Course 1 – Management Control

Lecture notes 3: Value-based management

Value-based Management
In essence, value-based management suggests that corporate management acts according to the
interest of equity holders, or more precisely, the market for equity. The ultimate objective, then, is to
maximize the firm’s market value. For instance, Roberts (2004) describes that

“[…] the purpose of the firm can be expressed as “value creation.” This is not an uncontroversial
position, either on prescriptive or descriptive grounds. Indeed, it should not even be
immediately clear what it means. The value created by economic activity is the difference
between the maximum that people would be willing to pay for it, less the opportunity costs of
the activity.”
(John Roberts, The Modern Firm, 2004)

Among the biggest advocates for value-based management, was Bennett Stewart III in the 1990s:

“It is easy to forget why senior management‘s most important job must be to maximize its
firm’s current market value. If nothing else, a greater value rewards the shareholders who,
after all, are the owners of the enterprise. But, and this really is much more important, society
at large benefits too.

A quest for value directs scarce resources to the most promising uses and most productive
users. The more effectively resources are deployed and managed, the more robust economic
growth and the rate of improvement in our standard of living will be.”
(G. Bennett Stewart III, The Quest for Value, 1991)

In this course, we will focus on two main concepts of value-based management:

• Discounted cash flow analysis.

The basic idea is that a firm’s current value is captured by the future cash flows a firm can
generate. By discounting we acknowledge (i) individuals’ time preferences, as well as, (ii) the
uncertainty of the future, thus only expected cash flows. Specifically, the discount rate reflects
the cost of capital employed and should capture the opportunity costs of the investment and
the risk of future results. Consequently, discounted cash flow analysis compares expected cash
flows with the costs of capital by discounting.
• Residual income.
Management accountants measure residual income by periodically comparing income with
the cost of capital necessary to generate this income, that is, income less the cost of capital. If
the difference is positive, the firm created value. Importantly, cost of capital does not only
include the cost of debt, but also a compensation for equity, at a rate customary in the market
(including a risk premium).
In practice, consulting firms have developed their own measures of residual income. For
instance, Stern Stewart & Co developed and market the Economic Value Added (EVA), Boston
Consulting Group the Cash Value Added (CVA), McKinsey the Economic Profit (EP) concept, and
Arthur Andersen the Shareholder Value Added (SVA). Primarily, those measures differ in the
specific adjustment of the income measure.

More specifically, among the discounted cash flow methods we, first, investigate the shareholder
value (SV) where free cash flows are discounted with the firms weighted average cost of capital
(WACC) in order to determine a firm’s market value. Second, we discuss the Economic Value Added

Course 1 – Management Control: Value-based management 1

(EVA), a practical refinement of the concept of residual income, which measures value creation for a
given period. Figure 1 depicts the two methods discussed in this course.

SV Method EVA

free cash NOPAT

flow Profit measure
cost of capital cost of capital
Reference measure (WACC)
(WACC)
multi-period Observation period single period

valuation of companies Purpose performance measure

Figure 1. Shareholder value versus Economic Value Added, based on https://www.controlling-

wiki.com/de/index.php/Value_Based_Management_(VBM)

1. Shareholder value
The shareholder value (SV) is a discounted cash flow method to calculate a firm’s value. In this course,
we specifically consider the future free cash flow as defined in the next subsection.

1.1. Free cash flow

The free cash flow (FCF) is the cash a firm generates from operations after accounting for all capital
expenditures, such as buildings or PPE. The excess cash can be used to expand operations, make
acquisitions, pay dividends or reduce debt. We adjust the cash flow from operations and investing (see
Lecture notes 1) by adding back interest paid on borrowed capital in order to eliminate any distortions
caused by the firm’s capital structure. In that way, we derive the FCF that would have been realized if
the firm was completely equity financed. However, in that (theoretical) case, a firm would not have to
pay any interests on borrowed capital, which increases earnings. Those additional earnings are taxable.
Hence, we subtract these (theoretical) taxes by a tax shield, as indicated in Table 1. See Appendix A
for a reminder on how to determine the cash flows based on information from the Income Statement
and Balance Sheet.

