EVA by xiaopangnv

VIEWS: 6 PAGES: 35

									 The value of any stock, bond or business today is determined by
the cash inflows or outflows – discounted by an appropriate
discount rate – that can be expected to occur during the
remaining life of an asset.
                    - Warren Buffett, Berkshire Hathaway Annual Report (1992)
       The Evolution of Value Based Management

Basic Notion
 Firm value = PV (future free cash flows).


Strategic Value Analysis LEK / Alcar
 Firm value = PV (FCF of existing assets)+ PV (Growth opportunities)

EVA   Stern Stewart & Co.
 Firm value = ΣPV t (EVA t ) + Invested Capital.

CVA   BCG and HOLT Value Associates
 Firm value = ΣPV t (CVA t ) + Invested Capital.
                 Free Cash Flow Approach

        Firm’s FCF = Financing or Investors’ cash flow


      Firm’s perspective               Investor’s perspective

      EBITDA                         FCF = The amount received
–     cash tax payments                    by investors

–     incremental investment
                                       interest payment to creditors
      in operating assets
                                     + repayment of debt principal
                                     - additional debt issued
                                     + dividends
                                     + share repurchases
1. Net working capital (CA-CL)       - additional stock issued

2. Capital expenditures and             Financing cash flow
   long-term assets.
            Free Cash Flow& Firm valuation


Firm    =       Present value of          +          Value of
Value            free cash flow                 Non-operating assets

                                              - Marketable securities
                                              - Excess real state
                                              - Over funded pension plan


Firm    =                                 +
                   Future claim                   Shareholder value
Value

            - Interest-bearing debt
            - Capital lease obligations
            - Under funded pension plan
            - Contingent liabilities
               Free Cash Flow Approach

Free cash flow and firm’s valuation

1. How long should we calculate?
       1. CF during strategic planning period
       2. After strategic planning period, “residual value”
       • How long is strategic planning period?

2. How to forecast free cash flow? (Value drivers)
      - Assumption of “Value Drivers”                 Through value
              a) Sales growth                         drivers, we can
              b) Operating profit margin              analyze how to
              c) Cash tax rate                        improve to firm’s
              d) Net working capital / sales          FCF.
              e) Other long-term assets / sales

3. Determine the discount rate.
        - Based on opportunity cost.
             Forecasting Free Cash Flow
Case: Ashley Corporation

Value driver assumptions                  Residual
                                           period
                                           begins
                Free Cash Flow Calculations




Sales of prior year=$240,000
Year 1 =(1+Sales growth rate) × Prior year sales
       = ( 1+0.08) ×$240,000=259,200


                 Incremental asset investment in year t =
                 ( Sales in year t – Sales in year t-1) × Asset-to-sales percent
                 Year1
                 Net working capital=($259,200-$240,000) ×5.5%=$1,056
                 Fixed assets=($259,200-$240,000) ×40%=$7,680
                 Other long term assets= =($259,200-$240,000) ×2%=$384
                 Determining the Discount Rate


Weighted cost of capital
       【Cost of debt×(1-Tax rate) ×Debt/Firm Value】
               7.68%×(1-0.27)=5.61%
     +【Cost of equity × Equity/Firm value】
           risk free rate+ company beta × market premium
           6%+(1.35×8%)=16.8%


                 Percentage    After-Tax    Weighted
                  of capital     Cost         Cost

  Debt              25%        5.61%        1.40%
  Equity            75%        16.80%       12.60%
  WACC                                      14.00%
                     Free Cash Flow Calculations


Planning period present value




Residual value in year T

Free cash flow in year T  1
Cost of capital - Growth rate

Residual value in year 10=$18,623/(0.14-0.026)=$163,36
Present value of residual CF=$163,36/(1+0.14) 10=$44.06
                     Firm’s Economic value


Economic value=present value of all cash flows
               = Present value of the planning period free cash flow
               +Present value of the residual period free cash flow


Present value of the cash flows for year1-10           $ 38.52
Present value of the cash flows for the residual value $ 44.06
Firm’s economic value                                  $82.58


Excess real estate                                          7.5
Firm value                                             $ 90.08
Debt                                                   $ 42.00
Shareholder value                                      $48.08
                            Magic Value Drivers


  Myth of Growth & Firm Value

  In Case Table 4.2 PV of cash flow=$82.6 million
  If sales growth =0 PV of cash flow=$87.6 million
  Potential value = negative 5 million


  Sales growth increase           Firm value increase


             Threshold profit margin=7.2%

  Sales growth increase           Firm value decrease




Firm value = PV (FCF of existing assets)+ PV (Growth opportunities)
                     Further Dissuasion of Value Driver

     sensitivity Analysis of operating margin

             Operating      Equity      Change in
            Profit Margin
                            Value     Base case of EV
                6.00%       $27,369   -$20,718
                6.50%        37,731     -10,353
Base case       7.00%        48,084           0
                7.50%        58,436     10,352
                8.00%        68,789     20,705
                8.50%        79,141     31,057
                9.00%        89,494     41,410          Thousands of dollars



