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Chapter 13 IM 10th Ed

Chapter 13 IM 10th Ed - CHAPTER 13 Managing for Shareholder...

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CHAPTER 13 Managing for Shareholder Value CHAPTER ORIENTATION This chapter identifies methods to measure firm value and techniques that can be employed to assure management and the firm’s board of directors make decisions that increase the value of the firm. Increases in firm value lead to increases in stock value, which aligns with the firm’s goal of maximizing shareholder wealth. Measures such as free-cash flow valuation, market value added, and economic value added can be used to evaluate the firm’s performance. Management of the firm can be provided compensation incentives that guide their decisions toward increasing the value of the firm. CHAPTER OUTLINE I. Top Creators of Shareholder Wealth A. Market Value Added (MVA) measures wealth created by the firm 1. MVA = Firm value – invested capital 2. Firm value = market value of firm’s outstanding debt and equity securities 3. Invested capital = total funds invested in the firm B. Value creation results from two activities: 1. Identifying performance measures linked to value creation that are under management’s control 2. Designing incentives to encourage employees to base decisions on these performance metrics. II. Business Valuation A. Accounting model 1. Focuses on firm’s earnings 2. Assumes increases (decreases) in earnings will lead directly to increases (decreases) in stock price based on the price-earnings relationship 3. Decreases in current earnings may result in increases in future cash flows, which may increase firm value and stock price. 75
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B. Free cash flow model 1. Focuses on firm’s projected cash flows for all future years a. Future years cash flows consist of the cash flows during a planning period of a finite number of years and a terminal value of all years beyond the planning period b. Firm value is calculated as 4 ) wacc k (1 4 Value Terminal 4 ) wacc k (1 4 Flow Cash Free 3 ) wacc k (1 3 Flow Cash Free 2 ) wacc k (1 2 Flow Cash Free 1 ) wacc k (1 1 Flow Cash Free Value Firm + + + + + + + + + = Terminal value is calculated as wacc 5 4 k Flow Cash Free Value Terminal = 2. Components of free cash flow values a. Estimated revenues b. Estimated net operating profits c. Investment in net working capital d. Capital expenditures 3. Firm value equals market value of its debt and equity III. Value Drivers A. Managers can increase firm value by managing value drivers. B. Using value drivers to increase firm value may increase equity value. IV. Economic Value Added (EVA®) A. EVA is the change in firm value during a specific time interval, usually 1 year B. EVA is calculated as [ ] × - = 1 - t Capital Invested ) wacc (k Capital of Cost Average Weighted (NOPAT) Tax After Profit Operating Net EVA t t C. EVA can also be calculated as 1 t wacc t t (IC) Capital Invested ) (k Capital of Cost Average Weighted (ROIC) Capital Invested on Return EVA - × - = 76
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V. Paying for Performance A. Agency problems arise when firm ownership and management are separate. B.
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Chapter 13 IM 10th Ed - CHAPTER 13 Managing for Shareholder...

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