Summary Value-Based Management

Table of contents

Lecture 1: Introduction to valuation...............................................................................................2
Lecture 3: Performance, continuing value, cost of capital..............................................................7
Lecture 4: Reorganizing financials, multiples, validating the valuation.........................................14
Lecture 5: Importance, benefits and implementation of VBM.....................................................21
Lecture 6: VBM implementation in practice.................................................................................28




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,Lecture 1: Introduction to valuation
Value-based management = the processes for measuring, creating, and managing value.

Value = value from the perspective of a long-term passive investor.

 The value of a business = the value of the expected future free cash flows
 The value of a business is the sum of the invested capital and the value of the expected
future economic profits using a CAPM-based opportunity cost of capital.

Value and price

Managers create value by:

- Continuing the business if ROIC > WACC.
- Growing the business RONIC > WACC.

Managing for value requires to align the firm’s strategy, key performance metrics, targets and
incentives with value creation in the firm‘s control and reporting systems.

Distinction in value:

 Value in exchange  the price in a transaction (= objective).
 Value in use  value in the eyes of the beholder (= subjective).

The value of a security is determined by its competitive market price.

 Law of one price = equivalent (portfolios of) securities
o Must trade at the same price.
o Have the same expected return.

No arbitrage condition = deviations of the law of one price are short-lived.

The vale of a security is:

 The price of an equivalent security.
 The present value of the cash flows the security is expected to generate using the expected
return of an equivalent security as a discount rate.
 Expected return = required return in perfect capital markets.

In the capital asset pricing model (CAPM):

 All investors invest in the market portfolio of risky assets and the risk-free asset (capital
market line).
 Investors are compensated for the time value of money and for bearing systematic risk
(security market line).




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,The price of an asset is the present value of the payoffs the asset is expected to generate using the
above expected return as a discount rate. Investors attach the same value to each asset (by
assumption).

In efficient capital markets:

 Competition among investors tends to eliminate all positive-net present value trading
opportunities given all information that is available to investors.
 Securities are said to be fairly priced and investors are said to earn a fair return on their
investments.

Empirical research: well-documented deviations from rationality and violations of assumptions.
However, consistently beating the market is hard, even for professional investors.

Koller et al. (2020) and other practitioners assume that securities are on average fairly priced.

Koller et al (2020) determine the value of a business:

 From the perspective of a long-term, passive international investor in equities and the risk-
free asset.
 As the value of the cash flows the assets of the business are expected to generate using the
expected return of the next-best investment opportunity that is available in the market as a
discount rate.

The above value may differ from the market price, because investors may have different:

 Investment horizons
 Investment universes
 Beliefs about the future prospects of the company
 Degrees of control

There are different valuation models:

1. Dividend discount model

Used to determine the value of a share from a company that pays out dividends.

Price of a share:




If dividends per share grow at a constant growth forever, the share price is:




All other things equal, higher growth increases the price of shares.




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, Continued growth of earnings:




Modigliani and Miller conclude that in perfect capital markets:

 There is an infinite number of debt and payout policies that results in the same share price
(irrelevance propositions).
 The value of a business is the value of the cash flows the assets of a business are expected to
generate.

Koller et al. (2020):

- Determine the enterprise value of a business as the value of the free cash flows using the
weighted average cost of capital as discount rate.
- Add excess cash and subtract debt to obtain equity value (see Enterprise Value).
- Include any effects of financing choices in the cost of capital or the cash flows the assets are
expected to generate.

2. Discounted free cash flow model

Free cash flow = the cash that is available for distribution to all investors (debt + shareholders).




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