CREATING SHAREHOLDER VALUE A GUIDE FOR MANAGERS AND INVESTORS by ALFRED RAPPAPORT

Author:ALFRED RAPPAPORT
Language: eng
Format: epub
Publisher: THE FREE PRESS
Published: 1998-07-15T00:00:00+00:00

Sales growth rate 12

Operating profit margin 15

Incremental fixed capital investment 20

Incremental working capital investment 10

Cash income tax rate 35

Cost of capital 10

* * *

These value drivers generate the cash flows presented in Table 6-1. Note that the value growth duration is five years, that is, it takes five years to justify the market value of $130 million. The $130 million of shareholder value is comprised of $86.3 million of baseline value 3 (see shareholder value in historical period) plus $43.7 million of shareholder value added (SVA). The presence of a positive SVA number indicates that XYZ expects to invest in value-creating opportunities over the next five years and therefore its corporate rate of return—the return on its real investments—will be greater than the 10 percent cost of capital. More precisely, the corporate rate of return is 27.17 percent. This can be seen in Table 6-2 where the capitalized value of increases in NOPAT when discounted at the 27.17 percent corporate rate of return (R) is equal to the cumulative present value of incremental investments of $16.97 million.

Assuming no change in expectations, shareholders will earn their required rate of return. Based on the expectations impounded in the stock price, management’s investment in growth opportunities must yield an overall corporate return of about 27 percent. The 10 percent cost of capital properly represents the minimum acceptable rate of return or hurdle rate for investment opportunities bearing the same level of risk as the overall company. Management must of course realize that if investments begin to yield less than the 27 percent corporate rate of return implied by the market price of XYZ’s shares, expectations will be lowered and investors as a consequence will not earn their required rates of return.

Table 6-1. XYZ Corporation: Market Signals Analysis

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