Week 1: Introduction course and corporate valuation
Chapter 1: Why Value Value?
Businesses create value when they grow and earn a return of capital that exceed their cost of capital.
Managers, board of directors, and investors sometimes ignore the foundation of value in the heat of
competition and focus on the short-term rather that creating value over the long term for stakeholder
Create shareholder value: value creation is not limited to maximizing today’s share price, but rather
maximizing company’s collective value to its shareholders, now and in the future
Since investors don’t have perfect information, they might not know that maximizing its
current share price might be equivalent to maximizing its value over time
Companies with long strategic horizon create more value than those run with a short-term mindset
Short-term: even though intrinsic investor preference is long-term value creation, too many
managers plan and execute strategy against short-term measures like earnings per share (EPS), and
so passes up long-term value-creating opportunities (also because of their compensation).
There is no evidence of linking increased EPS with the value created by an acquisition. Deals
that strengthen EPS and deals that dilute EPS are equally likely to create or destroy value
Any short-term efforts to massage earnings that undercut productive investment make achieving
long-term growth even more difficult, spawning a vicious circle. Sorting out the trade-offs between
short-term earnings and long-term value creation is part of a manager’s job
Shareholder capitalism cannot solve every challenge > managers struggle to make many trade-offs
on issues affecting people who aren’t immediately involved with the company (externalities); climate
> Long-term oriented companies must be attuned to long-term changes that investors and
governments demand, in order to adjust their strategies over a time horizon and reduce risk
Stakeholder interests: companies need to focus on a broader set of stakeholders beyond just its
shareholders. Pursuing the creation of long-term shareholder value requires satisfying other
stakeholders (customers, suppliers, and employees) as well.
Decisions involve trade-offs; interests of different groups can be at odds with one another
Companies that create the most shareholder value, show a stronger employment growth
When companies forget the simple value-creation principles, the negative consequences to the
economy can be huge; Internet bubble of 1990s and the financial crisis of 2008
Chapter 2: Finance in a Nutshell
Companies create value when they earn a return on invested capital (ROIC) greater than their
opportunity cost of capital. If the ROIC is at or below the cost of capital, growth may not create value
return on invested capital (ROIC):
aftertax operating profits
capital invested ∈working capital∧ property , plant ,∧equipment
Companies should aim to find the combination of growth and ROIC that drives the highest discounted
value of their cash flows; it is beneficial to consider ROIC along with growth
,Seek for maximize economic profit, not ROIC, over the long term; Even though some units might
earn a lower ROIC than others, the lower-earing units are still earning more than the cost of capital
Discounted cash flow (DCF): collapsing the future performance into a single number by
forecasting the future cash flow and discount it back to the present at the same opportunity
cost of capital
Typ hier uw vergelijking.
Economic profit: focus on the ROIC in combination with the amount of capital
( ROIC−cost of capital )∗amount of invested capital
The value of a company’s shares in the stock market equals the intrinsic value based on the market’s
expectations of future performance, but the market’s expectations of future performance may not be
the same the company’s
Chapter 3: Fundamental Principles of Value Creation
The amount of value is the difference between cash inflows and the cost of the investments made,
adjusted to reflect the fact that tomorrow’s cash flows are worth less than today’s because of the
time value of money and the riskiness of future cash flows; return on invested capital (ROIC)
A company will create value if its ROIC is greater than its cost of capital
Return on
invested capital
Cash flow
Revenue growth Value
Cost of capital
Terminology
NOPAT: net operating profit after taxes, it represents the profits generated from the
company’s core operations after subtracting the income taxes related to those operations
Invested capital: cumulative amount the business has invested in its core operations
(property, plant, and equipment and working capital)
Net investment: increase in invested capital from one year to the next
Free cash flow (FCF): cash flow generated by the core operating of the business after
deducting investments in new capital
FCF=NOPAT −Net Investment
Return on invested capital (ROIC): return the company earns on each dollar invested (on all
capital or on new/incremental capital)
NOPAT
ROIC=
Invested Capital
Investment rate (IR): portion of NOPAT invested back into the business
Net investment
IR=
NOPAT
Weighted average cost of capital (WACC): 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): rate at which the company’s NOPAT and cash flow grow each year
RONIC: return on new invested capital
Relationship of growth, ROIC and cash flow: compare the company’s growth rate of its industry or
the economy, and analyze its ROIC relative to peers, its cost of capital, and its own historical
performance to evaluate a company’s performance.
