• 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 + re)t
Ct
Where:
V market value of the firm Ct free cash flow in time t re+d weighted 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 = C1
( r - g )
With varying cash flows which can be forecasted for years:
V = C0 + C1 + C2 + C3 + VH
(1 + r ) (1 + r )2 (1 + r )3 (1 + r )3