valcre - 1 Value Creation and Enhancement: Back to the...

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1 1 Value Creation and Enhancement: Back to the Future Aswath Damodaran Stern School of Business 44 West Fourth Street New York, NY 10012 adamodar@stern.nyu.edu
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2 2 Abstract In recent years, firms have turned to their attention increasingly to ways in which they can increase their value. A number of competing measures, each with claims to being the "best" approach to value creation, have been developed and marketed by investment banking firms and consulting firms. In this paper, we begin with a generic discounted cash flow model, and consider the ways in which value can be created or destroyed in a firm. We then look at two of the most widely used value enhancement measures, Economic Value Added and Cash Flow Return on Investment, and consider where these approaches yield similar results to those obtained from traditional valuation models, and where (and why) there might be differences. In conclusion, we show that there is little that is new or unique in these competing measures, and while they might be simpler than traditional discounted cash flow valuation, the simplicity comes at a cost that is substantial for high growth firms with shifting risk profiles.
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3 3 Financial theorists have long argued that the objective in decision making should be to maximize firm value. Managers and practitioners have often criticized them for being too single minded about value maximization and for not considering the broader aspects of corporate strategy or the interests of other stakeholders. In the last decade, however, managers seem to have come around to the view that value maximization should be, if not the only, at least the primary objective for their firms. This turn-around can be partly attributed to the frustration that many of them have felt with strategic consulting and its failures, or partly to an increase in their ownership of equity in the firms that they manage. Whatever the reason, the shift of focus to value maximization has created an opening for investment bankers and consultants to offer their advice on the best ways to create value. To exploit this opening and differentiate their offerings, firms have come up with measures that they claim offer new insights into value enhancement. In some cases, these measures have been promoted as needing less information than traditional approaches, and in other cases, the claim is made that value is better estimated using these new measures. In this paper, we return to basics. We begin with a generic model of value, where we relate value to expected cash flows in the future and consider all of the potential routes that are available for a firm to create value. In the process, we consider the interaction between corporate finance and the other functional areas of the firm, as well as the role that corporate strategy can play in value creation. We then look at two of the most widely used value enhancement strategies, Economic Value Added(EVA) and its numerous imitators, and Cash Flow Return on Investment
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This note was uploaded on 12/01/2011 for the course FINANCE 350 taught by Professor Aswath during the Summer '10 term at NYU.

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valcre - 1 Value Creation and Enhancement: Back to the...

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