Growth=ROIC∗Investment rate
, Discounted-cash-flow approach
ROIC: increase profits divided by investments made last year. A company’s performance is describes
in terms of growth and ROIC, because you can analyze growth and ROIC across time and peers
Value companies by discounting their future free cash flows at a discount rate (10%) that reflect
what investors expect to earn from investing in the companies (cost of capital)
Cash flow=Earnings∗( 1−Investment rate )=Earnings∗ 1− ( Growth
ROIC )
Price-to-earnings ratio (P/Es): divide each company’s value by its first-year earnings to express the
companies’ value.
Value driver formula; If a company grows at a constant rate and maintains a constant ROIC, the
discounted cash flow
g ( growth)
NOPAT t =1 (1− )
ROIC
Value=
WACC −g
Implications for managers: to decide which strategies and investments will create the most value for
shareholders in the long run, and help investors assess the potential value of companies.
> faster growth rarely fixes a company’s ROIC problem. Low returns usually indicate a poor
industry structure (airlines), a flawed business model, or weak execution. If a company has a
problem with ROIC, the company shouldn’t grow until the problem is fixed
> Improving ROIC, for any level of growth, always increases
value because it reduces the investment required for
growth, hover the impact of growth is ambiguous; when
ROIC is high, faster growth increase value, but when ROIC is
lower than the cost of capital faster growth destroys value
(investing more at a value-destroying return)
> When ROIC = cost of capital, is line between creating and
destroying value through growth
> High-ROIC companies create more value by increasing
growth, while lower-ROIC companies create more value by increasing ROIC
> Anything that doesn’t increase cash flows, like noncash accounting charges or changes in
accounting methods, won’t create value; like changing structure of debt and equity
> Earnings don’t tell the whole story of value creation!
Economic profit method
Economic profit: measures the value created by a company in a single period, by combining ROIC and
size into a currency metric. Useful for comparing the value creation of different companies or
business units. Besides that it encourages a company to undertake investments that earn more than
their cost of capital, even if their return is lower than the current average return.
Economic Profit=Invested Capital∗(ROIC (% )−Cost of Capital( %))
Value a company: discounting the growing economic profit at a discount rate gives a present value of
economic profit
Value=Starting Invested Capital+ PV ( Projected Economic Profit)
Chapter 1: Why Value Value?
Businesses create value when they grow and earn a return of capital that exceed their cost of capital.
Managers, board of directors, and investors sometimes ignore the foundation of value in the heat of
competition and focus on the short-term rather that creating value over the long term for stakeholder
Create shareholder value: value creation is not limited to maximizing today’s share price, but rather
maximizing company’s collective value to its shareholders, now and in the future
Since investors don’t have perfect information, they might not know that maximizing its
current share price might be equivalent to maximizing its value over time
Companies with long strategic horizon create more value than those run with a short-term mindset
Short-term: even though intrinsic investor preference is long-term value creation, too many
managers plan and execute strategy against short-term measures like earnings per share (EPS), and
so passes up long-term value-creating opportunities (also because of their compensation).
There is no evidence of linking increased EPS with the value created by an acquisition. Deals
that strengthen EPS and deals that dilute EPS are equally likely to create or destroy value
Any short-term efforts to massage earnings that undercut productive investment make achieving
long-term growth even more difficult, spawning a vicious circle. Sorting out the trade-offs between
short-term earnings and long-term value creation is part of a manager’s job
Shareholder capitalism cannot solve every challenge > managers struggle to make many trade-offs
on issues affecting people who aren’t immediately involved with the company (externalities); climate
> Long-term oriented companies must be attuned to long-term changes that investors and
governments demand, in order to adjust their strategies over a time horizon and reduce risk
Stakeholder interests: companies need to focus on a broader set of stakeholders beyond just its
shareholders. Pursuing the creation of long-term shareholder value requires satisfying other
stakeholders (customers, suppliers, and employees) as well.
Decisions involve trade-offs; interests of different groups can be at odds with one another
Companies that create the most shareholder value, show a stronger employment growth
When companies forget the simple value-creation principles, the negative consequences to the
economy can be huge; Internet bubble of 1990s and the financial crisis of 2008
Chapter 2: Finance in a Nutshell
Companies create value when they earn a return on invested capital (ROIC) greater than their
opportunity cost of capital. If the ROIC is at or below the cost of capital, growth may not create value
return on invested capital (ROIC):
aftertax operating profits
capital invested ∈working capital∧ property , plant ,∧equipment
Companies should aim to find the combination of growth and ROIC that drives the highest discounted
value of their cash flows; it is beneficial to consider ROIC along with growth
,Seek for maximize economic profit, not ROIC, over the long term; Even though some units might
earn a lower ROIC than others, the lower-earing units are still earning more than the cost of capital
Discounted cash flow (DCF): collapsing the future performance into a single number by
forecasting the future cash flow and discount it back to the present at the same opportunity
cost of capital
Typ hier uw vergelijking.
