Principles of value creation
ROIC: return on capital invested
The amount of Capital invested
Economic profit:
spread
Formula :
Economic profit = (ROIC-WACC)*Invested Capital
Maximize economic profit over the years not ROIC
In case if new investments are made initially the economic profits may decline so one should
know how to do tradeoffs
Discounted cash flow: forecast the future cash flow of the company and discount it to the
present at the same opportunity cost of the capital.(WACC)
Difference between financial markets and real markets. Good performance in one does not
necessarily translates good performance in another.
In real markets your strategies are simple: choose activities or strategies that help to
increase present value of future cash flow or economic profits.
In financial markets management must deal with outside investors and analyst. To
raise money, company sells shares to investors who trade those shares in markets.
The activity of trading between investors and speculators sets a market price for
those shares. Each investor determines the value of the share and trades it on the
basis of whether the current price of the share is above or below the estimated
intrinsic value of the share.
Intrinsic value being the company’s ability to generate cash flow in the future.
That means investors pay for the performance that they expect the company would
achieve in future and not what they have achieved in past or not for the cost of
assets in the company.
The task as a manager is to increase the intrinsic value of the company and to properly
manage the expectation of financial markets.
If the company promises for high performance and cannot keep it then the price of the shares drops
when the market understand the companies real position and this it may take years to regain the
creditability.
Other hand if the share price of the company is low and market expectations is also too low in
relation to the opportunities company faces than this situation leads to hostile turnover.
Value is created by earning a ROIC > opportunity cost of capital.
Growth creates value ROC>cost of capital.
Select strategies that maximize the present value of the future cash flows or economic
profits.
Value of company’s share depends upon market’s expectation of company’s future
performance.
The returns that shareholders would earn depend upon the company’s future performance
as compared to actual performance.
ROIC: return on capital invested
The amount of Capital invested
Economic profit:
spread
Formula :
Economic profit = (ROIC-WACC)*Invested Capital
Maximize economic profit over the years not ROIC
In case if new investments are made initially the economic profits may decline so one should
know how to do tradeoffs
Discounted cash flow: forecast the future cash flow of the company and discount it to the
present at the same opportunity cost of the capital.(WACC)
Difference between financial markets and real markets. Good performance in one does not
necessarily translates good performance in another.
In real markets your strategies are simple: choose activities or strategies that help to
increase present value of future cash flow or economic profits.
In financial markets management must deal with outside investors and analyst. To
raise money, company sells shares to investors who trade those shares in markets.
The activity of trading between investors and speculators sets a market price for
those shares. Each investor determines the value of the share and trades it on the
basis of whether the current price of the share is above or below the estimated
intrinsic value of the share.
Intrinsic value being the company’s ability to generate cash flow in the future.
That means investors pay for the performance that they expect the company would
achieve in future and not what they have achieved in past or not for the cost of
assets in the company.
The task as a manager is to increase the intrinsic value of the company and to properly
manage the expectation of financial markets.
If the company promises for high performance and cannot keep it then the price of the shares drops
when the market understand the companies real position and this it may take years to regain the
creditability.
Other hand if the share price of the company is low and market expectations is also too low in
relation to the opportunities company faces than this situation leads to hostile turnover.
Value is created by earning a ROIC > opportunity cost of capital.
Growth creates value ROC>cost of capital.
Select strategies that maximize the present value of the future cash flows or economic
profits.
Value of company’s share depends upon market’s expectation of company’s future
performance.
The returns that shareholders would earn depend upon the company’s future performance
as compared to actual performance.
