Corporate Value Creation

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Karlson Lawrence C.. Corporate Value Creation

Preface

⧉ About This Book

Acknowledgments

Foreword

CHAPTER ONE. Basic Concepts1

⧉ Introduction

⧉ Financial Statements

⧉ The Income Statement

⧉ The Balance Sheet

⧉ The Cash Flow Statement

⧉ Required Revenue for a Given Level of Net Income24

⧉ Case Study: Advanced Solar Systems Corporation

CHAPTER TWO. The Envelope Equations28

⧉ Introduction

⧉ ROCE and NiROCE

⧉ Net Investments32 , 33

⧉ Investment Rate

⧉ Incorporating the IR and NiROCE into the Expression for Net Income41

⧉ Incorporating IR into the expression for Cash Flow after Investing Activities

⧉ NI and CFaIA – A Sequential Year-by-Year Analysis

⧉ NI and CFaIA – The General Model

⧉ Estimating Growth Rates of Cash Flow after Investing Activities and Net Income

⧉ Growth Rate of CFaIAg with Constant IR and NiROCE

⧉ Growth Rate of Net Income (NIg)

⧉ Net Income Growth Rate (NIg) with Constant IR and NiROCE

⧉ Envelope Equations Methodology for Estimating Net Income, Cash Flow after Investing Activities, and Growth Rates

⧉ Example 2-1: Impact of Net Income Return on Capital Employed and Investment Rate on Cash Flow after Investing Activities when NiROCE and IR Are Constant

⧉ Example 2-2: Impact of Variable NiROCE and IR on CFaIA

⧉ Example 2-3: Calculating the Growth Rate of NI and CFaIA Knowing IR and NiROCE

⧉ Example 2-4: Impact of NiROCE and Target Net Income Growth Rates on the Investment Rate and Cash Flow after Investing Activities

⧉ Required Revenue Revisited

⧉ Example 2-5: Calculating Required Revenue for the Stephenson Corporation

⧉ Growing the Net Income

⧉ Case Study: American Technology Corporation

CHAPTER THREE. The Weighted Average Cost of Capital55

⧉ Why Is a Company's Weighted Average Cost of Capital Important?

⧉ Weighted Average Cost of Capital Defined

⧉ Operating and Capital Leases

⧉ Weighting of the Components of Capital Structure

⧉ Market Value of Debt and Equity

⧉ Impact of Taxes on the Weighted Average Cost of Capital

⧉ Estimating the Cost of Debt and Equity and the Capital Asset Pricing Model

⧉ General Equations for Estimating the WACC for a Company with One Class of Debt and Equity

⧉ Levered and Unlevered Betas66

⧉ Estimating Beta for Non-Public Companies or Business Units

⧉ Example 3-1: Estimating Beta Using the Comparable Company Method

⧉ Significance and Uses of the WACC

⧉ Origin of the Coefficients Used in Calculating a WACC

⧉ Example 3-2: Calculating the Cost of Equity Using Market Data for Hope Inc

⧉ Example 3-3: Estimating the WACC of a Company with One Class of Debt and Equity

⧉ Multiple Hurdle Rates

⧉ Example 3-4: Retail Corporation's WACC

⧉ Example 3-5: Retail Corporation Decides to Access the Debt Markets

⧉ Example 3-6: Comparison of Retail Corporation's WACCs

⧉ Introduction to Present Value

⧉ Example 3-7: Calculating the Value of a Stream of Cash Flows Using the WACC

⧉ Case Study: Omega Corporation

CHAPTER FOUR. Introduction to Valuation Models83

⧉ Introduction to Estimating Value84,85

⧉ Example 4-1: Valuing A&D Incorporated's Forecasted Cash Flows

⧉ Example 4-2: Company C's Valuation of Acquisition Target Company A

⧉ Example 4-3: Company A Values Various Business Plans

⧉ Valuation Considerations – Lessons Learned

⧉ Most Frequently Used Single-Stage Valuation Models

⧉ Multi-Stage Valuations

⧉ Example 4-4: Multi-Stage Valuation of Company A's Plan 2

⧉ Example 4-5: Company C's Multi-Stage Valuations of Companies A and B

⧉ Equivalence of the Post-Forecast-Period Models

⧉ Impact of 1/(k − g) on the Perpetual Growth Model

⧉ Considerations of the Terminal Value Multiplier as Implied by the Equivalency Equations

⧉ Case Study: NexgenSonics and the Power of Discipline!

