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