IE 5325 Advanced Economic Analysis

1
IE 5325Advanced Economic Analysis

• Week 15
• Managing for
• Shareholder Value

2
Long-TermShareholder Value

• Cash-flow approach (future)
• Periodic review of strategies as they affect
  investment, finance, and operations
• Return on new investments exceeds the cost of
  capital
• Existing assets generate cash flows that meet or
  exceed expectations

3
Impact of Decisionson Shareholders
Positive Cash Flows for Dividends and Growth

• Investment
• Facilities, new products, WC
• Operations
• Price/volume/cost tradeoffs, efficiency
• Financing
• Cost of capital

Negative Cash Flows
4
Performance Measures

• Historic
• Profit margin ()
• 1980s
• Total profits (profit growth)
• 1990s
• Return on assets ()
• Emerging
• Shareholder value (EVA, CFROI)

5
Emerging Methods

• Cash flow based
• Free cash flow generated by company
• Net cash flow generated by investments
• Cost of capital considered
• A business is an economic system that should be
  judged over a reasonable period of time

6
Two Measures

• Economic Value Added (EVA)
• NOPAT (adjusted)
• Net Assets (capital employed)
• Cost of capital
• Cash Flow Return on Investment (CFROI)
• Net assets (capital employed)
• Operating cash flows
• Residual values

7
Value Through Restructuring

• Company performing poorly compared to peers
• Outdated business strategies and practices
• Disposal of business components that no longer
  fit, or redundant assets
• Reduce debt (interest expense)
• Special dividend to shareholders
• Share buyback
• Expand core business

8
Value Through Combinations

• Much recent activity has created huge companies
• AOL/Time-Warner
• Daimler-Chrysler
• Exxon-Mobil
• Few combinations have provided increased
  shareholder value
• Complications and premiums paid have outweighed
  synergies

9
Potential Combination
10
After Acquisition
11
Combinations

• Advantages
• Eliminate duplicate functions
• Consolidate marketing/sales/admin.
• Critical mass needed to succeed
• Disadvantages
• Difficulties in combining companies
• Premium paid for acquisition
• Results slow in coming

12
Things that affect value

• Perspective (viewpoint)
• Expectations (yield)
• Time period (planning horizon)
• Cash flow patterns (future)
• Ongoing values (residual)
• Comparables (value of peers)

13
Major Themes

• Five major themes of this course

14
Business System

• A business is an ever-evolving system of

Economic Decisions
Investments
Financing
Operations
15
Management Decisions

• Management is a sequence of (largely economic)
  decisions in the areas of
• Investment
• Operations
• Financing

16
Accounting vs. Economic Analysis

• Accounting
• Past and current values
• Costs, sales
• Profit/loss/taxes
• Economic
• Current and future values
• Cash flow analysis
• Trade-offs (cost/benefit, risk/reward))

17
Analysis Viewpoints

• Manager
• Owner/Investor/Shareholder
• Lender/Creditor
• Different analysis for different viewpoints

18
Creating Shareholder Value
Prudent Funding Options
Sound Resource Decisions
Shareholder Value
Operate Resources Cost Effectively, Competitively
19
Shareholder Value

• Managements goal is to maximize the economic
  value to the shareholders
• Long term, sustainable
• Based on future expectations
• Requires cash-flow analysis
• Involves estimates, forecasts, judgment