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What Return to expect depending on the companies industry?

Historical
- Rate of return of number 1 in industry through time
- Industry return as a whole
5, 10, 20, 30, 40 years return
Current
- Rate of Return

Forward

Average performance of companies based on life

HOLT Valuation Model

Over the long term, firms NCR streams reflect managerial skill and
competition. The skill level of management is revealed in the track records
of firms. While the level of CFROIs is a key indicator of management skill,
variability of CFROIs and the rate of asset growth are others.

Consistent with the competitive life cycle, empirical results indicate that
competition tends to compress CFROIs toward the average. The direction
and magnitude of change over four-year spans for firms grouped by
CFROI was: (1) top-quintile-CFROI firms faded downward the most; (2)
second-quintile firms faded downward; (3) middle-quintile firms, those with
CFROIs near the average, faded little; (4) fourth-quintile firms faded
upward; and (5) bottom-quintile firms faded upward the most. The fade
effects of CFROI variability and asset growth also were consistent with lifecycle reasoning.
Sustainable growth for any year is the asset growth that would result from
a continuation of the existing capital structure, the existing dividendpayout policy, and the CFROI for the same year. HOLTs growth-rate
calculation procedures resolve end-of-year and beginning-of-year data
problems.

Warranted-value calculations are traced step-by-step for an actual


company. In treating all companies similarly and objectively, and in being
consistent with the complete CFROI model, HOLTs life-cycle procedures
serve as useful baselines for organizing data and thought, but they should
not be considered sacrosanct. If users have better information about ROIs
on future projects and asset growth for near-term than is implied by the
baseline procedures, it should be used.
The advantages of a total system way of thinking become clear in
enumerating the different effects of variables involved with quantifying the
impact of share repurchase.

Finally, hypotheses are suggested for empirical tests to investigate why


firms quarterly earnings surprises affect stock prices so differently. They
invoke the key CFROI model components of (a) CFROI level, (b) importance
of future investments to warranted value, and (c) the markets assessment
of managements skill.

CFROI an example
1

Present value (PV) of the investment: Gross investment (GI) in t

Payment (PMT) or cash flow: Gross cash flow (GCF) adjusted for

Project life (NPER): Gross asset life estimated by the depreciatio

Future value (FV): Non-depreciating assets which include workin


constructionin-progress. The logic is that these non-depreciating

Gross Cash Flow


Year
Inflation Adjusted gross Investment

0
200

40
1

11.2.1 Gross Investments

Depreciating assets

The first step when calculating gross investment is to separate depreciating and non-deprec

Depreciating assets
1 EOY adjusted gross plant (adjusted fixed assets+accumulated depreciation)
2+
Inflation adjustment for gross plant
3+
Construction in progress
4+
Capitalized operating leases
5+
Capitalized research and development
6+
Inflation adjusted gross plant recaptured
7+
Non-depreciating assets (net working capital) = Gross investme
=
Gross Investment

Example Theory
1&2 EOY Adjusted Gross plant + Inflation adjustment
Ajustment gross plant
Gross Plant (adjusted fixed
+
=

asset + accumulated depreciation)


Land
Construction in Progress (CIP)
Inflation adjustment
Total adjusted Gross Plant

Asset delayering (Example)


Years
Nominal Growth Rate of asset
Asset Layers (CAPEX)
Inflation
Inflation Adjustement
Inflation adjusted gross plant
Inflation adjustment factor

-4
22.40%
320
2%
26
347

4 Capitalized operating leases


Table 11.4 Capitalizing leases
Nominal bond rate
Expected Inflation Rate
Real debt rate (i)
Asset Life (nper)
Lease expense (pmt)
Capitalized lease (pv)

-3
22.40%
392
2%
24
416

5.0%
2.5%
2.44% (Nom/Inflation)-1
10
100
878

5 Capitalized research and development


Table 11.5 Capitalized R&D
Year
-4
-3
-2
-1
0
Infl adj

R&D Expense
per I/S
100
110
115
125
130
580

Infation rate
2.70%
2.70%
2.70%
2.70%
2.70%

6 Inflation adjusted gross plant recaptured

Company A
Gross plant
Accumulated depr
Net Plant
Fair value adjustment (assume = net asset)

1000
500
500

buys

Net Plant/ Gross plant ratio


[Net plant]/[NP/GP ratio] =
Less: reported gross plant
Equal: gross plant recaptured

