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Ch. 13: Managing for Shareholder Value

Ch. 13: Managing for Shareholder Value.  2002, Prentice Hall, Inc. Top Creators of Shareholder Value 1999. invested cost of MVA capital return capital Microsoft 328,257 10,954 56.16% 12.64% Gen Elect 285,320 65,298 19.29% 11.92%

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Ch. 13: Managing for Shareholder Value

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  1. Ch. 13:Managing for Shareholder Value  2002, Prentice Hall, Inc.

  2. Top Creators of Shareholder Value1999 invested cost of MVA capital return capital Microsoft 328,257 10,954 56.16% 12.64% GenElect 285,320 65,298 19.29% 11.92% Intel 166,902 23,626 35.44% 12.92% Wal-Mart 159,444 36,188 13.24% 9.82% Coca-Cola 157,536 13,311 31.22% 11.24%

  3. Market Value Added MVA = Firm Value - Invested Capital Firmvalue = market value of the firm’s outstanding debt and equity securities. InvestedCapital = the sum total of the funds that have been invested in the firm.

  4. Value Creation • The combination of opportunity and execution. • Opportunities must be recognized, and • Employees must be ready, willing and able to take advantage of the opportunities.

  5. Business Valuation:The Accounting Model • Using the P/E ratio: • If a firm’s P/E ratio is 20, then a dollar increase in earnings per share will create $20 in additional equity value per share. • Problem: ignores R&D, which would reduce earnings per share, but should increase future earnings!

  6. Business Valuation:Free Cash Flow Valuation Model • Value = the PV of the firm’s projected free cash flows for all future years.

  7. Business Valuation:Free Cash Flow Valuation Model • Value = the PV of the firm’s projected free cash flows for all future years. Value = FCF + FCF + FCF + … + Terminal value ( 1+k)1 (1+k)2 (1+k)3 (1+k)n

  8. Value Drivers Variables that managers can tweak to increase firm value. • Examples: • Sales growth • operating profit margin • net working capital to sales ratio • property, plant and equipment to sales ratio • cost of capital

  9. Economic Value Added

  10. Economic Value Added Net operating weighted average invested EVAt = profit after - cost of x capital t-1 tax (NOPAT)t capital (kwacc)

  11. Economic Value Added Net operating weighted average invested EVAt = profit after - cost of x capital t-1 tax (NOPAT)t capital (kwacc) alternative definition: Return on weighted average invested EVAt = invested - cost of x capital t-1 capital (ROIC)t capital (kwacc)

  12. Paying for Performance Shareholder and manager interests are aligned when: • contributions of individuals and groups toward creation of shareholder value are measured using EVA, and • rewards are structured accordingly.

  13. Components of a Firm’s Compensation Policy • base pay • bonus: quarterly, semi-annual, or annual • long-term compensation: options, grants

  14. Designing a Compensation Program 1) How much to pay? 2) Base pay versus at-risk or incentive compensation 3) Linking incentive compensation to performance 4) Paying with a cash bonus versus equity

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