CF I: Cash flow from operations

+ CF II: Cash flow from investing
+ interest on borrowed capital
- tax shield (= interest on borrowed capital * tax rate)
Free cash flow (FCF)
Table 1. Free cash flow

Hence, the FCF is not influenced by interest paid to creditors, and repayments of debt or taking out
new loans. Adding back interests on borrowed capital and the tax shield eliminate tax distortions
caused by a firm’s capital structure.1

1.2. Discount rate – WACC

To discount future FCF we use the firm’s weighted average cost of capital (WACC).

The WACC represents the rate that a firm is expected to pay on average to all its equity and debt
holders. Importantly, the “weighting” results from the market, that is, we consider the market value

of equity and debt. Thus, usually, the weighting will not equal the equity and debt ratios derived from
the firm’s books.

1
Interests on borrowed capital reduce a firm’s profit, in contrast to dividends provided to equity holders.
Consequently, a firm financed completely by debt would pay less tax than a firm financed by equity.

Course 1 – Management Control: Value-based management 2

 Weighted average cost of capital

𝐸𝑀 𝐷𝑀
WACC = 𝑟𝐸 * + 𝑟𝐷 ∗ ∗ (1 − 𝑡)
𝐸𝑀 + 𝐷 𝑀 𝐸𝑀 + 𝐷 𝑀

𝑟𝐸 … cost of equity rate

𝑟𝐷 … cost of debt rate
𝐸 𝑀 … market value of equity
𝐷𝑀 … market value of debt
𝑡 … tax rate

In the formula above, the last term captures a firm’s savings in taxes as a result of tax-deductible
interest payments. Every Euro spent on interests reduces the firm’s taxes by 𝑡 cents. Hence, only the
share of (1 − 𝑡) is considered as cost of capital.

The cost of debt 𝑟𝐷 is the average of the effective rates of interest for borrowed capital. In order to
determine the cost of equity, we employ the capital asset pricing model (CAPM) which assumes a
linear relation between risk and the investors’ demand for return.
Capital asset pricing model

𝑟𝐸 = 𝑟𝑓 + (𝑟𝑚 − 𝑟𝑓 ) ∗ 𝛽

𝑟𝐸 … cost of equity
𝑟𝑓 … risk-free rate of interest
𝑟𝑚 … (expected) market return
𝛽 … beta (the sensitivity of the expected asset returns to the expected market returns)2

Be aware that the WACC formula entails a circularity problem relevant for both, theory and
calculations in practice. To calculate equity at market value, we might consider the firm’s SV minus
debt. However, in order to calculate the SV we already need the WACC for discounting. In this course,
we either use approximated values or the firm’s (market-valued) leverage is predetermined.

1.3. Terminal value

In practice, the SV is calculated using projected data for a specific planning horizon, typically, three to
ten years. All FCFs after that planning horizon (where we can access detailed data), are captured by
the terminal value (TV). To be able to calculate the terminal value we have to make very restrictive
assumptions about the development of a firm’s future cash flows3:

• For instance, assume that the free cash flows after the planning horizon are constant, i.e.,
𝐹𝐶𝐹𝑡 = 𝐹𝐶𝐹𝑇+1 for all 𝑡 ≥ 𝑇 + 1, where 𝑇 indicates the ending of the planning horizon.
Terminal value, constant FCFs

∞
𝐹𝐶𝐹𝑇+1
𝑇𝑉𝑇 = ∑ 𝐹𝐶𝐹𝑡 ⋅ (1 + 𝑊𝐴𝐶𝐶)−(𝑡−𝑇) =
𝑊𝐴𝐶𝐶
𝑡=𝑇+1

𝑇𝑉𝑇 … terminal value (measured at the ending of the planning horizon 𝑇)

𝐹𝐶𝐹𝑇+1 … free cash flow of the first period after the planning horizon
𝑊𝐴𝐶𝐶 … weighted average cost of capital

2 𝐶𝑜𝑣(𝑟 𝐸 ,𝑟𝑚 )
Formally, 𝛽 = .
𝑉𝑎𝑟(𝑟𝑚 )
3
The derivations of the terminal values are provided in a technical appendix at the end of this lecture note. The
proofs are not relevant for examination.

