Topic 2
à 3 fundamental questions when capital is invested in the business = key questions for strategy
(1) Is value created by the business?
• Value created = Willingness to pay (WTP) – costs of providing goods or services
• 2 drivers
o What affects WTP?
o What affects costs?
• Remember:
𝑅! 𝑅!
𝑁𝑃𝑉 = !
𝑤𝑖𝑡ℎ 𝑝𝑒𝑟𝑝𝑒𝑡𝑢𝑖𝑡𝑦: 𝑁𝑃𝑉 =
(1 − 𝑖) 𝑖
(2) Is value captured by the business? Relative to the capital invested
• Measuring enterprise value
o 3 drivers
§ Margin = price – cost
§ Resource utilization = quantity / invested capital
§ Sales growth = (ROIC – WACC) / g
o Fundamental metrics for measuring and evaluating the performance of the business
§ Sales
§ EBITDA = sales – costs
= corporate taxes + strategic investments + + ∆working capital +
replacement investments + FCF
§ EBIT = EBITDA – depreciation
§ NOPAT = EBIT – taxes
• NOPLAT = NOPAT – tax benefit as a consequence of debt financing
o Tax benefit … = interest expenses * tax rate
o Tax rate = taxes / earnings before taxes
• The key variable for evaluating strategy
𝑁𝑂𝑃𝐿𝐴𝑇 𝑁𝑂𝑃𝐿𝐴𝑇 𝑠𝑎𝑙𝑒𝑠
= 𝑅𝑂𝐼𝐶 = = 𝑥
𝐾 𝑠𝑎𝑙𝑒𝑠 𝐾
o 𝑖𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝑐𝑎𝑝𝑖𝑡𝑎𝑙
o 𝑚𝑎𝑟𝑔𝑖𝑛
o 𝑟𝑒𝑠𝑜𝑢𝑟𝑐𝑒 𝑢𝑡𝑖𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛
• Invested capital
= cumulative amount the business has invested in its core operations: primarily
property, plant and equipment (PPE) and working capital
= fixed assets (PPE) + inventories + trade receivables – current liabilities
= equity + non-current liabilities – cash
• Evaluating the performance can be done by using the economic value added (EVA)
EVA = NOPLAT – WACC x invested capital
o Projects that generate EVA = projects where ROIC > WACC
o Discontinuing projects with ROIC < WACC generates EVA
o Only concentrating on highest ROIC projects does not optimize EVA
o 𝑘" = 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦
𝐸 𝐷 𝑘# = 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑑𝑒𝑏𝑡
𝑊𝐴𝐶𝐶 = 𝑘" 𝑥 + 𝑘# 𝑥 (1 − 𝑡) 𝑥 o
𝐸+𝐷 𝐸+𝐷 o 𝑡 = 𝑐𝑜𝑟𝑝𝑜𝑟𝑎𝑡𝑒 𝑡𝑎𝑥 𝑟𝑎𝑡𝑒
o 𝐾 =𝐸+𝐷
à 3 fundamental questions when capital is invested in the business = key questions for strategy
(1) Is value created by the business?
• Value created = Willingness to pay (WTP) – costs of providing goods or services
• 2 drivers
o What affects WTP?
o What affects costs?
• Remember:
𝑅! 𝑅!
𝑁𝑃𝑉 = !
𝑤𝑖𝑡ℎ 𝑝𝑒𝑟𝑝𝑒𝑡𝑢𝑖𝑡𝑦: 𝑁𝑃𝑉 =
(1 − 𝑖) 𝑖
(2) Is value captured by the business? Relative to the capital invested
• Measuring enterprise value
o 3 drivers
§ Margin = price – cost
§ Resource utilization = quantity / invested capital
§ Sales growth = (ROIC – WACC) / g
o Fundamental metrics for measuring and evaluating the performance of the business
§ Sales
§ EBITDA = sales – costs
= corporate taxes + strategic investments + + ∆working capital +
replacement investments + FCF
§ EBIT = EBITDA – depreciation
§ NOPAT = EBIT – taxes
• NOPLAT = NOPAT – tax benefit as a consequence of debt financing
o Tax benefit … = interest expenses * tax rate
o Tax rate = taxes / earnings before taxes
• The key variable for evaluating strategy
𝑁𝑂𝑃𝐿𝐴𝑇 𝑁𝑂𝑃𝐿𝐴𝑇 𝑠𝑎𝑙𝑒𝑠
= 𝑅𝑂𝐼𝐶 = = 𝑥
𝐾 𝑠𝑎𝑙𝑒𝑠 𝐾
o 𝑖𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝑐𝑎𝑝𝑖𝑡𝑎𝑙
o 𝑚𝑎𝑟𝑔𝑖𝑛
o 𝑟𝑒𝑠𝑜𝑢𝑟𝑐𝑒 𝑢𝑡𝑖𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛
• Invested capital
= cumulative amount the business has invested in its core operations: primarily
property, plant and equipment (PPE) and working capital
= fixed assets (PPE) + inventories + trade receivables – current liabilities
= equity + non-current liabilities – cash
• Evaluating the performance can be done by using the economic value added (EVA)
EVA = NOPLAT – WACC x invested capital
o Projects that generate EVA = projects where ROIC > WACC
o Discontinuing projects with ROIC < WACC generates EVA
o Only concentrating on highest ROIC projects does not optimize EVA
o 𝑘" = 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦
𝐸 𝐷 𝑘# = 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑑𝑒𝑏𝑡
𝑊𝐴𝐶𝐶 = 𝑘" 𝑥 + 𝑘# 𝑥 (1 − 𝑡) 𝑥 o
𝐸+𝐷 𝐸+𝐷 o 𝑡 = 𝑐𝑜𝑟𝑝𝑜𝑟𝑎𝑡𝑒 𝑡𝑎𝑥 𝑟𝑎𝑡𝑒
o 𝐾 =𝐸+𝐷
