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14 Cards in this Set
- Front
- Back
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SVA concept
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Based on NPV concept. Provides simplified & standardised approach to task of estimating co's future CFs and finding their PVs.
Focus on 'value drivers' - factors that increase s/h value. Use these to make approx estimates of future CFs & to discount them to give PVs. Aim is to control the factors relating to value drivers so as to maximise s/h value. Used by The Disney Coro and Pepsi Cola Inc Nb - assumptions & tf may involve large errors. Uncertainty re estimates tf not universal appeal. |
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SVA value drivers
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Growth in sales
Profit margins Investments in FAs Investment in WC Cost of capital Tax rate |
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Free cash flow
(central to idea of SVA) |
Cash flow in excess of the amount needed to fund all projects that have a positive NPV. I.e. surplus cash.
sales less operating costs = net operating profit less tax less incremental investment in NCAs * less incremental investment in WC (inventory, receivables & payables) = free cash from operations * FAs - to replace existing assets - FCF assumption that annual dep equals replacement value - saves adding back dep (non-cash expense) _OR_ additional FAs - new projects - 'incremental investment in fixed plant'. |
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Handing back cash to s/hs (free cash flow amount) & implications
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Firms should retain money that can be invested in any project which will give return in excess of cost of cap, surplus free to be distributed.
Reduces mngr power - smaller 'empire' Reduces flexibility to take investment opps quickly - no free cash w/in firm Reduces flexibility to react to economic downturn - no free cash to absorb losses |
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SVA steps
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Use value drivers as basis for estimating FCFs expected to arise in planning
Calculate NPVs of those FCFs Estimate value attributable to the period after the planning period ('residual' or 'terminal' period). (Done by calculating value of a perpetuity in the last yr of planning period). If done to co as a whole, gives the 'corporate value'. PV of planning horizon/period = sum of PVs for each yr PV of terminal value = FCF of last yr / req'd rate of return % x discount factor of last yr Corporate value = PV of FCFs (of planning horizon) + PV of terminal period Shareholder value = corporate value - market debt (total loan cap) |
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Strengths & weaknesses of SVA
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Strengths: CUVÉE
Consistent w valuation of shares on basis of DCFs Use can be at variety of diff levels (product lines, ind projects, divisional level, whole-firm) Value drivers used for benchmarking against competitors Explicit re value drivers for managerial attention Easy to understand & apply (partly bc uses accounting values) Weaknesses: AAA Assumes constant change in various CF elements & that they're related to level of sales Assumes constant % increase in value drivers - unrealistic Accounting system might be unable to provide required info (value drivers) |
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SVA as measure of s/h wealth v using earnings for perf evaluation (e.g P/E ration)
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SVA - over a one-yr period - subtract s/h value at start of yr from end of yr to reflect increase in s/h wealth. V diff from conventional use of earnings to measure bus perf.
EPS (& refinement of this, ROCE), takes into account value of capital employed in stmnt of FP. Earnings-based measures of perf limitations: CURD Cost of capital & discounting not taken into account Understated value of capital investment often - stmnt of FP excludes some assets (goodwill) & tangible assets poss stated below true value Risk not considered - risky projects may enhance return but could destroy value if add return doesn't compensate for add risk. Distortion of accounting profit poss - judgment made when calculating profit (eg dep method) |
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Value creation- changes to make to co's existing business to create additional value:
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DIRER
Divest assets from parts of bus where returns below cost of capital Increase return on existing capital Raise amount invested in parts of bus which generate +be returns in excess of c of c Extend length of planning horizon over which +ve returns are achieved Reduce req'd rate of return (eg change capital structure so as to reduce c of c - if poss!) |
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Economic Value Added (EVA)
(Alt to SVA, term coined by Stern Stewart & Co) |
The operating profit created during the yr in excess of the cost of invested capital. Profit should cover all costs, inc cost of the finance employed to provide that profit.
EVA = operating profit - (WACC x opening invested capital) WACC = weighted average cost of capital (average cost of LT finance to co) Opening invested capital = opening net assets |
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Advantages & disadvantages of using EVA
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Advs: ARM
Accounting concepts used, such as profits, familiar to mngrs - sits more closely w a/cing than SVA Reduces need to overhaul data collection & reporting procedures Makes cost of cap visible to managers Disadvs: PIS PV not considered - function of this yrs earnings figures & may lead to pursuit of ST projects by mngrs Invested cap of necy reflected in BS - eg value of brands may be excluded & understate value of invested cap req'd for EVA Subjective nature of earnings calculation (bc based on accounting earnings) - limited reliability |
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Measuring value creation: total shareholder return (TSR)
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TSR is made up if the capital gain (or loss) on a share plus the dividend income. Directly measures the return actually achieved by s/hs.
TSR = (selling price + all divs received) - purchase price / purchase price Limitations due to being a function of the market price of the share - TSR will be subject to: market-wide factors (affect all shares) risk characteristics of co's particular industry sector Need an appropriate benchmark for full understanding - eg other co's in same sector which all have same level of risk. TSR also dependent on time period chosen. |
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Measuring value creation: market value added (MVA)
(Stern Stewart & Co created) |
Difference between current value of co and the funds invested in the co by s/hs & LT debt holders. Ie the value added to the bus since formed, over and above money invested.
MVA = market value - capital Market value = current market value of debt, pref shares + ord shares Capital = all cash raised from finance providers or retained from earnings to finance new investment in bus since co founded. |
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Dividend payment effect & stock market influence on MVA
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Dividend - no effect because both market value & capital parts of equation reduced by same amount. Share price falls by amount of div and s/hs funds balance reduced by amount of div (in stmnt of FP & BS). Assumption that pattern of divs has no effect on s/h wealth...
Stock market - market efficiency (how quickly info reflected in price of share & tf market value of co) & competitive advantage (value created by generating return in excess of req'd return for period of planning horizon but when value-creating opps published, risk of informing competitors who response may remove that value - barriers needed eg patents). |
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Weaknesses if EVA
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WEAR
When was the value created? Previous d's work? Estimation of amount of cap invested ('cap' based on values in stmnt of FP - if items omitted then MVA overstated) Absolute measure - less useful for judging perf than the change in MVA over a period Rate of return high enough? Timing of MVA creation unclear tf diff to identify whether the implicit return suff to compensate for the risk |
