Fm10e ch13

• 1. Chapter 13- Managing for Shareholder Value 2005, Pearson Prentice Hall

2. Top Creators of Shareholder Value for 2001 ($ Millions)

• investedcost of

• MVAcapitalreturncapital

• Gen Elect 339,200 82,11120.0% 9.4%

• Microsoft 325,87226,34321.5%13.7%

• Wal - Mart 221,16665,67712.4%8.9%

• Intel 169,98041,3979.0%16.2%

• Citigroup 155,695104,21014.7%12.0%

3. Market Value Added

• MVA= Firm Value - Invested Capital

• Firm value= market value of the firms outstanding debt and equity securities.

• Invested Capital= the sum total of the funds that have been invested in the firm.

4. Value Creation

• The combination ofopportunityandexecution .

• Opportunities must be recognized.

• 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 firms P/E ratio is20 , then a dollar increase in earnings per share will create$20in 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 firms projected free cash flows for all future years.

7. Business Valuation: Free Cash Flow Valuation Model

• Value = the PV of the firms 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 operatingweighted averageinvested

• EVA t= profit after-cost ofx capitalt-1

• tax (NOPAT) t capital (k wacc )

11. Economic Value Added

• Net operatingweighted averageinvested

• EVA t= profit after-cost ofx capitalt-1

• tax (NOPAT) t capital (k wacc )

• alternative definition:

• Return onweighted averageinvested

• EVA t= invested-cost ofx capitalt-1

• capital (ROIC) t capital (k wacc )

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 Firms 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