Week 1

Question 1

Value is a particularly helpful measure of performance because

Answer 1

takes into account the long-term interests of all the stakeholders in a company, not just the shareholders

Question 2

why is value relevant to all shareholders

Answer 2

companies that maximize value for their shareholders in the LONG TERM also create more employment, treat their current and former employees better, give their customers more satisfaction, and shoul- der a greater burden of corporate responsibility than more shortsighted rivals.

Question 3

Benefits of long term perspective of value creation on the economy

Answer 3

more robust and build stronger economies, create more jobs, greater commitment to meeting their social responsibilities

• coporate social responsibility initiatives that companies take can help them create shareholder value

Question 4

value creation

Answer 4

companies create value by investing capital they raise from investors to generate future cash flows at rates of return exceeding the cost of capital i.e. operation generates higher return than cost of capital

Question 5

what drive value

Answer 5

combo of ROIC, growth relative to its cost of capital

Question 6

conservation of value

Answer 6

Anything that does not create cash flow does not create value unless it reduces the risk.

Question 7

example of conservation of value

Answer 7

• when a company substitutes debt for equity or issues debt to repurchase shares, it changes the ownership of claims to its cash flows. However, it doesn’t change the total available cash flows – value is conserved, not created
• changing accounting techniques will change the appearance of cash flows without actually changing the cash flows

Question 8

Why is creating sustainable value a long term endeavour

Answer 8

in the long term, competitive with drive down competitive adv and ROIC

Question 9

long term perspective of value creation

What must managers do?

Answer 9

managers must resist short- term pressure to take actions that create illusory value quickly at the expense of the real thing in the long term

Question 11

long-term perspective on value creation

what correlation is there

Answer 11

strong positive correlation between long-term shareholder returns and investments in R&D

• companies with the highest total returns to shareholders (TRS) also had the largest increases in employment.
• companies that earned the highest shareholder returns also invested the most in R&D.

Question 12

the amount of value a company creates is governed ultimately by

Answer 12

its ROIC, revenue growth, and of course its ability to sustain both over time.

Question 13

focusing too much on earnings or earnings growth often leads

Answer 13

leads companies to stray from a value-creating path.

Question 14

Disaggregating cash flow into ____

Cash flow increase may come from

Answer 14

revenue growth or investment reduction, or cost reduction

Question 15

Growth opportunity ‐‐ Additional value is created if

Answer 15

the company can invest in new projects earning above the cost of capital.

‘True’ growth stocks have access to such opportunities.

Investments that earn below cost of capital will destroy value, regardless of what happens to top‐line sales growth

Question 16

Cost of capital

Answer 16

a discount rate that reflects what investors expect to earn from investing in the company

Question 17

Growth =

Answer 17

Investment rate x ROIC

Question 18

Link between growth, ROIC and value creation

Answer 18

for all levels of growth, any increase in ROIC –> increase in value

but when ROIC is high, faster growth increases value

when ROIC is lower than company’s cost of capital , faster growth destroys value

ROIC = cost of capital neither increase or destroy value

Question 19

Should low ROIC companies strive for growth?

Argument

Counterargument

Answer 19

Argument: if a company grows, its ROIC will naturally in- crease. However, we find this is true only for young, start-up businesses.

Counterargument: Most often in mature companies, a low ROIC indicates a flawed business model or unattractive industry structure.

Question 20

If growth is a significant value driver, does getting bigger translate into creating value?

Answer 20

No. getting bigger does not translate into creating value. • Growth can harm value if the return on the growth is less than the cost of capital. Growth creates value if the return exceeds the cost of capital.

Question 21

Link between ROIC, growth and cash flow

Answer 21

Higher ROIC = higher cash flow because because it means the firm need not reinvest as much to maintain its growth and operating cash flow

Cash flow can be broken down into growth and ROIC

Question 22

What should high ROIC and low ROIC companies do

Answer 22

companies already earning a high ROIC can generate more additional value by increasing their growth rate, rather than their ROIC, while low-ROIC companies will generate relatively more value by focusing on increasing their ROIC.

i.e. high-ROIC companies should focus on growth, while low-ROIC companies should focus on improving returns before growing.

Question 23

If value is based on discounted cash flows, why should a company or investor analyse growth and ROIC?

Answer 23

Although the discounted cash flow gives an estimate of value, the sources of value creation are growth and increasing ROIC. This is because increases in cash flow can be broken into growth and ROIC

Question 24

when does growth destroy value

Answer 24

Growth destroys value when the ROIC on the new projects is less than the cost of capital.

Question 25

despite the resulting decline in average ROIC.

Answer 25

can still create value as long as the cost of capital was lower

Question 26

he companies that created the most value

second highest value creation

Answer 26

were those that grew fastest and maintained their high ROICs.

But the second-highest value creators were those that grew fastest even though they experienced moderate declines in their ROICs. They created more value than companies that increased their ROICs but grew slowly.

Question 27

companies with low returns pursue growth on the assump- tion that this will also improve their profit margins

BUT

Answer 27

Except for small start-up companies, faster growth rarely fixes a company’s ROIC problem. Low returns usually indicate a poor industry structure (e.g., airlines), a flawed business model, or weak execution. If a company has a problem with ROIC, the com-pany shouldn’t grow until the problem is fixed.

• The companies that had low growth but increased their ROICs outperformed the faster-growing companies that did not improve their ROICs.

Question 28

Value conservation principle and debt financing

Answer 28

substitution of debt for equity in and of itself; it only matters if the substitution changes the company’s cash flows through tax reductions (interest payment are tax deductible –> higher cash flow) or if associated changes in management decisions change cash flows (must have cash available to pay debt)

Question 29

value is driven by

Answer 29

This chapter showed that value is driven by expected cash flows discounted at a cost of capital. Cash flow, in turn, is driven by expected returns on invested capital and revenue growth. The corollary is that any management action that does not increase cash flow does not create value.

Question 30

Management implications of value of conservation

share repurchases

Answer 30

When a company buys back its shares, it does not increase total cash flows –> does not create value even though there is an increase in EPS

EPS increases because number of shares has declined. But at the same time debt increases b/c company borrows money to buyback its shares –> more volatile cash flows –> investors demand higher return –> P/E drops and offsets increase in EPS

Question 31

acquisitions create value only when

Answer 31

combined cash flows of the two companies increase due to cost reductions/savings, accelerated revenue growth, or better use of fixed and working capital i.e. synergy w

Question 32

cash

Question 33

cash flow risk

Answer 33

uncertainty about future cash flows

Question 34

ROIC

and formula

Answer 34

is the return the company earns on each dollar invested in the business:

NOPLAT/ invested capital

Question 35

invested capital

Answer 35

cumulative amount the business has in- vested in its core operations—primarily property, plant, and equipment and working capital.

Question 36

NOPLAT

Net operating profit less adjusted taxes

Answer 36

net operating profit - (tax rate x net operating profit)