Through sensitivity Analysis of different Value Divers
We can find the one affects firm’s value most !
            Economic Value Road Map




Operating
Decision




Investing
Decision

Financing
Decision
 EVA is based on something we have know for a long time: what
we call profit, the money left to service equity, is not profit at all.
Until a business returns a profit that is greater than its cost of
capital, it operates at a loss. Never mind that it pays taxes as if it
had a genuine profit. The enterprise still returns less to the
economy than it devours in resources…. Until then it does not
create wealth; it destroys it.
                  - Peter Drucker, The Information Executives Truly Need (1995)
                              EVA Approach


             Accounting profits v.s. Economic profits



Accounting                    Cost of       Operating        Interest
  profits
             =   Sales   -    goods     -   expenses
                                                        -    expense
                                                                            -   Taxes
                               sold


                                                                                Charge
                              Cost of       Operating
Economic                                                     Taxes      -       for all
  profits
             =   Sales    -   goods     -   expenses     -                      capital
                               sold
    or                                                                           used
Residual
 income
                                    NOPAT
                         Net operating profits after taxes
            Free Cash flow & Residual Income Approach




Firm               Present value of
Value
        =        future free cash flow


                 Invested                   Present value of
        =                         +
                  Capital                future residual Income
         Free Cash flow & Residual Income Approach




                                    1. Profit margin = 6.25%

                                    2. Retention ratio = 60%

                                    3. Investment (WC & real) = 0.5 per
                                    dollar of sales growth

                                    4. Cost of capital = 10%

g=7.5%                                     g=7.5%
         Free Cash flow & Residual Income Approach


                                    Residual Income: 1,250-10,000 × 10% = 250




g=7.5%                                     g=7.5%
            Free cash flow or Residual Income?


The weakness of free cash flow:

Doesn’t provide readily apparent measure of
Annual Operating performance
When Free cash flow < 0

a) Investment is high in profitable firm
b) Operating is poor in unprofitable firm
e.g.Wal-Mart FCF -13% of capital, R is +8 % above its cost of capital
    Kmart    FCF +7% of capital, R is -3 % below its cost of capital



Residual Income provides better measure of period performance!
                         EVA Approach



        Cash flow
                                        After-tax       Capital       Accounting
EVA =     from       +   Accruals   +   interest
                                                    -   charges
                                                                  +   adjustments
        operations

              Earnings

                Operation profits

                         Economic profits

                          Economic Value Added (EVA)
        EVA Drivers



   EVA = NOPAT- (k*Capital) = (r- k)*capital

       NOPAT = operating profits after taxes but before financing
        costs and noncash bookkeeping entries except depreciation
       Return on capital (r) = NOPAT      Capital
                                             Turnover    Cash tax rate
                               Capital
                          Profit Margin
        Return on capital =               NOPBT Sales  Cash tax 
    
                                                        1    
                                           Sales Capital  NOPBT 
       NOPBT = firm’s net operating profits before taxes
EVA Drivers
                 EVA Calculation


Convert NOPAT and Capital form accounting book
value to economic book value


  1.Convert from accrual to cash accounting
    (LIFO, Bad debt reserves)
  2.Capitalize market-building expenditures
    that have been expensed in the past (R&D)
  3.Remove cumulative unusual losses or gains
    after taxes
NOPAT
CAPITAL
Example :Hobbs-Meyer Co.
Example :Hobbs-Meyer Co.
Example: Hobbs-Meyer co



                 Finance



               Equity Equivalents




                  Tax



                Equity Equivalents
Example: Hobbs-Meyer co
    Example :Hobbs-Meyer Co.


   法一
    EVA=NOPAT-Cost of capital* Capital
       =686000-10%*3984000=288000
   法二
    EVA=(Return on capital-Cost of capital)
         *Capital
        =(686000/3984000-10%)*3984000
        =288000
EVA V.S MVA

Market Value Added
= Market Value of Equity - Book Value of
 Equity
= Present value of all future EVA



Market Value of Equity
= Book Value of Equity + Present value of
 all future EVA
EVA V.S MVA

              Positive MVA



                             Negative MVA
EVA VS Investment




                     相



                     反




       Source: Stern Stewart Research “Special Report”,Apr,2002
               Advantages of EVA

   EVA is closely related to NPV.

    It avoids the problems associates with
    approaches that focus on percentage
    spreads( rate of return- rate of cost)

   It makes top managers responsible for a
    measure that they have more control over

   It is influenced by all of the decisions that
    managers have to make within a firm
    Side Effects of EVA with minimize risk

   increases in current EVA come at the
    expense of future EVA

   higher EVA is accompanied by an
    increase in the cost of capital

   increase in EVA is less than what the
    market expected it to be, leading to a
    drop in the market price

								
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