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Value Drivers

Value Drivers. The Context of Business Valuation. Mergers and acquisitions Fundamental analysis for share valuation Evaluation of a business strategy. Fundamental Principles.

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Value Drivers

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  1. Value Drivers

  2. The Context of Business Valuation • Mergers and acquisitions • Fundamental analysis for share valuation • Evaluation of a business strategy

  3. Fundamental Principles • In the real market, a firm creates value by earning a return on invested capital greater than the opportunity cost of capital. • The more a firm invest at returns above the cost of capital, the more value it creates

  4. Fundamental Principles (Contd.) • Afirm selects strategies that maximize the present value of expected cash flows or economic benefits • The value of a company’s shares in the stock market is based on the market’s expectations of future performance of the company.

  5. Fundamental Principles (Contd.) • After an initial price is set, the return that shareholders earn depends more on the changes in expectations about the company’s future performance than its actual performance.

  6. NOPLAT • NOPLAT (Net operating profits less adjusted taxes) represents the profits generated from the company’s core operations after subtracting the income taxes related to the core operations.

  7. Invested Capital • Invested capital represents the cumulative amount the business has invested in its core operations – primarily property, plan and equipment and working capital. • Invested capital is the total of equity and total borrowings in the balance sheet of a company, reduced by the amount of non-operating assets.

  8. Net Investment • Net investment is the increase in invested capital from one year to the next • Net Investment = Invested capitalt+1 - Invested capitalt

  9. Free Cash Flow (FCF) • FCF is the cash flow generated by the core operations of the business after deducting investments in new capital. • FCF = NOPLAT – Net Investment

  10. Return on Invested Capital (ROIC) • ROIC is the return the company earns on each rupee invested in the business • ROIC = NOPLAT /Invested capital

  11. Investment Rate (IR) • IR is the portion of NOPLAT invested back into the business. • IR = Net investment/NOPLAT

  12. Weighted Average Cost of Capital (WACC) • WACC is the rate of return that investors expect to earn from investing in the company and therefore, the appropriate discount rate for the free cash flow

  13. Growth (g) • ‘g’ is the rate at which the company’s NOPLAT and cash flow grows each year • If the company’s revenue and NOPLAT grow at a constant rate and the company’s IR is also constant, its FCF will grow a constant rate

  14. Perpetuity Formula • Enterprise Value = FCFt+1 /(WACC-g)

  15. Free Cash Flow • FCF = NOPLAT – Net Investment • FCF = NOPLAT – (NOPLAT x IR) • FCF = NOPLAT x (1-IR)

  16. Growth • g = ROIC x IR • IR = g/ROIC • Technically one should use the return on new or incremental capital

  17. FCF in Terms of Growth • FCF = NOPLAT x (1 – IR) • FCF = NOPLAT x (1-g/ROIC)

  18. Key Value Drivers • Value = [NOPLATt=1×(1-g/ROIC)] WACC – g • Value drivers : Growth; ROIC; and Cost of capital

  19. Economic Profit Model • The value of a company equals the amount of capital invested, plus a premium equal to the present value of the value created each year.

  20. Economic Profit (EVA) • Economic Profit = Invested capital x (ROIC – WACC) • PV of economic profit = EP/(WACC-g)

  21. Enterprise Value • Value = Invested capital + PV of projected EVA

  22. Drivers of Earnings Multiple • Value = NOPLATT=1 x (1-g/ROIC) WACC – g • Value = (1-g/ROIC) NOPLATt=1 WACC - g

  23. Drivers of earnings multiple (Contd.) • A Company’s earnings multiple is driven by both its expected growth and its return on capital

  24. Drivers of Market Value/ Book Value Multiple • NOPLAT = Invested Capital x ROIC • Value = Invested CapitalxROICx(1-g/ROIC) WACC - g

  25. Drivers of Market Value/Book Value Multiple • Value = ROICx(1-g/RONIC) Invested Capital WACC – g Drivers are : WACC;ROIC; and g

  26. Value Drivers • Revenue growth • Profit margin (per cent) • Cash tax rate • Working capital/Revenue (per cent) • Capital expenditure/Revenue (per cent) • Cost of capital (per cent) • Value growth duration period (years) • Value growth duration period represents the future period for which the entity has a foreseeable competitive advantage.

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