Course 1 – Management Control: Value-based management 3

• Alternatively, we might assume constant growth of the free cash flows (known as the perpetuity
growth model), that is, 𝐹𝐶𝐹𝑡 = 𝐹𝐶𝐹𝑇+1 ⋅ (1 + 𝑔)𝑡−(𝑇+1) for all 𝑡 ≥ 𝑇 + 1, where 𝑔 is the constant
growth rate. Additionally, we assume that 𝑊𝐴𝐶𝐶 > 𝑔, because otherwise the terminal value
would be infinite.

Terminal value, perpetuity growth model

∞ ∞
−(𝑡−𝑇)
𝐹𝐶𝐹𝑇+1
𝑇𝑉𝑇 = ∑ 𝐹𝐶𝐹𝑡 ⋅ (1 + 𝑊𝐴𝐶𝐶) = ∑ 𝐹𝐶𝐹𝑇+1 ⋅ (1 + 𝑔)𝑡−𝑇−1 (1 + 𝑊𝐴𝐶𝐶)−(𝑡−𝑇) =
𝑊𝐴𝐶𝐶 − 𝑔
𝑡=𝑇+1 𝑡=𝑇+1

𝑇𝑉𝑇 … terminal value (measured at the ending of the planning horizon 𝑇)

𝐹𝐶𝐹𝑇+1 … free cash flow of the first period after the planning horizon
𝑊𝐴𝐶𝐶 … weighted average cost of capital
𝑔 … growth rate of the FCFs

Note that, in both cases, we additionally assume that the WACC remains constant over time.

1.4. Calculating the shareholder value

Finally, the firm’s total market value is calculated according to the discounted cash flow method.
Firm’s valuation

𝑇
𝐹𝐶𝐹𝑡 𝑇𝑉𝑇
𝑀𝑉 = ∑ +
(1 + 𝑊𝐴𝐶𝐶)𝑡 (1 + 𝑊𝐴𝐶𝐶)𝑇
𝑡=1

𝑀𝑉 … firm’s market value

𝑊𝐴𝐶𝐶 … weighted average cost of capital
𝑇𝑉𝑇 … terminal value (measured at the ending of the planning horizon 𝑇)

In order to calculate the value of equity, and thus, the shareholder value, we have to subtract the
market value of debt.
Shareholder value

𝑀
𝐸 𝑀 = 𝑀𝑉 − 𝐷

𝐸 𝑀 … market value of equity

𝑀𝑉 … firm’s market value
𝐷𝑀 … market value of debt

Course 1 – Management Control: Value-based management 4

 2. Economic Value Added (EVA4)
The performance measure EVA describes the value remaining after all claims of a firm’s capital
providers have been satisfied. If managerial compensation is linked to EVA, managers have the
incentive to focus their activity on value-creating operations.

The basic structure of calculating the EVA is depicted in Table 2. The income measure is the operating
profit after taxes, but before interest payments. Financing costs are considered as invested capital (net
operating assets) multiplied with the cost of capital (WACC). However, the EVA calculation requires
certain adjustments of the income and assets.

Revenues
- operating expenses
EBIT (Earnings before interest and tax)
- taxes
NOPAT (Net operating profit after tax)
- capital charges (invested capital * cost of capital)
EVA
Table 2. Basic structure of EVA calculation

2.1. Accounting Adjustments

Stern Stewart & Co propose 164 conversions to transform the so-called “accounting model”, with
information from financial accounting, which aims particularly towards creditors, to the “economic
model” which reflects the investors’/shareholders’ point of view. Those conversions can be structured
into four categories: (i) shareholder conversions, (ii) operating conversions, (iii) funding conversions,
and (iv) tax conversions. (e.g., Young & O’Byrne, 2001, chapter 6)

As discussing all the conversion proposed by Stern Stewart & Co is beyond the scope of this course, we
will only consider some (prominent) examples. We adjust the total assets from the balance sheet in
order to derive the net operating assets (NOA). For the income measure we adjust the EBIT to end up
with the net operating profit after taxes (NOPAT).

