Download
1 / 26
270 likes | 598 Vues
Chapter 11. Creating Value for Shareholder. Shapiro and Balbirer: Modern Corporate Finance: A Multidisciplinary Approach to Value Creation Graphics by Peeradej Supmonchai. Learning Objectives.
E N D
Chapter 11 Creating Value for Shareholder Shapiro and Balbirer: Modern Corporate Finance: A Multidisciplinary Approach to Value Creation Graphics by Peeradej Supmonchai
Learning Objectives • Calculate a firm’s market-to-book value ratio and indicate why it is a good measure of the value management creates for shareholders. • Discuss the nature of cross-subsidies within a multidivisional firm and how value-based analysis can eliminate these value-destroying activities. • Discuss the nature of strategic fit and focus and their role in creating shareholder value. • Indicate the degree to which the market is capable of recognizing management’s ability to implement long-term value-creating strategies.
Learning Objectives (Cont.) • Discuss the trade-offs between short- and long-term profits and describe the methods that can be used to encourage long-term profit maximization. • Explain how the proper design of executive compensation contracts can improve organizational performance. • Discuss the challenges of measuring economic profits and indicate how approaches like market value added (MVA) and economic value added (EVA) can be used to assess the wealth created by managers. • List the synergies that can be generated by acquisitions that are designed to exploit strategic fit. • Capture the effects of potential synergies in valuing an acquisition candidate.
Investment Opportunities and Value Creation Projects that deliver a return greater than the required rate of return increase shareholder value. Conversely, shareholder value is dissipated anytime a project’s return is less than the required return.
Market-to-Book Value Ratio Where: P0 = the market value of the firm’s common stock B0 = the book value of the firm’s common stock R = the return on equity g = the dividend growth rate k = the cost of equity capital
Interpretation of Market-to-Book Value Ratio The ratio of market-to-book value measures the value created by the firm because it compares the present value that shareholders receive for each dollar they invested in the business.
Estimating the Market-to-Book Value - An Example Ten investors each contribute $10,000 for one share each in a new company. Earnings at the end of the year are expected to be $30,000, of which 40% will be retained in the business. Future retentions will also be 40% of earnings. The return on equity for current and future projects is expected to be 30%, and the required rate of return is 25%. What is the ratio of market-to-book value?
Estimating the Market-to-Book Value - An Example Since there are 10 share of stock, earnings per share is $3,000. With a payout of 60%, the first-year dividend is expected to be $1,800. The dividend growth rate is (1.0 - 0.6) x 30% = 12%. The value of a share is therefore: P = DIV1/(k-g) = $1,800/(0.25 - 0.12) = $13,846 With a price/share of $13,846 and an initial investment of $10,000, the market-to-book ratio = 1.38.
Value-Based Analysis Value-based analysis stems from the idea that you can calculate the value of each line of business using DCF techniques. Some lines of business may be so profitable that they are cross-subsidizing other units that are actually dissipating value. Such value-destroying units should be prime candidates for divestiture.
Value Creation and Strategic Fit Strategic fit relates to the existence of synergies across business units. If synergies exist, it is possible to generate economies of scale or scope through • serving similar market or sharing channels of distribution • employing similar production methods • exploiting special technical or other skills
Creating Value Through a Focus Strategy By sticking to its core business, management can create value by: • streamlining the organizational structure • reducing expenses • speeding decision making • promoting initiative
Performance Improvement Through Decentralization Exposing business units to market forces typically improves performance. By allowing unit managers to operate their divisions as independent profit centers, a company can: • identify underperforming units • recognize and reward managers and employees of value-creating units • reduce the likelihood of cross-subsidization
Is the Stock Market Myopic? Empirical evidence indicates that investors can discern the effect of current management actions on the firm’s true economic status. Some examples: • The announcements of increased capital expenditures is viewed as “good news,” as are announcements of increased investment in R&D. • Stock price reaction to short-term financial results are often related to their longer-term implications. • Accounting changes that effect reported earnings but not cash flows do not affect stock prices.
Trade-offs between Short- andLong- Term Profits The following are actions that managers take to make short-term results look better: • postpone capital outlays • defer operating expenses • reduce operating expenses • market special promotions
Controlling Short-Term/Long-Term Trade-offs • Budgeting allowances that encourage long-term maximizing behavior • Setting realistic goals • Emphasizing long-term goals when measuring performance • Linking long-term performance to pay
Designing Executive Compensation Contracts • Avoid linking compensation to ac-counting measures of performance. • Some portion of the executive com-pensation package should be tied to stock returns. • Stock options can help offset man-agement’s natural risk aversion. • Compensate manager or measures critical to the firm’s strategic success.
Golden Parachutes Agreements whereby a company rewards key executives with substantial payments if they elect to (or are forced to) leave the company when a change of control takes place.
Partial Spin-offs A partial spinoff involves a public offering of parts of the shares in a subsidiary unit. This allows subsidiary managers to own a stake in their own operation thereby linking compensation to performance.
Measuring Economic Profits Part of the challenge of designing executive compensation systems is that accounting measures of profitability may not reflect the economic profitability being created in a given year. Two ways that can be used to capture the wealth created by manager are: • Market Value Added (MVA) • Economic Value Added (EVA)
Market Value Added (MVA) MVA measures shareholder wealth creation by looking at the difference between the market value of the firm’s common stock and the capital supplied by shareholders: MVA = Market Value of the Common Stock - Equity Capital
Calculating MVA - Occidental Petroleum (OXY) 1997 Market Value of Common Stock = $29.25/share Share Outstanding = 341.126 billion Book Value of the Common Stock = $3.109 billion MVA = $29.25 (341.126 million shares) - $3.109 billion = $6.869 billion
Economic Value Added (EVA) EVA represents the after-tax operating profits of a company after it has been charged for all of the capital used to generate those profits: EVA = EBIT (1-T) - WACC (Capital Employed)
Calculating EVA - Occidental Petroleum (OXY) 1997 EBIT = $962 million Corporate Tax Rate = 32.3% WACC = 10.1% Invested Capital = $6.761 billion
Using EVA - The Benefits and Limitations • Benefits • Theoretically simple • EVA can adjust for risk easily by estimating risk-adjusted WACCs. • Limitations • EVA only measures the benefits of the assets in place. It is not suitable for firms with significant growth opportunities. • EVA is a short-term measure. It doesn’t capture the impact of actions that look bad immediately but can create long-term value.
