FIN-690 / Dr. Mo VaziriFIN-690 / Dr. Mo Vaziri“VALUATION” “VALUATION”

Chapter 4:Chapter 4:

“Metrics Mania: Surviving the Barrage of Value Metrics”

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1. What is “Metrics”?”1. What is “Metrics”?”

Mathematics: A mathematical function defined for a coordinates system that associates properties to each pair of elements that are analogous to distance between points on a line

2. What does it mean this 2. What does it mean this Chapter?: Chapter?:

Knowing what we are measuring and using right measures for managerial control and performance valuation.

3. What are the measurements 3. What are the measurements and objects discussed?and objects discussed?

(1) Stock Price Performance: Measurements from market for shareholders.

(2) Intrinsic Value: Irrelevant to market measurement for managers.

(3) Financial Indicators: Also good for managers when combined with above “(2)”for short ~ medium term.

(4) Value Driver: Indirect measurements and indicators of business strength and can be combined with “(3)” as measurements for managerial targets

(1) Stock Price Performance: (1) Stock Price Performance: Measurements from market for Measurements from market for

shareholders.shareholders. TRS (Total Return to Shareholders): The sum of dividend and

share price appreciation. “Share prices can be affected by market and sector movements”. MVA (Market Value Added): Market value of stock – Equity capital

supplied by shareholders = Share outstanding x Stock Price – Total common equity (net worth) = Market premium on liquidation value. Expressed often as market-to capital ratio (Value by Entrepreneur: Value of undertaken assets from shareholders).

“Share prices can be affected by market and sector movements in short term.”

“Market treadmills” and “Side effects from stock option”. “Need market! Has to be publicly traded””

(2) Intrinsic Value: Irrelevant to (2) Intrinsic Value: Irrelevant to market measurement for market measurement for

managers.managers. - DCF (Discounted Cash Flow): Cash flow

discounted at rate that reflects the (opportunity) cost of capital.

- EVA (Economic Value Added) = NOPAT (Net Operating Profit After Tax) – After Tax dollar cost of capital used = EBIT (1-Tax Rate) – (Operating Capital) x (After Tax Percentage Cost of Capital) = (Operating Capital – WACC).

- CFROI (Cash Flow Return On Investment) = IRR of “NOPLAT + depreciation” from gross investment to PPE (property, plan and equipment)

“Can be used for privately held companies or business units”

(3) Financial Indicators: Also good for (3) Financial Indicators: Also good for managers when combined with above managers when combined with above

“(2)”for short ~ medium term“(2)”for short ~ medium term..» - Economic Profit = Invested Capital x (ROIC) – WACC):

The value created in a company in a single period. Spread between the return on invested capital and the cost of capital times amount of invested capital.

» - ROIC (Return On Invested Capital) = NOPLAT (Net Operating Profit less adjusted tax) / Invested Capital = NOPAT [EBIT x (1-Tax rate)] / *Operating Capital

» *Operating Capital = Net Operating Working Capital (Cash + Account Receivable + Inventory – Account Payable + Accrual) + Operating Long Term Assets.

» - EPS (Earning Per Share) = Net Income / Number of Outstanding Share

» - Profit Margin = Revenue – Cost of Revenue.

(4) Value Driver: Indirect measurements (4) Value Driver: Indirect measurements and indicators of business strength and and indicators of business strength and

can be combined with “(3)” as can be combined with “(3)” as measurements for managerial targets.measurements for managerial targets.

- Market Share: Indicator of performance and market influence.

- Cost per unit: Indicator of operating efficiency and cost competitiveness.

- R&D Value: Indicator of future market leadership.

Much More!

4. Question: Can discount 4. Question: Can discount method used for the past method used for the past

performance?performance?Yes! We can review the marginal

change of the past performance measured by discount method.

Case-1Case-1Term -5 -4 -3 -2 -1 0 Total

Year 1995 1996 1997 1998 1999 2000 　Cash Flow-In

40 40 40 40 40 200

Cash Flow-Out

-100 -100

Net Cash flow

-100 40 40 40 40 40 100

IRR 29% 　NPV(10%)

152 　 　 　 　 　 　

Case-2Case-2Tern -5 -4 -3 -2 -1 0 Total

Year 1995 1996 1997 1998 1999 2000 　Cash

Flow-In

20 30 40 50 60 200

Cash Flow-Out

-100 -100

Net Cash flow

-100 20 30 40 50 60 100

IRR 23% 　NPV(10

%)144 　 　 　 　 　 　

Case-3Case-3

Year19

95

1996 1997 1998 1999 2000 Total

Cash Flow-In

60 50 40 30 20 200

Cash Flow-Out

-100

-100

Net Cash flow

-100

60 50 40 30 20 100

IRR36%

　

NPV(10%)

159 　 　 　 　 　 　

Period -5 -4 -3 -2 -1 0 1Tota

l

Year199

5199

6199

7199

8199

9200

0200

1　

Cash Flow-In

40 40 40 40 40 40 240

Cash Flow-Out

-100 -100

Net Cash flow

-100 40 40 40 40 40 40 140

IRR 33% 　NPV 174 15 　 　 　 　 　 　

Case-5Case-5Period -5 -4 -3 -2 -1 0 1 2 Total

Year 1995 1996 1997 1998 1999 2000 2001 2003 　

Cash Flow-In 40 40 40 40 40 40 40 280

Cash Flow-Out -100 -100

Net Cash flow -100 40 40 40 40 40 40 40 180

IRR 35% 　

Marginal Performance 2% 　

NPV 195 21 　

Marginal Performance 5 　 　 　 　 　 　 　

Case-6Case-6Period -5 -4 -3 -2 -1 0 1 2 Total

Year 1995

1996

1997

1998

1999

2000

2001

2003 　

CF-In 40 40 40 40 40 40 40 280

CF-Out-100

-100

Net CF-100

40 40 40 40 40 40 40 180

IRR 35%#N

UM!

-14%

10% 22% 29% 33% 35% 　

Marginal Performance

#NUM!

#NUM!

23% 12% 7% 4% 2% 　

NPV -91 -58 -28 0 24 47 67 86 　Marginal

Performance

33 30 27 25 23 21 19 　

Case-7Case-7Period -5 -4 -3 -2 -1 0 1 2 Total

Year 1995 1996 1997 1998 1999 2000 2001 2003 　Cash

Flow-In

40 40 40 40 40 40 46 286

Cash Flow-Out

-100 -100

Net Cash flow

-100 40 40 40 40 40 40 46 186

IRR 35%#NU

M!

-14% 10% 22% 29% 33% 35% 　

Marginal Performance

#NUM!

#NUM!

23% 12% 7% 4% 3% 　

NPV -91 -58 -28 0 24 47 67 89 　Marginal

Performance

33 30 27 25 23 21 21