

  • Cash tax rate

  • Working capital/Revenue (per cent)

  • Capital expenditure/Revenue (per cent)

  • Cost of capital (per cent)

  • Value growth duration period (years)

    • Value growth duration period represents the future period for which the entity has a foreseeable competitive advantage.


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