Shareholder conversions
One very essential EVA conversion is the capitalization (Aktivierung) of expenses with investment
character. Those expenses reduce income in the financial statements of this period although we can
anticipate (positive) effects in future periods. Typical examples, in practice, can be:

• R&D expenses
• Advertising and brand building
• Costs for training of employees
• Market development costs (e.g., market research)

If those expenses are considered to have long-term value, we capitalize (add) the expenses in the NOA
and only subtract the accumulated depreciation. For the NOPAT, we add back the expenses from the
income statement (from the year the expenses were realized) and subtract this periods depreciation
of the capitalized investment. Importantly, per definition, the EVA assumes that all investment
expenses take place on 1/1, so that we have to account for full-year depreciation already in the first
year.

Adjustment NOA Adjustment NOPAT

+ capitalized expenses + expenses from the income statement
- accumulated depreciation - depreciation of capitalized expenses

4
EVA is a registered trademark of Stern Stewart & Co.

Course 1 – Management Control: Value-based management 5

Operating conversions
In a first step, we want to eliminate capitalized non-operating assets from the balance sheet. Those
are assets that are not necessary for the firm’s operations. Specifically, we consider three items:

• Short-term securities in the current assets. Typically, marketable securities are not considered
necessary for operation. Consequently, we eliminate this position form the NOA. However, in
practice, it can be difficult to assess whether there is operational use for short-term securities,
especially from an external view.
• Plants under construction. As long as plants under construction cannot be used for operations
we eliminate this account from the NOA.
• Other non-operating assets. Other non-operating assets, as, for example, buildings rented
out, are eliminated from the NOA. Income generated by these assets are subtracted from the
NOPAT.

Adjustment NOA Adjustment NOPAT

- marketable securities (not necessary for operation) none

- plants under construction none

- other non-operating assets - income from other non-operating assets

Gains from the disposal of fixed assets are not considered as operating profit. Hence, we eliminate
them from the NOPAT.

Adjustment NOA Adjustment NOPAT

none - gains from the disposal of fixed assets

Funding Conversions
In principle, we can assume that trade payables are not free of interest; prices for materials and
services include some portion of interest expenses if they are not paid immediately. Consequently, the
NOPAT includes some financing costs. The EVA, however, wants to present an operating profit in
absence of any financing costs. As it would be very complicated to eliminate the (fictitious) interest
component from all expenses in the NOPAT, we employ a practical approach and eliminate non-
interest-bearing current liabilities from the NOA, instead.

Adjustment NOA Adjustment NOPAT

- trade payables none

- prepaid income none

- other non-interest-bearing short-term liabilities none

and provisions

Tax Conversions
Cash operating taxes (COT) are hypothetical taxes a firm would have to pay for its operating profit if
the firm was completely equity financed. To calculate the COT we can adjust the taxes from the income

Course 1 – Management Control: Value-based management 6

statement. Note that we do not expect you to be able to determine COT in this course, but to be aware
about the general concept. If you are interested in more details about COT, see Hostettler (2000).

2.2. Summary of conversions

The NOA represents the invested capital necessary to generate the NOPAT. Table 3 provides the
structure of calculating the NOA.

Total assets (from balance sheet)

+ capitalized expenses with investment character
- accumulated depreciation of capitalized expenses with investment character
- marketable securities (not necessary for operation)
- plants under construction
- other non-operating assets
- non-interest-bearing short-term liabilities and provisions
= Net operating assets (NOA)
3. Table 3. Calculation of the NOA

In total, the NOPAT should reflect a firm’s operating profits after taxes, but before the cost of financing.
Table 4 summarizes the calculation of the NOPAT.