Economic profit: focus on the ROIC in combination with the amount of capital
( ROIC−cost of capital )∗amount of invested capital
The value of a company’s shares in the stock market equals the intrinsic value based on the market’s
expectations of future performance, but the market’s expectations of future performance may not be
the same the company’s
Chapter 3: Fundamental Principles of Value Creation
The amount of value is the difference between cash inflows and the cost of the investments made,
adjusted to reflect the fact that tomorrow’s cash flows are worth less than today’s because of the
time value of money and the riskiness of future cash flows; return on invested capital (ROIC)
A company will create value if its ROIC is greater than its cost of capital
Return on
invested capital
Cash flow
Revenue growth Value
Cost of capital
Terminology
NOPAT: net operating profit after taxes, it represents the profits generated from the
company’s core operations after subtracting the income taxes related to those operations
Invested capital: cumulative amount the business has invested in its core operations
(property, plant, and equipment and working capital)
Net investment: increase in invested capital from one year to the next
Free cash flow (FCF): cash flow generated by the core operating of the business after
deducting investments in new capital
FCF=NOPAT −Net Investment
Return on invested capital (ROIC): return the company earns on each dollar invested (on all
capital or on new/incremental capital)
NOPAT
ROIC=
Invested Capital
Investment rate (IR): portion of NOPAT invested back into the business
Net investment
IR=
NOPAT
Weighted average cost of capital (WACC): 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): rate at which the company’s NOPAT and cash flow grow each year
RONIC: return on new invested capital
Relationship of growth, ROIC and cash flow: compare the company’s growth rate of its industry or
the economy, and analyze its ROIC relative to peers, its cost of capital, and its own historical
performance to evaluate a company’s performance.
Growth=ROIC∗Investment rate
, Discounted-cash-flow approach
ROIC: increase profits divided by investments made last year. A company’s performance is describes
in terms of growth and ROIC, because you can analyze growth and ROIC across time and peers
Value companies by discounting their future free cash flows at a discount rate (10%) that reflect
what investors expect to earn from investing in the companies (cost of capital)
Cash flow=Earnings∗( 1−Investment rate )=Earnings∗ 1− ( Growth
ROIC )
Price-to-earnings ratio (P/Es): divide each company’s value by its first-year earnings to express the
companies’ value.
Value driver formula; If a company grows at a constant rate and maintains a constant ROIC, the
discounted cash flow
g ( growth)
NOPAT t =1 (1− )
ROIC
Value=
WACC −g
Implications for managers: to decide which strategies and investments will create the most value for
shareholders in the long run, and help investors assess the potential value of companies.
> faster growth rarely fixes a company’s ROIC problem. Low returns usually indicate a poor
industry structure (airlines), a flawed business model, or weak execution. If a company has a
problem with ROIC, the company shouldn’t grow until the problem is fixed
> Improving ROIC, for any level of growth, always increases
value because it reduces the investment required for
growth, hover the impact of growth is ambiguous; when
ROIC is high, faster growth increase value, but when ROIC is
lower than the cost of capital faster growth destroys value
(investing more at a value-destroying return)
> When ROIC = cost of capital, is line between creating and
destroying value through growth
> High-ROIC companies create more value by increasing
growth, while lower-ROIC companies create more value by increasing ROIC
> Anything that doesn’t increase cash flows, like noncash accounting charges or changes in
accounting methods, won’t create value; like changing structure of debt and equity
> Earnings don’t tell the whole story of value creation!
Economic profit method
Economic profit: measures the value created by a company in a single period, by combining ROIC and
size into a currency metric. Useful for comparing the value creation of different companies or
business units. Besides that it encourages a company to undertake investments that earn more than
their cost of capital, even if their return is lower than the current average return.
Economic Profit=Invested Capital∗(ROIC (% )−Cost of Capital( %))
Value a company: discounting the growing economic profit at a discount rate gives a present value of
economic profit
Value=Starting Invested Capital+ PV ( Projected Economic Profit)