50%
700 divided by

Adjusted post acquisition Company A


Gross plant as reported post acquisition
Plus: Gross plant recaputered
Equal; Adj GP recaptured
Divided by net plant as reported post acquisition
Equal: Adj NP/GP ratio

11.2.2 Non-depreciating assets

Non-depriciating assets include working capital and other non-depreciating items such as la
Conceptually, non-deprecating assets include:
Non-Depriciating assets
Current assets less inventory
- Current non-debt monetary liabilities
+ Inflation adjusted invetories
+ Inflation adjusted land
+ Other tangible assets
+ Non-depriciating, non-goodwill intagible assets
= Non-depriciating assets

11.2.3 Project Life

Since CFROI is equivalent to the weighted average return on all of a firm's projects, and esse
life. There are three inputs into the project life calculation: adjusted gross plant project life,
project life:

Gross plant project life


Life = (Adjusted gross plant + Gross Plant recaptured ) / Depreciating
Capitalized leases

Leased assets genrally consist of a similar asset mix as capital assets. If the leased assets h
plant it should be used.

Leased assets genrally consist of a similar asset mix as capital assets. If the leased assets h
plant it should be used.
Capitalized leases

The capitalized R&D project life is the same as the number of years R&D is capitalized. The
opinion given the company and industry
Life
Asset
Fixes Assets
Capitalized leases
Capitalized R&D
Total
Harmonic Mean

11.2.4 Gross cash flow


Net income after tax
+Depreciation and amortization
+ Interest expense
+ Rental expense
+ R&D expense
+ Monetary holding gain (loss)
+ FIFO profits
+ Pension expense (FASB 87)
+ Minority interest
+/- Special items (after tax)
= Inflation-adjusted gross cash flow

Historic Cost

12
8
4

5000
3000
2000
10000

nt: Gross investment (GI) in the company adjusted for inflation. Gross investment can be thought of as the gros

cash flow (GCF) adjusted for inflation and non-cash expenses. GCF is the cash flow generated from the gross in
estimated by the depreciation expense and total depreciating assets.

g assets which include working capital (current assets less current liabilities) and other non-depreciating assets
s that these non-depreciating assets are released at the end of the project, or reinvested in another project.

40
2

40
3

Non-Depreciating Asset
80
4

depreciating and non-depreciating assets. The basic adjustments are as follows:

depreciation)

ng capital) = Gross investment

11.2.1 Gross I

Example Vod

34943
0
0
2376
37319

Gross Plant
+
+
+
+
=
Figure 11.3

-2
22.40%
480
2%
19
500

-1
22.40%
588
2%
12
599

0
22.40%
719
2%
0
719

Ajustment gros
Gross Plant (adjus
=

YR 0 GP
2500
82
2582
1.033

Inflation Adjust
GP life (GP/Depr e
Inflation adjustme
Historical Growth
Real Historical Co
Inflation adjustme
Inflation adjust

Capitalized leas
Rent Expenses (p
Project life (n-rou
Real debt rate (pe
Current gross le

m/Inflation)-1

Capitalized R&D
(2005, Note 5 and
previous years)
Inflation Factor
1.112
1.083
1.055
1.027
1.000

Company B
400
300
100

Infl adj R&D


111
119
121
128
130
610

As Reported post
acquisition Company A
1200
500
700

Telecom R&D life


5-year inflation ad
4 R&D Expense
3 R&D Expense
2 R&D Expense
1 R&D Expense
0 R&D Expense
Inflation Adjusted
Inflation %

The True post


acquisition
balance sheet
1400
800
600

Gross plant rec


Inflation Adjustme
Gross plant recap
+ GP recaputered
Inflation adjust

50%

25%

58%

1400
1200
200

ost acquisition

43%

1200
200
1400
700
50%

depreciating items such as land.

l of a firm's projects, and essential part of the CFROI calculation is the project
usted gross plant project life, capilized lease project life, and capitalized R&D

assets. If the leased assets have a different know asset life than that of gross

Vodafone Deprec

Depreciating As
Inflation Adjusted
+ Construction-in
+ Capitalized lea
+ Capilalized R&D
+ Inflation adjust
Total Inflation adj

Non-Depreciatin
Current assets les
+ Current non-de
Net monetary a
Land
Land Inflation adj
Infation adjuste
Net monetary ass
+ Inventory
+ Inflation adjust
+ Other tangible
+ Prepaid Pension
+3G adjustment
Total Inflation adj

