14.10 Shareholder value analysis

Question 1

What is shareholder value analysis?

Answer 1

A management strategy focusing on the creation of economic value or wealth for shareholders.

Question 2

What two factors generally inform the value of a share?

Answer 2

1 The expected dividends to be earned

2 The expected returns from the share

Question 3

What are “value drivers”?

Answer 3

Factors that drive a business, which in return create value for the company.

Question 4

What are some examples of key financial value drivers?

Answer 4

• growth in sales
• improvement of profit margin
• investment in fixed assets or capital
• investment in working capital
• cost of capital
• tax rate

Question 5

Surplus profits are not always distributed to equity shareholders as dividends. What else might profit be used for?

Answer 5

• investments
• to retain flexibility in decision making (e.g. last minute investments
• to absorb losses during economic downturn

Question 6

How is “free cash flow” created?

Answer 6

Free cash flow = [net operating profit] - [tax and investment]

Question 7

How is shareholder investment analysis conducted?

Answer 7

1 Calculate free cash flow (FCF)
2 Calculate net present value (NPV)
3 Estimate value attributable for period beyond the planning horizon (aka the terminal period)

Question 8

What are the strengths of shareholder value analysis?

Answer 8

• no complex calculations
• uses universally accepted techniques
• focuses on value drivers and so it can inform managerial decisions
• can be used to benchmark against competition

Question 9

What are the weaknesses of shareholder value analysis?

Answer 9

• uses a fixed rate of cash flow over future years, whereas in reality cash flow will var
• value drivers are assumed to grow at a constant rate which is unlikely to be accurate