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Chapter 13 IM 10th Ed

Chapter 13 IM 10th Ed

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Published by: notnull991 on Aug 24, 2014
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Managing for Shareholder Value
This chapter identifies methods to measure firm value and techniques that can be employedto assure management and the firm’s board of directors make decisions that increase thevalue of the firm. Increases in firm value lead to increases in stock value, which aligns withthe firms goal of maximizing shareholder wealth. easures such as free!cash flowvaluation, market value added, and economic value added can be used to evaluate the firm’s performance. anagement of the firm can be provided compensation incentives that guidetheir decisions toward increasing the value of the firm.
I.Top "reators of #hareholder $ealth%.arket &alue %dded '&%( measures wealth created by the firm).&% * +irm value  invested capital-.+irm value * market value of firms outstanding debt and equity securities.Invested capital * total funds invested in the firm/.&alue creation results from two activities0).Identifying performance measures linked to value creation that are under management’s control-.1esigning incentives to encourage employees to base decisions on these performance metrics.II./usiness &aluation%.%ccounting model).+ocuses on firms earnings-.%ssumes increases 'decreases( in earnings will lead directly to increases 'decreases( in stock price based on the price!earnings relationship.1ecreases in current earnings may result in increases in future cash flows, which may increase firm value and stock price.23
/.+ree cash flow model).+ocuses on firm’s pro4ected cash flows for all future yearsa.+uture years cash flows consist of the cash flows during a  planning period of a finite number of years and a terminal value of all years beyond the planning period b.+irm value is calculated as
5(wacc')5&alueTerminal 5(wacc')5+low"ash +ree .(wacc').+low"ash +ree -(wacc')-+low"ash +ree )(wacc'))+low"ash +ree &alue+irm
Terminal value is calculated as
+low"ash +ree &alueTerminal
-."omponents of free cash flow valuesa.6stimated revenues b.6stimated net operating profitsc.Investment in net working capitald."apital expenditures.+irm value equals market value of its debt and equityIII.&alue 1rivers%.anagers can increase firm value by managing value drivers./.7sing value drivers to increase firm value may increase equity value.I&.6conomic &alue %dded '6&%8(%.6&% is the change in firm value during a specific time interval, usually ) year /.6&% is calculated as
[ ]
       ×=
)!t"apitalInvested (wacc'k "apitalof "ost %verage$eighted '9:;%T(Tax %fter ;rofit :perating 9et 6&%
".6&% can also be calculated as
'I"("apitalInvested ('k "apitalof "ost %verage$eighted '<:I"("apitalInvestedon <eturn 6&%
×     =
&.;aying for ;erformance%.%gency problems arise when firm ownership and management are separate./.>inking 6&% measures to employee compensation encourages employees to act on behalf of owners"."ompensation ;olicy).Three components of compensation are base pay, bonus, and long!term compensation-.The mix of base pay and performance!based pay is important in attracting quality employees and achieving target performance measures..;ercentage of total compensation that is ?at!risktypically increases with employee rank.5.Incentive pay should be linked to achieving target performance measures.a.Incentive pay can be calculated as
                 =
e;erformancTarget e;erformanc%ctual <isk at ;ayof +raction ;ay/ase ;ayIncentive
 b./ounded incentive pay rewards employees only when a minimum threshold of performance is achieved and caps the  bonus payout at a maximum level of performance.c.7nbounded incentive pay has no upper or lower bonus limits.3.Incentive pay can be paid in cash, stock, or a combination of cash andstock.a.#tock rewards employees for current and future performance. b.#tock compensation may be the ma4ority of "6: and /oard of 1irectors’ pay.
)!). The accounting model of equity evaluation focuses on reported earnings incon4unction with the market’s valuation of those earnings as reflected in the price!earnings ratio. +or example, if the price!earnings ratio is -@ then a dollar increase inearnings per share should create A-@ in additional equity value per share. #imilarly,a one!dollar loss in earnings per share may lead to a drop of A-@ in share value.22

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