Gross Investme
Total inflation adj
Total inflation adj
Inflation adjust

11.2.3 Project

Gross plant pro


Adj gross plant
+ Gross plant rec
Adj gross plant fo
Depreaciation exp
Gross Plant Pro
Three year media

Three-year med

years R&D is capitalized. The capitalization period should reflect the analysts

Implied
Depcreciati
on
416.66667
375
500
1291.6667
7.7

Asset life
cycle
1
1.5
3

Asset life
cycle
investment
5000
4500
6000
15500

Weighting

32%
29%
39%

Total project lif


Inflation adjusted
Operating leases

Harmonic mean

3.9
2.3
1.5
7.7

Capitalized R&D
Sum of depricat
Blended asset life
Asset Life used

11.2.4 Gross c

Monetary Holdi
Current assets les
+ Current non-de

Net Monetary a
x % change in GD
Monetary holdi

FIFO profits
inventory book va
X % of inventory
FIFO inventory
X % change in PP
FIFO profits

Gross Cahs Flow


Net income after
+Depreciation an
+ Interest expens
+ R&D expense
+ Rental expense
+ Monetary holdi
+ FIFO profits
+ Pension expens

+ Minority interes
+ Associate and J
+/- Special items
Total inflation a

11.3 CFROI C

Gross Cash Flow


Inflation adjusted
Inflation adjusted
Inflation adjusted
Inflation adjusted
Project life (nper)
CFROI calculatio

thought of as the gross amount invested in the company.

rated from the gross investment.

on-depreciating assets such as land and


d in another project.

CFROI

6.36%

11.2.1 Gross Investments

Example Vodafone

Gross Plant
Land and Buildings
Machinery and equipment
Construction in progress
Tangible and intangible asset imparement (FASB 121)
Total Gross plant
Figure 11.3

Ajustment gross plant


Gross Plant (adjusted fixed asset + accumulated depreciation)
Land
Construction in Progress (CIP)
Total adjusted Gross Plant
Inflation Adjustment for gross plant
GP life (GP/Depr exp, 3-year median)
Inflation adjustment factor
Historical Growth Rate
Real Historical Cost
Inflation adjustment
Inflation adjusted gross plant
Capitalized leases
Rent Expenses (pmt)
Project life (n-rounded)
Real debt rate (per a corp bond rate)
Current gross leased property

Capitalized R&D
(2005, Note 5 and
previous years)
Telecom R&D life years
5-year inflation adjustment factor
R&D Expense
R&D Expense
R&D Expense
R&D Expense
R&D Expense
Inflation Adjusted Capitalized R&D
Inflation %

Amount

2001
2002
2003
2004
2005
2.70%

Gross plant recaptured


Inflation Adjustment factor
Gross plant recaptured
+ GP recaputered inflation adjustment
Inflation adjusteed gross plant recapture

5
1.04188892
72
110
164
171
219
736

Inflation Factor

1.11
1.08
1.05
1.03
1.00

Vodafone Depreciating Assets


Depreciating Asset
Inflation Adjusted gross plant
+ Construction-in-progress
+ Capitalized leases
+ Capilalized R&D Expense
+ Inflation adjusted gross plant recaptured
Total Inflation adjusted depreciating assets

Non-Depreciating Asset
Current assets less inventory
+ Current non-debt liabilities
Net monetary assets
Land
Land Inflation adjustment factor
Infation adjusted land
Net monetary assets
+ Inventory
+ Inflation adjusted land
+ Other tangible assets
+ Prepaid Pension
+3G adjustment
Total Inflation adjusted non depreciating assets
Gross Investment
Total inflation adjusted non-depreciating assets
Total inflation adjusted depreciating assets
Inflation adjusted gross investment

11.2.3 Project Life


Gross plant project life
Adj gross plant
+ Gross plant recaptured
Adj gross plant for asset life
Depreaciation expense
Gross Plant Project life =
Three year median GP project life

Three-year median GP project life

Total project life


Inflation adjusted gross plant + GP recaptured
Operating leases

Capitalized R&D
Sum of depricating assets
Blended asset life using implied depreciation
Asset Life used for CFROI calculation (rounded)

