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Fundamental Principles of Value Creation

Fundamental Principles of Value Creation. Fred’s Hardware Story Small chain of hardware stores Superhardware stores Additional retail stores Fred’s Furniture Fred’s Garden Supplies. Fred’s Hardware-Low Return Store Analysis. Measure financial results by Return on Invested Capital

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Fundamental Principles of Value Creation

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  1. Fundamental Principles of Value Creation • Fred’s Hardware Story • Small chain of hardware stores • Superhardware stores • Additional retail stores • Fred’s Furniture • Fred’s Garden Supplies

  2. Fred’s Hardware-Low Return Store Analysis • Measure financial results by Return on Invested Capital • Measure financial results by Economic Profit

  3. Fred and Sally-Projected Operating Profit Fred’s sister Sally was achieving better operating profits.

  4. Fred and Sally-Projected Economic Profit Operating Profit is not the best way to measure financial results As shown the true financial results are measured from the ROIC and Economic Profit

  5. Fred’s New Concept of Fred’s Superhardware stores

  6. Discounted Cash Flows • This is a way of collapsing the future performance of the company into a single number. • Forecast future cash flow of the company and discount it to the present at the same opportunity cost of capital. • Economic profit and discounted cash flow (DCF) are the same. • Discount economic profit to the amount of capital you have invested today and you get DCF

  7. Fred goes Public • The financial market is different than the real market. • The financial market reacts to expectations • These expectations are what investors want to be steady • Investors depend on their money to grow • The financial market is like betting on football • Stock prices go up with the growth of a company • They exceed stock price with higher than expected economic profit. • The stock price declines with less than expected economic profit

  8. Fred expands into related Formats • Fred’s Furniture and Fred’s Garden Supplies • The financial market presents the demand for accurate expectations of economic profits • Economic profits must be managed

  9. Summary • The accurate method of measuring financial results in the real market is with Economic Profit • Use DCF to collapse future performance into a single number • This enables you to forecast the future cash flow of the company and discount it to the present at the same opportunity cot of capital • In the financial market a company must forecast future economic profits accurately to keep investors happy and to continue investing

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