• From profit maximization to value maximization —Net present value of firm = Discounted future profits. over the life of the firm.[r]
(1)Goals, Values and Performance
Goals, Values and Performance
•
Strategy as a quest for value
•
What is profit?
•
The shareholder value approach
•
The shareholder value and strategy
formulation
•
Mission and values
(2)Strategy as a Quest for Profit
Strategy as a Quest for Profit
•
The stakeholder approach
: The firm is a coalition of
interest groups—it seeks to balance their different
objectives.
•
The shareholder approach
: The firm exists to maximize the
wealth of its owners.
•
Why is profit maximization a reasonable goal?
(1) Boards of directors legally obliged to pursue shareholder
interests.
(2) To replace assets, firm must earn return on capital > cost of
capital (difficult when competition intense).
(3)What is Profit?
What is Profit?
•
Profit maximization an ambiguous goal
–
Total profit vs Rate of profit
–
Over what time period?
•
Accounting profit
versus
Economic profit
•
Economic Value Added (EVA) as a measure of
economic profit:
—
Post-tax operating profit less cost of capital
•
From profit maximization to value maximization
—Net present value of firm = Discounted future profits
(4)Net Inc ROS ROE EVA Market Return to
Value Added Shareholders
($m) (%) (%) ($m) ($m) (%)
General Motors 2,956 1.8 19.7 -5,525 -17,943 21.4 General Electric 6,573 9.4 22.2 4,370 285,320 45.3 Exxon 6,370 6.3 14.6 -2,262 114,774 22.4 Philip Morris 5,450 10.3 39.0 5,180 98,657 64.8 IBM 6,328 7.7 32.6 2,541 -5,878 77.5 Coca-Cola 3,533 18.8 42.0 2,194 157,356 1.3 Wal-Mart 4,430 3.2 21.0 1,159 159,444 107.7 Procter & Gamble 3,780 10.2 12.2 61,661 102,379 15.9 Microsoft4,490 31.0 27.0 3,776 328,257 37.5
Hewlett-Packard 2,945 6.3 17.4 -593 45,464 10.7
How U.S Companies Perform Under
Different Profitability Measures, 1998
(5)Value Maximization
Value Maximization
Maximizing the value of the firm:
Max net present value of free cash flows :
max V =
(1 + r
e)
tC
tWhere:
V market value of the firm
C
tfree cash flow in time t
r
e+dweighted average cost
of capital
(6)Applying Shareholder Value
Maximization to Strategy Choice
Applying Shareholder Value
Maximization to Strategy Choice
•
Identify strategy alternatives
•
Estimate cash flows associated with cash
strategy
•
Estimate cost of capital for each strategy
(7)Valuing Companies and Business Units
Valuing Companies and Business Units
If net case flow growing at constant rate (g)
V = C
1( r - g )
With varying cash flows which can be forecasted
for years:
V = C
0+ C
1+ C
2+ C
3+ V
H