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Finance ROI and Other Metrics

Finance ROI and Other Metrics. Fall 2012. “A bird in hand is worth two in the bush” “If you can’t measure it you can’t manage it”. From Last Time. What is the most important time in a new job? What are the traits/characteristics of CEOs and managers?. New Job.

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Finance ROI and Other Metrics

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  1. Finance ROI and Other Metrics Fall 2012 “A bird in hand is worth two in the bush” “If you can’t measure it you can’t manage it”

  2. From Last Time • What is the most important time in a new job? • What are the traits/characteristics of CEOs and managers?

  3. New Job • Our judgments of others are often far less accurate then we think • We tend simplify: we size people up right away and stick to first impressions • Self fulfilling prophecy: beliefs lead to expectations that are transmitted via cues – people adjust behavior accordingly – fulfillment • We tend to view things as good or bad

  4. Successful CEOs • “Thin slicing” from Malcolm Gladwell’s Blink • Snap judgments can save us time but are inaccurate in many instances • Nevertheless, we have associations deeply-rooted in our subconscious which may be in conflict with our stated conscious values • Implicit Association Test (IAT)

  5. IAT Test Results https://implicit.harvard.edu/implicit/demo/selectatest.html

  6. What’s the Point • You have inherent biases and tendencies whether you think you do or not • A “good” CEO is tall, good looking, dark haired and has a British accent • You are subject to the same biases – so if you don’t have the aforementioned, you are at an inherent disadvantage if you want to become a CEO

  7. Back to Finance

  8. The Basics of Finance • ROI – Return on Investment • IRR – Internal Rate of Return • DCF – Discounted Cash Flow • WACC – Weighted Average Cost of Capital • EBITDA – Earnings Before Interest, Tax, Depreciation and Amortization • P/E Ratio – Price to Earnings Ratio

  9. ROI • Simple way of determining profitability • ROI = Investment Gain/Investment • Doesn’t account for time (when will I get paid) • Good for short term analysis

  10. IRR • IRR is the rate at which the NPV of all cash flows is zero • Good way of comparing alternative projects • “Standardizes” investment to other types of investments (e.g. bonds) • Word of caution – IRR can be manipulated, the devil is in the details

  11. IRR Examples • Excel has IRR function • Hand Calc is an iterative calculation so use Excel • Go to spreadsheet

  12. DCF Analysis • Discounts all future cash flows to the present • Gives a value of a project/opportunity in today’s value • Good tool for comparisons • Independent Example

  13. WACC Getting capital for your business costs money

  14. WACC (Cont.) • All capital budgeting decisions should be weighed against WACC (e.g. if the IRR doesn’t meet WACC, you shouldn’t do it)

  15. WACC Example • You own firm that is 50% debt and 50% equity • Cost of debt is 8% • TEV – Total Enterprise Value is $10M • Corporate Tax Rate is 35% • Cost of Equity is 12% • You have a 1 yr project that will require $1M investment. Expected ROI is 10%

  16. WACC Calculation WACC = (5/10)*(0.12)+(5/10)(0.08)*(1-0.35) WACC = 8.6% Would you do project with ROI of 10 percent?

  17. WACC of CE Firms • Should be mostly Re • Can’t “leverage up” CE firms – there are no assets to borrow against • Re should be around 8-15 percent

  18. EBITDA • A measure of how much money a company generates • Used frequently as a “true” measure of profitability • Used to value companies in acquisitions • Takes accounting practices out of valuation

  19. Stock Prices

  20. Stocks (Cont.) • Lots of theories on stock prices (perfectly efficient, inefficient etc.) • Stocks generally valued on their earnings and prospect for growth • Can be valued on Dividends (D/Re)

  21. Price to Earnings • Ratio of Price of Stock to Earnings per Share • Tells you how “expensive” a stock is • Average is 14-16 (it would take this many years to recoup investment) • If growth is anticipated, expect high PE • PEG or Price/Earnings to Growth normalizes P/E for growth

  22. P/E Cont.

  23. Valuation • Lots of ways to value a company • P/E • EBITDA • DCF • Multiples

  24. Valuation (Cont.)

  25. Finance in CE • Where does this apply? • CE Firm acquisition • Project selection • New Revenue Line Decisions • These are the tools to help “quantify” decision making process

  26. Finance Assignment • OK to discuss assignment with others in the class – but, do your own work • There is ambiguity – you have to learn to deal with this. State assumptions and come up with an answer.

  27. Something for Next Time • Authority: Is wearing a uniform give you more authority?

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