Professional Documents
Culture Documents
Shareholder Value
Present value
of Free Cash
Flows
Shareholder value based on value drivers: links SHV to operating,
investment and financing decisions
Shareholder
Value
If we assume that the net capital expenditures and working capital changes
are financed using a fixed mix of debt and equity. If d is the proportion
that is raised from debt financing,
•Non-cash ROE
(Net Income - After tax income from cash and marketable securities) / (Book
Value of Equity - Cash and Marketable Securities)
•better model to use for stable firms that pay out dividends that
are unsustainably high (because they exceed FCFE by a
significant amount) or are significantly lower than the FCFE
•if the firm is stable and pays outs its FCFE as dividend, the value
obtained from this model will be the same as the one obtained
from the Gordon growth model
Two – Stage FCFE Model
• Caveats
– the assumptions made to derive the free cashflow to
equity after the terminal year have to be consistent with
the assumption of stability. For instance, while capital
spending may be much greater than depreciation in the
initial high growth phase, the difference should narrow
as the firm enters its stable growth phase
– The beta and debt ratio may also need to be adjusted in
stable growth to reflect the fact that stable growth firms
tend to have average risk (betas closer to one)
Two – Stage FCFE Model
FCFE 3 Stage Model
• Caveats
– Since the model assumes that the growth rate goes
through three distinct phases -high growth, transitional
growth and stable growth - it is important that
assumptions about other variables are consistent with
these assumptions about growth
– As the growth characteristics of a firm change, so do its
risk characteristics. In the context of the CAPM, as the
growth rate declines, the beta of the firm can be
expected to change
FCFF
Firm Valuation
Assets
ROCE=Earning / CSE
= RNOA + (FLEV X SPREAD)
Interest expense and MI
Dell, Oracle,
Level 2 PM = OI / sales ATO = sales / NOA
HUL, GM,
MICROSOFT
Gross margin Expense Ratios Other OI / sales Individual asset and Borrowing cost
Ratio Ratios liability turnovers
drivers
• High margins and high turnovers : printing and publishing and chemicals
• Low turnovers and high margins : pipelines, shipping, utilities and communications
• High turnovers and low margins : food stores, apparels, retail stores
Key Drivers : Select Industries
Cellular phones Population covered and churn rates Sales and ATO
Commercial real estate Square footage and occupancy rates Sales and ATO
Retail Retail space and sales per square foot Sales and ATO