EBIT
+ expenses with investment character
- depreciation of capitalized expenses with investment character
- income from other non-operating assets
- gains from the disposal of fixed assets
- cash operating taxes (COT)
= Net operating profit after taxes (NOPAT)
Table 4. Calculation of the NOPAT

2.3 Calculating EVA

To derive the EVA, we now deduct capital costs from the income measure NOPAT. When we calculate
the EVA we typically consider the invested capital at the beginning of the period. Hence, to derive the
EVA in period 𝑡, we have to look at the NOA of period 𝒕 − 𝟏 (which reflects the assets in the beginning
of period 𝑡).

Capital charge formula

𝐸𝑉𝐴𝑡 = 𝑁𝑂𝑃𝐴𝑇𝑡 − 𝑊𝐴𝐶𝐶 ⋅ 𝑁𝑂𝐴𝑡−1

𝐸𝑉𝐴𝑡 … Economic Value Added of period 𝑡

𝑁𝑂𝑃𝐴𝑇𝑡 … net operating profit after taxes
𝑊𝐴𝐶𝐶 … weighted average cost of capital
𝑁𝑂𝐴𝑡−1 … net operating assets at the end of period 𝑡 − 1, i.e., at the beginning of period 𝑡

However, by introducing another ratio, the return on net assets (RONA), we can formulate an
alternative to calculate the EVA, via the so-called value spread. Specifically, we determine the spread
between the return on net assets and the WACC in period 𝑡, and multiply it with the invested capital
𝑁𝑂𝐴𝑡 . Find the derivation below.
Value spread formula

Course 1 – Management Control: Value-based management 7

 𝑁𝑂𝑃𝐴𝑇𝑡
𝑅𝑂𝑁𝐴𝑡 =
𝑁𝑂𝐴𝑡−1

Dividing the capital charge formula by the assets yields

𝐸𝑉𝐴𝑡 𝑁𝑂𝑃𝐴𝑇𝑡 𝑊𝐴𝐶𝐶 ⋅ 𝑁𝑂𝐴𝑡−1

= −
𝑁𝑂𝐴𝑡−1 𝑁𝑂𝐴𝑡−1 𝑁𝑂𝐴𝑡−1

Thus,
𝐸𝑉𝐴𝑡
= 𝑅𝑂𝑁𝐴𝑡 − 𝑊𝐴𝐶𝐶.
𝑁𝑂𝐴𝑡−1

Re-arranging yields the value spread formula:

𝐸𝑉𝐴𝑡 = (𝑅𝑂𝑁𝐴𝑡 − 𝑊𝐴𝐶𝐶) ⋅ 𝑁𝑂𝐴𝑡−1 .

𝑅𝑂𝑁𝐴𝑡 … return on net assets of period 𝑡

𝑁𝑂𝑃𝐴𝑇𝑡 … net operating profit after taxes
𝑁𝑂𝐴𝑡−1 … net operating assets at the end of period 𝑡 − 1, i.e., at the beginning of period 𝑡
𝐸𝑉𝐴𝑡 … Economic Value Added of period 𝑡
𝑊𝐴𝐶𝐶 … weighted average cost of capital

This representation of the EVA shows us different strategies to increase the EVA:

• Increase return on existing assets (while keeping the assets and the WACC constant)
• Invest in projects that generate a return higher than the WACC
• Reduce the WACC

3.1. Market Value Added

One extension of the EVA is the multi-period performance measure market value added (MVA), which
is the sum of future discounted EVAs.
Market value added

∞
𝐸𝑉𝐴𝑘
𝑀𝑉𝐴𝑡 = ∑
(1 + 𝑊𝐴𝐶𝐶)𝑘
𝑘=𝑡

𝑀𝑉𝐴𝑡 … Market Value Added at period 𝑡

𝐸𝑉𝐴𝑘 … Economic Value Added in period 𝑡
𝑊𝐴𝐶𝐶 … weighted average cost of capital

Adding the assets in place we can derive the (theoretical) market value in period 𝑡.
Market value

