CHAPTER 15: Corporate Valuation
and Value-Based Management

Corporate Valuation

Value-Based Management

Corporate Governance
Financial Management
1
Corporate Valuation

2 Types of Company Assets

Operating Assets (Assets-in-place)

Financial, or Nonoperating, Assets
Financial Management
2
Operating Assets (Assets-in-Place)

Tangible Assets



Buildings, Equipment, Inventory
Usually expected to grow
Generate Free Cash Flows
FCFs = NOPAT – Net Invest in Ops Capital

The PV of expected FCFs is the
Value of Operations
Financial Management
3
Value of Operations
VOp
t 1
Financial Management
FCFt
t
(1 WACC)
4
Horizon Value Formula
HV VOp at time t

FCFt (1 g)
WACC g
Horizon value is also called Terminal
Value (TV) or Continuing Value
Financial Management
5
Financial or Nonoperating Assets


Marketable securities
Ownership of non-controlling interest in
another company
Financial Management
6
Total Corporate Value

Total Corporate Value is sum of:

Value of Operations
PLUS

Value of Financial (Nonoperating) Assets
Financial Management
7
Claims on Corporate Value

Debtholders (first claim)

Preferred Stockholders (next claim)

Common Equity Stockholders
(Remaining Value)
Financial Management
8
Corporate Valuation Model

Forecast the Financial Statements

Calculate Free Cash Flows (FCFs)

Model can be applied to any Company



No dividend payments
Privately held
Division of a company

Financial Management
(spinoffs or mergers)
9
Valuation Example

See MagnaVision Inc. in Textbook

See Class Example

Chapter 15 Corp Valuation
Financial Management
10
Total Firm and Equity Value

Sources of Corporate Value




Value of Operations = $615.27
Value of Financial Assets = $63
Total Corporate Value = $678.27
Claims on Corporate Value



Value of Debt = $247
Value of Preferred Stock = $62
Value of Equity = ? = $369.27
Financial Management
11
Value of Common Equity
Value of equity
= Value of Firm - Value of Debt & Pref
= $678.27 - $309 = $369.27 million
Price per share = $369.27 /100 = $3.69
MVA = $369.27 – 245.00 = $124.27
Financial Management
12
Market Value Added (MVA)



MVA = Total corporate value of firm
minus total book value of firm
Total book value of firm = book value of
equity + book value of debt + book value
of preferred stock
MVA = $678.27 - ($245 + $247 + $62)
= $124.27 million
Financial Management
13
Breakdown of Corporate Value
(See Fig 15-2)
MVA
600
500
Book equity
400
Equity (Market)
300
Preferred stock
200
Debt
100
0
Sources Claims Market
of Value on Value vs. Book
Financial Management
Marketable
securities
Value of operations
14
Value-Based Management (VBM)


Systematic Application of Corporate
Valuation Model to corporate
decisions & strategic initiatives
Objective of VBM

Increase Market Value Added (MVA)
Financial Management
15
4 MVA “Value” Drivers


Sales Growth (%)
Operating Profitability (%)


Capital Requirements (%)



OP=NOPAT/Sales
CR=Operating Capital/Sales
Ops Capital = Debt + Pref + Common
- Financial (Nonoperating) Assets
WACC (%)
Financial Management
16
MVA for Constant Growth Firm
MVA t
Sales t (1 g )
WACC g
OP
CR
WACC
(1 g )
 OP (%) = NOPAT/Sales
 CR (%) = Total Ops Capital/Sales
Financial Management
17
Constant Growth Model Insights

1st term is MVA of sales revenues
alone (i.e., Operating Profit Margin is
100% & no Investments in Operating
Capital)
Salest (1 g )
WACC g
Financial Management
18
Insights (Cont.)

2nd term is Operating Profit (%) the
firm keeps, minus the return (%)
investors require for investing their
capital in the firm.
OP
Financial Management
CR
WACC
(1 g )
19
Impact of Growth

2nd term can be positive or negative, depending on
relative size of Profitability, Capital Requirements, &
Required Return (WACC)
 If the second term in brackets is negative, then
growth decreases MVA. In other words, profits are
not enough to offset the return on capital required
by investors

If the second term in brackets is positive, then
growth increases MVA
OP
Financial Management
CR
WACC
(1 g )
20
Improving MVA

MVA will improve if:

Profitable Sales Growth occurs

Will decrease if Sales Growth not profitable

WACC is reduced

Operating Profitability (OP %) increases

Capital Requirement (CR %) decreases
Financial Management
21
Expected Return on Invested Capital
(EROIC)

Expected Return on Invested Capital

Expected next period NOPAT divided by
amount of Ops Capital currently invested:
EROIC t
Financial Management
NOPAT t 1
OpsCapitalt
22
MVA in Terms of Expected ROIC
MVAt
OpsCapitalt EROIC t WACC
WACC g
■ If the spread between Expected Return
(EROICt) & Required Return (WACC) is
positive, MVA is positive & growth makes MVA
larger.
■ The opposite is true if the spread is
negative.
Financial Management
23
Corporate Governance &
Shareholder Wealth

Corporate Goal


LT Shareholder Wealth Maximization
Influences on Management

“Sticks”

Threat of Removal


Preventing Management Entrenchment
“Carrots”

Financial Management
Compensation for building value
24
Preventing Managerial Entrenchment

3 Provisions for Corporate Charters




Greenmail (Target Share Repurchase)
Poison Pills (Shrhldr Rights Provision)
Restricted Voting Rights
Effective Monitoring by Strong Board



Promote Qualified Board Members
Promote Independent Members
Limit “Inside” Members
Financial Management
25
Compensation Influences on
Management

Align Managerial & Shrhldr Interests


Stock Options
Employee Stock Ownership Plans (ESOPS)





Enhances Employee Productivity
Add’l Employee Compensation
Help Retain Employees
Strong Tax Incentives
May Discourage Takeover

Financial Management
Trustee votes ESOP shares
26