Question Shareholder Value Analysis (SVA) is one member of the family

Shareholder Value Analysis (SVA) is one member of the family of techniques for determining the market value of a firm based on the drivers of its projected cash flows. Other cash-based techniques include Cash Flow Return on Investment (CFROI) and Total Shareholder Return (TSR). SVA is superior to other techniques because valuations are derived from explicitly identified or postulated drivers of value in a strategic framework.

SVA starts with fundamental financial theory: the value of an asset is the net present value of its cash flows over the life of the asset. In SVA, the firm is the asset to be valued. One identifies or postulates the drivers of firm cash flows over the life of the firm and integrates the drivers into a model, which generates the estimated free cash flows on a year-by-year basis. Let’s look at the drivers of cash/value.

1. Sales growth rate: Everything else being constant, the higher the sales growth rate, the greater the projected cash flows.
2. Operating profit margin: The higher the profit margin (sales – cash operating expenses), the greater the cash flows.
3. Tax rate: The higher the tax rate, the lower the after tax net cash flow.
4. Working capital investment: Increased sales require greater investments in working capital (inventories, cash, receivables, offset by simultaneous financing provided by accounts payable and accruals), which decrease cash flows accordingly.
5. New fixed capital investment: An expansion (growth in sales) of the business requires a larger base of fixed capital investments, which will decrease cash flows. This is equivalent to total projected capital investment for the year less depreciation.
6. Competitive advantage period: In a perfectly competitive market there are no superior profits to be had, given that all firms must price at marginal cost if they want to make sales. However, by making use of technology, positioning oneself in emerging or high growth industries, through superior customer service/relationship management and by developing a differentiated or niche product, firms will be able to set prices above marginal costs. Firms strive to achieve competitive advantage and thus the flexibility to sell at higher prices and realize higher profit margins. The more a firm is able to exploit a competitive advantage and maintain it over time, the more successful it will be and the higher its cash flows. The competitive advantage period affects the estimate of the sales growth rate and the cash profit margin over time. For example, an analysis of Microsoft’s core competencies and its ability to develop and maintain competitive advantage over time could provide the basis estimation g at 20% per year for the next five years, 15% per year for years 6-10 and then leveling out after year 10. The cash profit margin would reflect the loss of superior competitive advantage over time accordingly, perhaps being estimated at 35% for years 1-5, 25% for years 6-10 and 10% after year 10. The greater the competitive advantage, the greater the cash flows and the calculated shareholder value.
7. Cost of capital: The cost of capital represents the expectations of stakeholders (stock and bondholders). When the firm earns more on its assets than expected/required by stakeholders, value is created for shareholders. The management actions taken by the firm have an effect on the firm’s cost of capital and, the lower the cost of capital, the greater the (net present) value of the firm. Management would be able to decrease the firm’s cost of capital and create shareholder value by financing the firm’s capital structure with the optimal proportion of debt and by identifying ways to decrease the systematic risk of the firm’s investments.

Model: Firm Value = PV free cash flows over the forecast period + residual value beyond the forecast period + firm’s marketable securities.

1. PV free cash flows over the forecast (competitive advantage) period = Base sales * sales growth * cash profit margin * after-tax cash income rate – new capital investment – incremental working capital investment to support increased sales, over the period that the company is projected to maintain a competitive advantage. Expected cash flows are calculated for each year of the forecast (competitive advantage) period and discounted by the cost of capital. In the Microsoft example above, the forecast (competitive advantage) period of cash flows would be years 1-5 and years 6-10.

2. Residual value after the forecast (competitive advantage) period has expired and the firm’s sales and earnings level out:

The residual value is the present value of cash flows after expiration of competitive advantage. After some period, the ability of the firm to earn profits greater than the normal economy-wide risk-adjusted return on capital may dissipate. For example, competitors may enter the market and provide work-alike or superior products, or patents might expire. Should this point be reached, no incremental capital investments or additional investments in working capital are required; only maintenance-level investments are required. The expected cash flows are the same each year after the competitive advantage period, or perpetuity. The present value of a perpetuity, you will recall, is just the expected cash flow divided by the discount rate/cost of capital for a no growth perpetuity, or by the cost of capital less the constant growth rate for a growth perpetuity.

Our website has a team of professional writers who can help you write any of your homework. They will write your papers from scratch. We also have a team of editors just to make sure all papers are of HIGH QUALITY & PLAGIARISM FREE. To make an Order you only need to click Ask A Question and we will direct you to our Order Page at WriteDemy. Then fill Our Order Form with all your assignment instructions. Select your deadline and pay for your paper. You will get it few hours before your set deadline.