CHAPTER FIVE. ROCE and Cash Flow Analytics117

⧉ Introduction

⧉ Basic Drivers of ROCE

⧉ Example 5-1: Calculating Mayfair Company's Return on Capital Employed

⧉ Example 5-2: Achieving a Targeted ROCE for the Richmond Company

⧉ Some Practical Aspects of Managing Return on Capital Employed

⧉ Case Study: Pharos Corporation – The Early Days

CHAPTER SIX. Strategies and Best Practices for Managing ROCE and Cash Flow129

⧉ Introduction to Maximizing Return on Capital Employed and Cash Flow

⧉ Basic Pricing-Driven Models

⧉ Value-Added Models

⧉ Introduction to Factors that Impact Corporate Performance

⧉ Example 6-1: Estimating the R&D Cost of New Tech Inc.'s Next Generation Product

⧉ Example 6-2: Exceeding Customer Expectations

⧉ Depreciation and Amortization

⧉ Example 6-3: Depreciation of Assets136

⧉ Example 6-4: Amortization of Assets

⧉ Example 6-5: Calculating Balance Sheet Statistics

⧉ Case Study: Innovative Engineering Corporation

CHAPTER SEVEN. Productivity and Operating Margin148

⧉ Productivity

⧉ Cycle Time

⧉ Closing Comments on Value Added and Cost

⧉ Case Study

CHAPTER EIGHT. The Expense Coverage Ratio158

⧉ The Expense Coverage Ratio

⧉ Conclusion

⧉ Case Study: Safety Solutions Corporation

CHAPTER NINE. Debt and Leverage164

⧉ Introduction

⧉ Debt and Leverage

⧉ LIBOR and Pricing Loans

⧉ Debt Financing Alternatives

⧉ Credit Ratings173

⧉ Relative Cost of Debt Financing

⧉ Impact of Debt on Return on Capital Employed and Return on Equity

⧉ Example 9-1: Impact of Leverage on Capital Structure, ROCE, and ROE

⧉ Financial Covenants

⧉ Example 9-2: Financial Performance Covenants

⧉ Case Study: Edsson Corporation

CHAPTER TEN. Understanding Financial Statements187

⧉ Introduction

⧉ The Income Statement

⧉ The Balance Sheet

⧉ Some Complications

⧉ The Cash Flow Statement

⧉ Cash Flow Statement Revisited

⧉ Case Study: Light Technologies Inc

APPENDIX A. Present Value Models

⧉ Present Value of Any Stream of Cash Flows232

⧉ Present Value of a Cash Flow E That Takes Place at the End of Year n

⧉ Present Value of the Terminal Value of a Cash Flow at the End of Year n

⧉ Present Value of a Stream of Fixed Cash Flows E for n Years233

⧉ Present Value of a Fixed Stream of Cash Flows in Perpetuity (n = Infinity)235

⧉ Single-Stage Growth Models

⧉ Present Value of a Stream of Cash Flows that Grow at a Fixed Rate for a Finite Period236

⧉ Present Value of a Stream of Cash Flows That Grow at a Fixed Rate in Perpetuity237

⧉ General Equation for Present Value of Single-Stage Cash Flows That Grow at a Fixed Rate

⧉ Multistage Growth Models

⧉ Two-Stage Growth Models

⧉ Three-Stage Growth Models

APPENDIX B. Business Valuation Models

⧉ Introduction

⧉ Stream of Distinct Cash Flows248

⧉ Stream of Distinct Cash Flows Followed by a Stream of Perpetual Fixed Cash Flows

