Valuation measuring and managing the value of companies, 6 edition, university edition

The Wiley Finance series contains books written specifically for finance and investment professionals as well as sophisticated individual investors and their financial advisors Book topics range from portfolio management to e-commerce, risk management, financial engineering, valuation and financial instrument analysis, as well as much more For a list of available titles, visit our Web site at www.WileyFinance.com Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States With offices in North America, Europe, Australia and Asia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers' professional and personal knowledge and understanding VALUATION MEASURING AND MANAGING THE VALUE OF COMPANIES SIXTH EDITION McKinsey & Company Tim Koller Marc Goedhart David Wessels Cover image: ©iStock.com/alzajac Cover design: Wiley Copyright © 1990, 1994, 2000, 2005, 2010, 2015 by McKinsey & Company All rights reserved Published by John Wiley & Sons, Inc., Hoboken, New Jersey Published simultaneously in Canada No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at www.wiley.com//permissions Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose No warranty may be created or extended by sales representatives or written sales materials The advice and strategies contained herein may not be suitable for your situation Y ou should consult with a professional where appropriate Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 5724002 Wiley publishes in a variety of print and electronic formats and by print-on-demand Some material included with standard print versions of this book may not be included in e-books or in print-on-demand If this book refers to media such as a CD or DVD that is not included in the version you purchased, you may download this material at http://booksupport.wiley.com For more information about Wiley products, visit www.wiley.com Cloth edition: ISBN 978-1-118-87370-0 Cloth edition with DCF Model Download: ISBN 978-1-118-87368-7 University edition: ISBN 978-1-118-87373-1 Workbook: ISBN 978-1-118-87387-8 DCF Model Download: ISBN 978-1-118-87366-3 CONTENTS About the Authors Preface Why This Book Structure of the Book Valuation Spreadsheet Acknowledgments Part One: Foundations of Value 1: Why Value Value? What Does It Mean to Create Shareholder Value? Can Stakeholder Interests Be Reconciled? Shareholder Capitalism Cannot Solve All Social Issues Consequences of Forgetting Value-Creation Principles Short-Termism Runs Deep This Book Review Questions Notes 2: Fundamental Principles of Value Creation The Relationship of Growth, ROIC, and Cash Flow Balancing ROIC and Growth to Create Value Real-World Examples Managerial Implications Economic Profit Combines ROIC and Size The Math of Value Creation Summary Review Questions Notes 3: Conservation of Value and the Role of Risk Conservation of Value Risk and Value Creation Summary Review Questions Notes 4: The Alchemy of Stock Market Performance Why Shareholder Expectations Become a Treadmill Real-World Effects of the Expectations Treadmill Decomposing TRS Understanding Expectations Managerial Implications Review Questions Notes 5: The Stock Market Is Smarter Than You Think Markets and Fundamentals: A Model Markets and Fundamentals: The Evidence What about Earnings? Earnings Management Diversification and the Conglomerate Discount Size and Value Market Mechanics Don't Matter Value Creation Is More Important than Value Distribution Summary Review Questions Notes 6: Return on Invested Capital What Drives ROIC? Competitive Advantage Sustainability of Return on Invested Capital An Empirical Analysis of Returns on Invested Capital Summary Review Questions Notes 7: Growth Drivers of Revenue Growth Growth and Value Creation Why Sustaining Growth Is Hard Empirical Analysis of Corporate Growth Summary Review Questions Notes Part Two: Core Valuation Techniques 8: Frameworks for Valuation Enterprise Discounted Cash Flow Model Economic-Profit-Based Valuation Models Adjusted Present Value Model Capital Cash Flow Model Cash-Flow-to-Equity Valuation Model Other Approaches to Discounted Cash Flow Alternatives to Discounted Cash Flow Summary Review Questions Notes 9: Reorganizing the Financial Statements Reorganizing the Accounting Statements: Key Concepts Reorganizing the Accounting Statements: In Practice Advanced Issues Review Questions Notes 10: Analyzing Performance Analyzing Returns on Invested Capital Analyzing Revenue Growth Credit Health and Capital Structure General Considerations Review Questions Notes 11: Forecasting Performance Determine the Forecast's Length and Detail Components of a Good Model Mechanics of Forecasting Additional Issues Review Questions Notes 12: Estimating Continuing Value Recommended Formula for DCF Valuation Continuing Value Using Economic Profit Subtleties of Continuing Value Common Pitfalls Evaluating Other Approaches to Continuing Value Advanced Formulas for Continuing Value Closing Thoughts Review Questions Notes 13: Estimating the Cost of Capital Weighted Average Cost of Capital Estimating the Cost of Equity Estimating the After-Tax Cost of Debt Using Target Weights to Determine the Cost of Capital Complex Capital Structures Closing Thoughts Review Questions Notes 14: Moving from Enterprise Value to Value per Share Valuing Nonoperating Assets Valuing Debt and Debt Equivalents Valuing Hybrid Securities and