McKinsey Valuation

Question 1

What is the formula for Value?

Answer 1

[NOPLAT(1-g/ROIC)]/[WACC-g]

Question 2

What is NOPLAT?

Answer 2

Net Operating Profit Less Adjusted Taxes

Question 3

What time period should NOPLAT be used for?

Answer 3

t=1

i.e. next year

Question 4

What is P/E?

Answer 4

Price over earnings:

Price investors will pay for $1 of earning

Question 5

P/E is roughly the same as NOPLAT, enjoying yourself?

Answer 5

Neither am I

Question 6

What can be said for growth and value regarding ROIC and WACC?

Answer 6

If ROIC>WACC growth creates value.

If ROIC=WACC, equilibrium exists.

Question 7

Is growth necessarily a good thing for the value of a company?

Answer 7

Not always, in some situations it can destroy value. It amplifies the affects of profit or loss. The greater the growth rate the greater the value gain/loss in the event of profitability or lack thereof

Question 8

What is the key to value creation from the McKinsey Formula?

Answer 8

The spread between ROIC and WACC.

Question 9

More and more people enter an industry, what happens to profitability typically?

Answer 9

It falls. Assuming that they entered because it was profitable the increased competition will reduce profitability,

Question 10

Where in financial statements do you find:
A) NOPLAT
B) Invested Capital
C) Historic Growth Rates

Answer 10

A) Income statements
B) Balance sheet (operating assets less Operating liabilities)
C) Comparative Income Statements

Question 11

In what 2 ways is ROIC computed?

Answer 11

1) NOPLAT/Invested cap

2) (1 - Tax Rate) x (price per unit - cost per unit)/Invested cap per unit

Question 12

Porter’s Five Forces are:

Answer 12

1) Bargaining Power of Suppliers
2) Bargaining Power of Buyers
3) Threat of New Entrants
4) Threat of Substitutes
5) Industry Rivalry

Question 13

Typically can estimate ROIC for a company/industry by analysing with Porters Five forces and common sense. Try this for Airlines and Pharmaceuticals

Answer 13

Airlines lots of people can enter, their suppliers have high bargaining power, easy for buyers to shop around therfore low ROIC. Conversely patents reduce the threat of new entrants for Pharma companies and therefore reduce the bargaining power of buyers.

Question 14

What 5 factors help create a price premium?

Answer 14

1) Innovative Products
2) Quality
3) Brand (apple/marlboro)
4) Lock In -> cost to shift off your product (i.e. everyone uses office so pain in the arse to switch)
5) Price Discipline -> Industry where someone sets the price and everyone follows (avoiding price competition)

Question 15

What are the 4 Cost and capital efficiency factors?

Answer 15

1) Innovative business process
2) Unique Resources
3) Economies of Scale (match the market)
4) Scalable Product or Process (google adds negligible cost with new customers)

Question 16

3 Sustainability of ROIC factors?

Answer 16

1) Length of Product Life Cycle (Patent gives high return over it’s life)
2) persistence of competitive advantage
3) Potential for product renewal (i.e. keep adding new products to keep return high

Question 17

What is Goodwill?

Answer 17

Goodwill is an accounting measure. If you take over another firm it rises.

Question 18

Mean reversion applies to profits of companies over time. What bias helps this trend?

Answer 18

Survivorship bias. Companies doing poorly revert to the mean or die therefore they seem like they all pick up from means.

Question 19

What is the main cause of growth? The second cause is what? What is the smallest cause?

Answer 19

Main: Performance of the industry (growing or in decline)
Second: Mergers and acquisitions
Small: Marketting

Question 20

What types of growth create the most/least value? (3)

Answer 20

1) most value = create new product/market or grow existing market
2) average value = grow market share (M&A)
3) least val = incremental inovations/product promotion and pricing (competitors can retaliate quickly) or huge acquisitions.

Question 21

What are the two key parts of the McKinsey Val formula (according to the lecture)?

Answer 21

ROIC and Growth

Question 22

Three key points about ROIC are:

Answer 22

1) Driven by competitive adv
2) Industry is important but not an exclusive determinant
3) ROIC may persist

Question 23

Three Key points about Growth are:

Answer 23

1) Driven by market growth
2) focus on $value per $additional revenue
3) sustaining growth is challenging