11.2.4 Gross cash flow


Monetary Holding gain (loss)
Current assets less inventories - BOY
+ Current non-debt liabilities - BOY
Net Monetary assets (liabilities) - BOY
x % change in GDP deflator
Monetary holding gain (loss)
FIFO profits
inventory book value - BOY
X % of inventory using FIFO
FIFO inventory
X % change in PPI
FIFO profits
Gross Cahs Flow
Net income after tax
+Depreciation and amortization
+ Interest expense
+ R&D expense
+ Rental expense
+ Monetary holding gain (loss)
+ FIFO profits
+ Pension expense (FASB 87)

+ Minority interest
+ Associate and JV income
+/- Special items (after tax)
Total inflation adjusted gross cash flow

11.3 CFROI Calcualtion for VODAFONE


Gross Cash Flow
Inflation adjusted depreciating assets
Inflation adjusted non-depreciating assets (FV)
Inflation adjusted gross investment (PV)
Inflation adjusted gross cash flow (pmt)
Project life (nper)
CFROI calculation [Excel Function = rate(

Metrics

Amount
1326
33617
0
0
34943

Source
Note 12
Note 12
Note 12
Calculated

tion Factor

Amount
34943
0
0
34943
Amount
8
1.068
19.60%
34943
2376
37319

Source
Note 12
Note 12
Note 12

Source
years
Inflation calculation
Calculated
Per above
Calculated

Inflation Factor table


Yeaar
5

10
Amount
1337
8.00
3.52%
9183

Source
Note 5
Calculated
External data

15

20
Inflation adjusted
R&D

80
119
173
176
219
767

Amount
1.068
3211
218.3
3429

Source
pr. Gross plant
Calculated
Calculated

Amount
37319
0
9183
767
3429
50698

Amount
9268
-14445
-5177
0
1.068
0
-5177
430
0
2096
-9
4275
1615
Amount
1615
50698
52313

Amount
34943
3211
38154
4528
8.4
2003
2004

8.6
8

Source
Calculated
Note 12
Note 5
Note 5
Calculated

Source
B/S, Note 15
B/S, Note 17
Note 12
per gross plant

B/S
B/S
Note 15
Note 32
Calculated

Source
Calculated
Calculated

Source
Calculated
Calculated
Calculated
Note 12

2005

Asset
Value
40748
9183

8.4
8.4

Life
8.4
8.4

767
50698

Implied
Depriciation
4851
1093

153
6098

8.31
8.30

Amount
11311
-12972

Source
B/S, Note 15
B/S, Note 17

-1661
2.20%
37

External data

Amount
458
100%
458
-2.50%
-11
Amount
-7540
19598
995
219
1337
37
-11
17

Source
B/S
B/S
Calculated
External Data

Source
I/S
Notes 5, 13
Note 7
Note 5
Note 5
Calculated
Calculated
Note 32

602
-2215
-293.1
12745

Amount
50698
1615
52313
12745
8.30
18.6%

I/S
I/S Notes 3, 10
Note 4 and I/S

flation Factor table


Inflation rate
1.00%
3.00%
5.00%
1.00%
3.00%
5.00%
1.00%
3.00%
5.00%
1.00%
3.00%
5.00%

Inflation factor
5.1%
15.9%
27.6%
10.5%
34.4%
62.9%
16.1%
55.8%
107.9%
22.0%
80.6%
165.3%

Consolidated Balance Sheet


As at 31 March 2005
31 March
2005
m

31 March
2004
m

83,464
18,398
20,250

93,622
18,083
22,275

19,398
852

21,226
1,049

122,112

133,980

430
2,096
5,602
816
2,850

458
1,380
5,521
4,381
1,409

11,794

13,149

(14,837)

(15,026)

(3,043)

(1,877)

Total assets less current liabilities

119,069

132,103

Creditors: amounts falling due after more than one year

(12,382)

(12,975)

(4,552)

(4,197)

102,135

114,931

4,286
52,284
98,927
(5,121)
629
(51,688)

4,280
52,154
98,927
(1,136)
713
(43,014)

99,317

111,924

1,965
853

2,132
875

102,135

114,931

Fixed assets
Intangible assets
Tangible assets
Investments
Investments in associated undertakings
Other Investments

Current assets
Stocks
Debtors: amounts falling due after more than one year
Debtors: amounts falling due within one year
Investments
Cash at bank and in hand

Creditors: amounts falling due within one year


Net current liabilities

Provisions for liabilities and charges

Capital and reserves


Called up share capital
Share premium account
Merger reserve
Own shares held
Other reserve
Profit and loss account
Total equity shareholders' funds
Equity minority interests
Non-equity minority interests