𝑀𝑉𝑡 = 𝑀𝑉𝐴𝑡 + 𝑁𝑂𝐴𝑡

𝑀𝑉𝑡 … Market Value at period 𝑡

𝑀𝑉𝐴𝑡 … Market Value Added at period 𝑡
𝑁𝑂𝐴𝑡 … net operating assets at the end of period t

Be aware that the real valuation on the market (e.g., on the stock exchange) will typically deviate from
the market value 𝑀𝑉𝑡 calculated with the EVA concept.

Course 1 – Management Control: Value-based management 8

 References
Hostettler, S. (2000). Economic Value Added (EVA) – Darstellung und Anwendung auf Schweizer
Aktiengesellschaft. Haupt.
Roberts, J. (2004). The Modern Firm: Organizational Design for Performance and Growth. Oxford
University Press.
Stewart III, G.B. (1991). The Quest for Value. HarperCollins.
Young, S.D. and O’Byrne S.F. (2001). EVA and Value-Based Management: A Practical Guide to
Implementation. McGraw Hill.

Course 1 – Management Control: Value-based management 9

Appendix A
Cash Flow Statement
The cash flow statement displays changes in cash and cash equivalents.

In general, we distinguish between the direct and indirect method to determine the cash flow
statement (or budget, see session 4). The direct method displays all gross cash receipts and gross cash
payments. The indirect method starts with the net income from the income statement and adjusts for
all non-cash transactions, that is, we add back (subtract) non-cash expenses (income) and add
(subtract) all cash inflow (outflows) that are not captured in the income (expenses).

In accordance with the representation of the cash flow statement proposed by IFRS, we structure the
cash flow statement in operating, investing, and financing activities, as indicated in Table 5, employing
the indirect method.

Net income
+ / - depreciation/write-ups
- / + gains/losses on disposal of fixed-assets
+ / - increase/decrease in long-term provisions
= cash earnings
- / + increases/decreases in inventories
- / + increases/decreases in receivables
- / + increases/decreases in other assets (if attributable to operations)
- / + increases/decreases prepaid expenses
+ / - increases/decreases in short-term provisions
+ / - increases/decreases in trade payables
+ / - increases/decreases in other liabilities (if attributable to operations)
+ / - increases/decreases prepaid income
CF I: Cash flow from operations

- investments in long-term assets (or other non-cash equivalents)

- own work capitalized
+ book value of disposed fixed-assets
+ / - gains/losses on disposal of fixed-assets
CF II: cash flow from investing

+ / - payment/pay-out of equity
- dividends paid to shareholder
+ / - cash-in/cash-out from loans
CF III: Cash flow from financing
CF I + CF II + CF III = Change in cash & cash equivalents
Table 5. Cash flow statement, indirect method

Course 1 – Management Control: Value-based management 10

Appendix B (NOT relevant for examination)
Calculation of terminal values
Constant FCFs:
In a first step, we exploit that FCFs are constant.
∞ ∞ 𝑡−𝑇 ∞
𝐹𝐶𝐹𝑡 𝐹𝐶𝐹𝑇+1 1
𝑇𝑉𝑇 = ∑ = ∑ = 𝐹𝐶𝐹𝑇+1 ∑ ( )
(1 + 𝑊𝐴𝐶𝐶)𝑡−𝑇 (1 + 𝑊𝐴𝐶𝐶)𝑡−𝑇 1 + 𝑊𝐴𝐶𝐶
𝑡=𝑇+1 𝑡=𝑇+1 𝑡=𝑇+1
∞ 𝑡 ∞ 0 𝑡
1 1 1
= 𝐹𝐶𝐹𝑇+1 ∑ ( ) = 𝐹𝐶𝐹𝑇+1 ⋅ [(∑ ( ) )−( ) ]
1 + 𝑊𝐴𝐶𝐶 1 + 𝑊𝐴𝐶𝐶 1 + 𝑊𝐴𝐶𝐶
𝑡=1 𝑡=0
∞ 𝑡
1
= 𝐹𝐶𝐹𝑇+1 ⋅ [(∑ ( ) ) − 1]
1 + 𝑊𝐴𝐶𝐶
𝑡=0
1
Now we use the formula for geometric series, ∑∞ 𝑘
𝑘=0 𝑟 = for all |𝑟| < 1.
1−𝑟
1
Thus, with 𝑊𝐴𝐶𝐶 > 0, so that < 1, we find
1+𝑊𝐴𝐶𝐶