Noncontrolling Interests Estimating Value per Share Review Questions Notes 15: Analyzing the Results Validating the Model Sensitivity Analysis Creating Scenarios The Art of Valuation Review Questions Notes 16: Using Multiples Value Multibusiness Companies as a Sum of Their Parts Use Forward Earnings Estimates Use Net Enterprise Value Divided by Adjusted EBITA or NOPLAT Adjust for Nonoperating Items Use the Right Peer Group Alternative Multiples Summary Review Questions Notes 17: Valuation by Parts Valuing by Parts: Mechanics and Insights Building Business Unit Financial Statements Cost of Capital Testing the Value Based on Multiples of Peers Summary Review Questions Notes Part Three: Advanced Valuation Techniques 18: Taxes Operating Taxes on the Reorganized Income Statement Converting Operating Taxes to Operating Cash Taxes Deferred Taxes on the Reorganized Balance Sheet Valuing Deferred Taxes Closing Thoughts Review Questions Notes 19: Nonoperating Items, Provisions, and Reserves Nonoperating Expenses and One-Time Charges Provisions and Their Corresponding Reserves Closing Thoughts Review Questions Notes 20: Leases and Retirement Obligations Operating Leases Securitized Receivables Pensions and Other Retirement Benefits Closing Thoughts Review Questions Notes 21: Alternative Ways to Measure Return on Capital Value-Based Returns on Capital: ROIC and CFROI Capitalizing Expensed Investments When Businesses Need Little or No Capital Summary Review Questions Notes 22: Inflation Inflation Leads to Lower Value Creation Historical Analysis in Times of High Inflation Financial Projections in Real and Nominal Terms Summary Review Questions Notes 23: Cross-Border Valuation Forecasting Cash Flows Estimating the Cost of Capital Incorporating Foreign-Currency Risk in the Valuation Using Translated Foreign-Currency Financial Statements Summary Review Questions Notes 24: Case Study: Heineken Reorganizing Financial Statements Analyzing Historical Performance Forecasting Performance Estimating Cost of Capital Estimating Continuing Value Calculating and Interpreting Results Notes Part Four: Managing for Value 25: Corporate Portfolio Strategy What Makes an Owner the Best The Best-Owner Life Cycle Dynamic Portfolio Management asset write-offs defined gains/losses on sale of assets intangibles litigation charges one-time vs ongoing persistence of special items reorganizing income statement restructuring charges separating from operating expenses special items Nonoperating income NOPLAT (net operating profit less adjusted taxes) calculating continuing value and defined key concepts in multiple business units for operating leases Norton, David Novo Nordisk O Off-balance-sheet debt Off-balance-sheet financing One-time expenses OpenTable Operating analysis Operating cash flows, projecting/testing Operating-cost productivity Operating expenses: forecasting separating from nonoperating expenses Operating leases adjusting for capitalized enterprise DCF model enterprise valuation with as form of debt proposed accounting changes for valuing Operating margins: in high-growth companies and inflation Operating metrics, multiples of Operating taxes: accrual-based converting to operating cash taxes deferred on reorganized balance sheet valuing determining comprehensive approach erroneous alternatives for public statements simple approach estimating forecasting Operating working capital Operational risk Operations valuation Options, real Organizational health Overconservatism P Payout ratio Pecking-order theory Peer groups PEG ratios Pensions and postretirement benefits analyzing and valuing expected return and earnings manipulation forecasting unfunded Percentage of property, plant, and equipment (PP&E) Performance analysis See Historical performance analysis Performance management consequences, appropriate metrics identifying value drivers understanding value drivers value driver trees organizational support performance reviews target-setting transparency perspective levels target-setting Perpetuities Pfizer Pillsbury Portfolio management Portfolio momentum Portfolio treadmill Preferred equity/stock Price-to-earnings ratio (P/E), leverage and Principles of Corporate Finance (Brealey, Myers, and Allen) Privately held subsidiaries Property, plant, and equipment (PP&E) Provisions defined income-smoothing long-term operating nonoperating ongoing operating restructuring provisions taxes and Publicly traded subsidiaries R R&D See Research and development Rackspace Hosting Rational price discipline Real options Real-option valuation (ROV) REITS (real estate investment trusts) Replicating portfolios Reputation management Rerating Research and development (R&D) Reserves See Provisions Restructuring reserves Retirement liabilities, unfunded Return on invested capital (ROIC) alternative measures of capitalizing expensed investments cash flow return on investment (CFROI) economic profit analyzing goodwill and acquired intangibles UPS/FedEx balancing with growth competitive advantage and cost and capital efficiency advantages decay analysis decomposing defined differences across industries drivers of effect of acquisitions on effect on value creation empirical analysis equaling IRR focus on high- vs low-ROIC companies in forecasting Heineken (case study) in high-growth companies historic trends intangible resources interaction between growth and interpreting and length of product life cycle line item