⧉ Stream of Distinct Cash Flows Followed by a Stream of Finite Fixed Cash Flows

⧉ Stream of Distinct Cash Flows Followed by a Stream of Perpetual Growth Cash Flows

⧉ Stream of Distinct Cash Flows Followed by a Stream of Finite Growth Cash Flows

⧉ Stream of Distinct Cash Flows Followed by a Terminal Cash Flow

⧉ Initial Cash Flow Sequentially Followed by a Finite Period of Cash Flows That Grow at a Fixed Rate gFG and a Terminal Cash Flow

⧉ Initial Cash Flow Sequentially Followed by a Finite Period of Cash Flows That Grow at a Fixed Rate gFG and a Perpetual Fixed Cash Flow

⧉ Initial Cash Flow Sequentially Followed by a Finite Period of Cash Flows That Grow at a Fixed Rate gFA for NA Periods and Perpetual Cash Flows That Grow at a Fixed Rate gPB

⧉ Stream of Cash Flows That Grow at a Fixed Rate gA for NA Periods, Followed by a Stream of Cash Flows That Grow at a Fixed Rate gB for NB Periods, and a Stream of Perpetual Growth Cash Flows That Grow at a fixed Rate gC

APPENDIX C. Growth Models

⧉ Introduction

⧉ General Compound Annual Growth Rate Model

⧉ General Expression for CFaIAg, the Growth Rate of CFaIA

⧉ General Expression for NIg, the Growth Rate of NI

APPENDIX D. General Equations for Estimating NI and CFaIA

⧉ Introduction

⧉ ROCE and NiROCE250

⧉ The General Case for the Envelope Equations

⧉ Special Case: Constant Investment Rate and Net Income Return on Capital Employed

⧉ Special Case: Focus on Operational Cash Flows

⧉ Net Income and Cash Flow Growth Equations

APPENDIX E. R&D Growth and Investment Equation

⧉ Introduction

⧉ Generational Cost Factor

⧉ Product Life Cycle

⧉ Developing an Expression for the Cost of the Next Generation

⧉ Lifetime Revenue Factor

⧉ Example E-1: Calculating the R&D Cost of the Next Generation

⧉ Growth Rates and Product Life Cycles that Satisfy the Requirement ICurrent = INext

⧉ Example E-2: Determining g and PLC when ICurrent = INext

APPENDIX F. Inventory Considerations and the EOQ Model

⧉ Introduction

⧉ Components of Inventory Costs256

⧉ Economic Order Quantity

⧉ Shortage Costs

Selected References

⧉ Author's Note

About the Author

Отрывок из книги

DURING MY CAREER I have been involved in numerous businesses in various industries: some doing well and others in need of drastic attention. At an early stage in my career, I realized that many businesses could improve their performance if shown how. So I began to develop presentations addressing some of the aspects of creating value in a business. I then systematically presented my thoughts to the various management teams I was involved with. The outcome was dramatic in many cases. Performing businesses did better. Turnarounds became profitable. The first codification of this material was documented in a series of VHS tapes I did in 1990 titled “A Smile Is Not Enough,” which have been used as training material for several firms.

When I stepped down as executive chairman of Spectra Physics I was no longer responsible for any day-to-day operations. While I had many board opportunities to keep me busy I still had “time on my hands,” so to speak. Given this state of affairs I decided to write a book that addressed what I perceived to be a need to combine the essence of sound business practices with an analytical framework that managers and executives who don't have an MBA could use to make better decisions and advance their careers.

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When considering the impact that Working Capital has on the Cash Flow Statement, it's the change (Δ) in the various accounts that is important. The usual procedure used to determine the impact of any change in the “Asset” Working Capital accounts is to subtract the “Current Year” from the “Prior Year” to get the correct sign. When this definition is applied to the Accounts Receivable, Equation [1-40] is obtained.

Accounts Receivable increased by $700,000. This is $700,000 of Revenues the Company didn't collect during the period covered by the financial statements and represents a use of cash and hence the negative sign.20 Similarly,

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