1 1 1 + 𝑊𝐴𝐶𝐶
𝑇𝑉𝑇 = 𝐹𝐶𝐹𝑇+1 ⋅ [ − 1] = 𝐹𝐶𝐹𝑇+1 ⋅ [ − 1] = 𝐹𝐶𝐹𝑇+1 ⋅ [ − 1]
1 1 + 𝑊𝐴𝐶𝐶 − 1 𝑊𝐴𝐶𝐶
1−
1 + 𝑊𝐴𝐶𝐶 1 + 𝑊𝐴𝐶𝐶
1 𝐹𝐶𝐹𝑇+1
= 𝐹𝐶𝐹𝑇+1 ⋅ [ + 1 − 1] = .
𝑊𝐴𝐶𝐶 𝑊𝐴𝐶𝐶

Constant growth of FCFs:

∞ ∞ 𝑡−𝑇 ∞
𝐹𝐶𝐹𝑡 𝐹𝐶𝐹𝑇+1 (1 + 𝑔)𝑡−(𝑇+1) 1+𝑔
𝑇𝑉𝑇 = ∑ 𝑡−𝑇
= ∑ 𝑡−𝑇
= 𝐹𝐶𝐹𝑇+1 ∑ ( ) ⋅ (1 + 𝑔)−1
(1 + 𝑊𝐴𝐶𝐶) (1 + 𝑊𝐴𝐶𝐶) 1 + 𝑊𝐴𝐶𝐶
𝑡=𝑇+1 𝑡=𝑇+1 𝑡=𝑇+1
∞ 𝑡 ∞ 𝑡
𝐹𝐶𝐹𝑇+1 1+𝑔 𝐹𝐶𝐹𝑇+1 1+𝑔
= ∑( ) = ⋅ [(∑ ( ) ) − 1]
1+𝑔 1 + 𝑊𝐴𝐶𝐶 1+𝑔 1 + 𝑊𝐴𝐶𝐶
𝑡=1 𝑡=0
1+𝑔
Thus, with the formula for geometric series, and the assumption 𝑊𝐴𝐶𝐶 > 𝑔, so that < 1, we find
1+𝑊𝐴𝐶𝐶

𝐹𝐶𝐹𝑇+1 1 𝐹𝐶𝐹𝑇+1 1
𝑇𝑉𝑇 = ⋅[ − 1] = ⋅[ − 1]
1+𝑔 1+𝑔 1+𝑔 1 + 𝑊𝐴𝐶𝐶 − 1 − 𝑔
1−
1 + 𝑊𝐴𝐶𝐶 1 + 𝑊𝐴𝐶𝐶
𝐹𝐶𝐹𝑇+1 1 + 𝑊𝐴𝐶𝐶 𝐹𝐶𝐹𝑇+1 1 + 𝑊𝐴𝐶𝐶 − 𝑊𝐴𝐶𝐶 + 𝑔 𝐹𝐶𝐹𝑇+1 1+𝑔
= ⋅[ − 1] = ⋅[ ]= ⋅
1+𝑔 𝑊𝐴𝐶𝐶 − 𝑔 1+𝑔 𝑊𝐴𝐶𝐶 − 𝑔 1 + 𝑔 𝑊𝐴𝐶𝐶 − 𝑔
𝐹𝐶𝐹𝑇+1
= .
𝑊𝐴𝐶𝐶 − 𝑔

Course 1 – Management Control: Value-based management 11