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443_1 - Applied Equity Analysis and Por3olio ...

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Unformatted text preview: Applied Equity Analysis and Por3olio Management Lecture 1 Four Cornerstones of Value Crea>on •  •  •  •  Companies create value by inves>ng capital from investors to generate future cash flows at rates of return that exceed the cost of capital Value is created by genera>ng more cash flow rather than rearranging claims on the cash flows A public company’s performance is driven by changes in expecta>ons rather than just its actual performance The value of a business will be determined by who is managing the business and the strategies that they choose to pursue Source: Value, Mckinsey 2 Valua>on 101 •  A company is worth the sum of the future cash flows that it is able to generate •  Investors will adjust the value or “discount” these cash flows based on risk PV of Cashflow from Opera>ons PV of Cashflow from Non Opera>ng Ac>vi>es = Enterprise Value Cash Available to Debt Equivalents Cash Available to Equity Equivalents 3 The Cashflow Cycle •  Interest •  Debt Repayment •  Taxes Return Capital Raise Capital Capital Markets •  Notes Payable •  Long Term Debt •  Preferred Stock •  Dividends •  Common Stock •  Treasury Shares •  Capital Surplus •  Revenues Operating Cash Operating Cash •  Cost of Goods Sold (COGS) •  Depreciation •  Amortization •  Accounts Receivable •  Inventory •  Property Run Operations Investments Make Investments •  Plant •  Equipment •  Goodwill •  Accounts Payable •  Accrued Expenses 4 Need for External Financing •  •  Days of Cash on Hand •  •  Average Cash Cycle In 2010, the average investment was >ed up for 219 days At the end of 2010, Raytheon had 53 days of cash on hand The difference of 166 days led to the need for Raytheon to borrow $15.1 billion of capital Each day of >me >es up $69mm of cash and requires an equal amount of financing 0 100 200 300 InvestedCapital Days = 365 x Sales 5 Which Alterna>ve is More Aarac>ve? Where would you invest your $1 of capital? 6 RTN ROIC vs. Stock Price 7 ROIC Drivers 8 Compara>ve ROIC Drivers 9 Compara>ve ROIC Drivers 10 Value Crea>on 101 Bank Deposit Account 7% Bank Loan Rate 9% Would you take a $10,000 loan and invest in this bank account? 11 Value Crea>on Terminology Invested Capital $ x Return on Invested Capital (ROIC) % minus Cost of Capital (%) = Value NOPAT $ minus Capital Charge $ 12 RTN WACC 13 Crea>ng Value 101 Value is created when return exceeds expecta>on 14 A Key Assump>on Over the long run, the rate of return earned by owning the investment will be equal to the cash rate of return the investment generates. External ROIC Internal ROIC 15 DCF and Economic Profit are Equal $ Thousand Economic profit valua>on Projected economic profit 61,911 39,691 22,220 Discounted at 10% Current invested capital 2004 PV of Total value economic profit 2005 2006 2007 2008 2009 2010 2004 2005 2006 2007 2008 2009 2010 Discounted cash flow valua>on Discounted at 10% 61,911 DCF value 16 Key Value Drivers Value ROIC vs WACC ROIC Cost of Capital Profit Margin Growth Ability to Sustain Factors driving value crea>on 1.  Spread 2.  Growth 3.  Compe>>ve Advantage Productivity 17 18 5 Lessons of Value Crea>on 19 ...
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