Sales Figures And Exercise Data For 660SVA Fin ✓ Solved

Sheet1fin 660sva Exercisegiven 000base Sales250000base Yearfad

Sheet1fin 660sva Exercisegiven 000base Sales250000base Yearfad

Sheet1 FIN 660 SVA EXERCISE Given: ($ '000) Base sales: $250,000 Base year Fade rate Yr. 10 and after Note: Fade rate is the year-to-year reduction in the rate to some steady state rate Sales growth: 1.15 0.01 1.05 Year 1 = 1.14, year 2 = 1.13, etc. Operating PM 0.20 0.01 0.1 Fixed capital inv rate 0.15 Note: on a per $ of sales basis WC inv rate 0.09 Note: on a per $ of sales basis Cash tax rate 0.38 COC 0.11 Market securities $20,000 Debt $50,000 # shares outstanding 5,000,000 (all dollars in thousands) Year1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Residual Sales $285,000.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 Operating Profit $54,150.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 NOPAT $33,573.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 New Investment $5,250.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 Add'l WC $3,150.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 Free cash flow $25,173.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 PV to year 10 Pv after year .

Value years . Value after year 10 Market securities Total Value Less debt 3. Value of equity 4. Value of equity/share Sheet2 Sheet3 Shareholder Value Added Homework Shareholder Value Analysis Notes and Exercise 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.

  • Sales growth rate: Everything else being constant, the higher the sales growth rate, the greater the projected cash flows.
  • Operating profit margin: The higher the profit margin (sales - cash operating expenses), the greater the cash flows.
  • Tax rate: The higher the tax rate, the lower the after tax net cash flow.
  • 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.
  • 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.
  • Competitive advantage period: Firms can maintain superior profits by leveraging technology, market positioning, innovation, or niche focus, which allows them to set prices above marginal costs for a period. Extending this period increases cash flows.

The greater the competitive advantage, the higher the firm’s projected cash flows and valuation. As competitive advantages diminish, cash flows tend to stabilize at a normal industry level. The model incorporates these drivers to estimate a firm’s value by projecting free cash flows during the competitive advantage period, calculating residual value after this period, and adding marketable securities, then subtracting debt to arrive at equity value.

The valuation steps are as follows:

  1. Forecast cash flows during the competitive advantage period, incorporating growth rates, profit margins, investments, and taxes.
  2. Calculate the residual (perpetuity) value after the competitive advantage period, assuming cash flows stabilize.
  3. Add marketable securities, then subtract debt to determine equity value.

The model allows for strategic analysis, including tweaking driver assumptions to evaluate different scenarios. Comparing the calculated equity value with the current market value helps assess whether the firm is over- or undervalued, guiding management decisions on strategic initiatives to create shareholder wealth.

Sample Paper For Above instruction

The application of Shareholder Value Analysis (SVA) provides a strategic framework for evaluating a company's intrinsic value based on its projected cash flows, driven by key operational and financial parameters. Using the provided case data, this analysis aims to compute the present value (PV) of cash flows during the firm’s competitive advantage period, estimate the residual value post-advantage, determine the equity valuation under different market scenarios, and provide strategic recommendations accordingly.

Forecasting Cash Flows During the Competitive Advantage Period

The initial step involves projecting cash flows over the forecast horizon, which typically spans five to ten years, capturing the sustainable competitive advantage. The base year's sales are $250 million, with a growth rate of 15% in year 1 decreasing by 1% annually over ten years, reflecting a fading competitive advantage. Specifically, the sales growth rates for each year can be expressed as:

  • Year 1: 14%, Year 2: 13%, Year 3: 12%, Year 4: 11%, Year 5: 10%, Year 6: 9%, Year 7: 8%, Year 8: 7%, Year 9: 6%, Year 10: 5%.

The profit margin starts at 20%, fading at 1% annually, reaching 10% after year 10, where it stabilizes. The cash profit for each year is calculated as:

Cash Profit = Sales  Profit Margin  (1 - Tax Rate)

Assuming incremental investments in fixed capital and working capital are proportional to sales, they are computed as:

Fixed Capital Investment = Sales * Fixed Capital Inv Rate (15%)
Working Capital Investment = Sales * WC Inv Rate (9%)

Annual Free Cash Flows (FCF) are derived by subtracting the net capital expenditures (fixed and working capital investments) from after-tax operating profits:

FCF = Operating Profit * (1 - Tax Rate) - Capital Expenditures - Working Capital Changes

The outputs of these calculations are discounted at the firm’s weighted average cost of capital (WACC), assumed to be 11%, to find the PV of cash flows over the period.

Estimating Residual (Terminal) Value

After the forecast period, cash flows are expected to stabilize at a perpetual growth rate, usually aligned with industry growth or GDP, here specified as 5%. The residual value is calculated as:

Residual Value = (Year 10 Cash Flow * (1 + Growth Rate)) / (WACC - Growth Rate)

This value is then discounted back to present using the WACC.

Calculating Enterprise and Equity Values

The total firm value (enterprise value) is the sum of the present value of forecasted cash flows and the residual value, plus marketable securities ($20 million). To obtain equity value, the debt ($50 million) is subtracted from the enterprise value:

Equity Value = Firm Value - Debt

This process is executed under two scenarios, with share prices at $50 and $70, respectively. For each, the total market value of equity is computed by multiplying the number of shares (5 million) by the share price, then compared to the SVA-derived value for strategic decision-making.

Strategic Implications and Recommendations

The differences between the market value and the SVA suggest whether the stock is undervalued or overvalued, prompting management to consider strategic initiatives. If market prices are below intrinsic value, it indicates potential undervaluation and opportunities to enhance strategic positioning, optimize resource allocation, or extend competitive advantages. Conversely, overvaluation signals the need to reassess growth assumptions, investments, or market perceptions.

For instance, if the SVA indicates a substantial intrinsic value exceeding the current market price, top management might focus on strategies to sustain or extend the competitive advantage period, such as innovation, customer loyalty programs, or technology investments. Alternatively, if the market price surpasses intrinsic valuation, management should evaluate market expectations, potential overoptimism, or the need to deliver tangible value through strategic pivots.

In conclusion, the SVA framework provides a comprehensive, driver-based approach to valuation that informs strategic decision-making to maximize shareholder wealth. Accurate estimation of key drivers, coupled with disciplined strategic execution, can significantly enhance a firm's market valuation and long-term sustainability.

References

  • Rappaport, A. (1986). Creating Shareholder Value: The New Standard for Business Performance. Free Press.
  • Damodaran, A. (2012). Investment Valuation: Tools and Techniques for Determining the Value of Any Asset. Wiley.
  • Brealey, R. A., Myers, S. C., & Allen, F. (2014). Principles of Corporate Finance. McGraw-Hill Education.
  • Penman, S. H. (2010). Financial Statement Analysis and Security Valuation. McGraw-Hill Education.
  • Ross, S. A., Westerfield, R. W., & Jaffe, J. (2013). Corporate Finance. McGraw-Hill Education.
  • Fassnacht, G. (2013). Shareholder Value Management. Springer.
  • Kaplan, R. S., & Norton, D. P. (1992). The Balanced Scorecard—Measures that Drive Performance. Harvard Business Review.
  • Pratt, S. P. (2002). Valuing a Business: The Analysis and Appraisal of Closely Held Companies. McGraw-Hill.
  • Lambert, R. A. (2008). Strategic Business Valuation Methods. Wiley.
  • Copeland, T., Koller, T., & Murrin, J. (2000). Valuation: Measuring and Managing the Value of Companies. Wiley.

Related Assignments