analysis managerial implications operating analysis for operating leases persistence by industries production outsourcing and and product renewal potential projecting relationship to growth and cash flow stability of sustainability of Return on new invested capital (RONIC) Revenue forecasting Revenue growth See also Growth analyzing accounting changes and irregularities currency effects mergers and acquisitions (M&A) from attracting new customers and balance with ROIC decay analysis decomposing drivers of empirical analysis historical trends from increasing market share from new product development from persuading existing customers to buy more product projecting rates across industries sustaining through acquisitions through incremental innovation through product pricing and promotion transition probability and value creation value of major types of variation in, by industry variation in, over product life cycle volatile, by industry Risk: cash flow risk diversifiable vs nondiversifiable exposure level hedging price of Risk-free rate Risk-neutral valuation Risk-weighted assets (RWA) Rockwell Automation ROIC See Return on invested capital (ROIC) Roll-up strategies RONIC (return on new invested capital) Russian government default crisis S Sale-leaseback transactions Sales productivity Savings and loan crisis Scalability of products/processes Scenario analysis Scenario DCF approach Scenario development Scenarios, creating Scenario weighting Schiller, Robert Scholes, Myron Securitized receivables Sell-side analysts Sensitivity analysis Shareholder capitalism Shareholder payouts Shareholder returns See Total returns to shareholders (TRS) The Shareholder Value Myth (Stout) Share repurchases Short-termism Siemens Simplified intermediate forecast Single-path DCF Social responsibility Sodexo Solvency Spin-offs Split-offs Stakeholder interests Stochastic simulation DCF Stock market: bubbles, (see also Financial crises) cross-listings diversification earnings (see Earnings per share (EPS)) fundamentals of growth vs value stocks index membership impact on company informed investors vs noise investors market mechanics relationship of company size to value stock splits total returns to shareholders (see Total returns to shareholders (TRS)) understanding expectations Stock splits Stout, Lynn Stranded costs Strategic vision Subsidiaries T Taiwan Semiconductor Target-setting Target weights Taxes deferred forecasting operating, (see also Operating taxes) provisions and Tax loss carryforwards Tax-loss carryforwards Tax on a maturity mismatch (TMM) Tax penalty on equity Tax shields, valuing Technology bubble Top-down forecasting Total debt Total funds invested, computing Total returns to shareholders (TRS) correlation with employment growth decomposing diversification and enhanced approach to analyzing impact of debt financing on key drivers of managerial implications as measure of management performance and spin-offs traditional approach to analyzing traditional vs enhanced decomposition Tracking stock TradeCo Traders Trade sales Transformational mergers Transparency Triangulation TRS See Total returns to shareholders Tyco U Uncertainty See Flexibility United Parcel Service (UPS) Unlevered cost of equity UPS/FedEx: coverage ratios ROIC V Valuation by parts corporate overhead costs cost of capital enterprise to equity value buildup estimating invested capital estimating NOPLAT financial subsidiaries individual unit financial statements intercompany receivables and payables intercompany sales and profits intercompany transactions mechanics of multiples of peers valuation public information ROIC breakdown valuation summary Valuation frameworks chart of DCF alternatives DCF-based approaches adjusted present value (APV) capital cash flow economic profit enterprise discounted cash flow, (see also Enterprise discounted cash flow) equity cash flow Valuation fundamentals Valuation metrics Valuation results, analyzing art of valuation consistency check model validation plausibility check scenario analysis sensitivity analysis Valuation summary, in forecasting Value, defined Value conservation principle See Conservation of value principle Value creation: from acquisitions (see Mergers and acquisitions (M&A)) for current and future shareholders importance, vs value distribution math of and revenue growth risk and stakeholder vs shareholder focus Value distribution Value drivers flexibility long-term strategic medium-term short-term Value driver trees Value per share, calculating W WACC See Weighted average cost of capital (WACC) Walgreens Wal-Mart Webvan Weighted average cost of capital (WACC): components of defined discounting free cash flow at in emerging markets estimating in forecasting Whole Foods Write-downs Y Yelp WILEY END USER LICENSE AGREEMENT Go to www.wiley.com/go/eula to access Wiley's ebook EULA ... understanding of value, although they need to understand it fully if they are to their jobs well and fulfill their responsibilities This book offers them the necessary understanding, and its... Size The Math of Value Creation Summary Review Questions Notes 3: Conservation of Value and the Role of Risk Conservation of Value Risk and Value Creation Summary Review Questions Notes 4: The. .. products and services for our customers' professional and personal knowledge and understanding VALUATION MEASURING AND MANAGING THE VALUE OF COMPANIES SIXTH EDITION McKinsey & Company Tim Koller