CFS W1 Exploration of a FEW* Issues From This Week’s Assigned Readings ( …
CFS W1 Exploration of a FEW* Issues From This Week’s Assigned Readings
Intro: Correlation between Market Value and DCF Value for 31 Large US Companies, 1999. (Copeland et al.)
Key point : CF (Cashflow) is most closely aligned with share price, thus 'pursuing max value'= maximising PV of CFs- NOT disbursements or EPS management !
Financial Theories of
(a) Value and
(b) Economic Profit (EP)
a. Shareholder Value / Financial Theory
What does the phrase “creating value” mean? How is that phrase sometimes mis-interpreted in other parts of the organisation? Why?
To what does the phrase “Financial Theory of Value” refer?
What has happened to use of accrual accounting-based methods of
valuing companies (e.g., dividend-based methods) in companies
overall since the emergence of CF based concepts in the mid 1970s?
What is the difference between Economic Profit (EP) and Economic
Value Added (EVA)?
If other functional parts and groups in the company insist on their own, bespoke
interpretations of what ‘added value’ represents, that’s OK right? After all, every one has
a right to their own opinion, correct?
NO!! “Value” is not some financial PR buzzword nor self-assigned (by
individual or department) attribute, but rather, objectively determined by
forward operating performance, expressed in financial terms…
Diagram: Value Triangle: Building corporate value through specific operations improvements
b. Worth of a Company is Mostly a Function of the Effectiveness of Asset (Investment) Deployment x NEXT CF Returns From Same
The 1956 Gordon Formula (aka Continuous Value Formula) was first designed for dividends. But while dividend distributions per se may effect ST share price, dividends exert no causal effect on worth (value). GF is now used mostly in DCF:
c.EP: Temporary Excess Returns on Capital Employed
Economic Profit: Difference Between Total Returns on Cap. Invested and Capital Charge
Capital Charge: Capital Invested x Weighed Average Cost of Capital
CF = NOPAT + Non Cash Items + Certain Deferables
FCF = CF minus period Investment (i)
Why do some FD’s claim that EP is superior to Present Value of FCF*s? What are some opposing arguments?
Why does the EP amount tend to decrease over time?
How might EP statistics temporarily be distorted?
d.Market Value Added (MVA)
Is Market Capitalisation
(MC) the price (market
value (MV) that you could
buy up all of the
company’s debt and
Is MVA primarily useful as
a dynamic (period-byperiod)
or instead, a static
(one time view) of the
financial performance of
How might the MVE
component be distorted
during a stock market
bubble period (e.g.
e. ‘Financial Management’
Financial management is concerned with
the use of financial resources
… for the objective of
increasing company profitability and value,
What’s included, what isn’t?
What are examples of superior performance in this domain…
or the opposite?
f. ‘Profit Improvement’
As customarily applied and perceived across the
financial community, short-term actions primarily
designed to fortify reported EPS.
?EPS objective (Stern paper, Wk 6)
? When desirable- corporate examples?
? Longer-term implications
? CFOs/FDs customary role
2.Various, including from the CFS course text,
Assigned reading for completion prior to today’s lecture session
a. Other Roles and Responsibilities in the Office of the Financial Director, Agency
How do the typical roles and responsibilities of the
CHIEF FINANCIAL OFFICER (CFO)
Who reports to whom? Type of coordination exercised by FD?
Given the diversity of roles, what skill sets / backgrounds does the CFO/FD typically exhibit.
Variability based on relative size of the company?
Variations by geography (UK versus US)
Does brinkmanship leverage / lingering recession change the likely key competencies of the CFO/FD?
What tends to be the
reason for CFO dismissal, and
how does that relate to the FD’s essential responsibilities?
What is the primary criteria that the CEO and the Board
consider in making its decision?
In walking this evaluative tightrope, what are the FD’s primary
challenges in terms of:
-Near term expectations v longer term performance
-Established ‘core’ activities v future key areas
-‘Super shareholders’ v best interests of the firm
b. Integration of Company Business Plan With Financing Plan
What Arnold says (p. 2):
Without clarity (on objective of the corporation) it is very difficult to run a business in a purposeful and effective manner.
ii. But in FD-relevant terms, isn’t this what he means?
No financial plan can save a fatally flawed business plan.
Vivendi, Zynga, Groupon
or a criminal one
(1) Fads are not plans (2) Continually changing BP means suboptimal FP.
H-P, MSFT, A&F
The basic TYPE of financing plan varies considerably based on the type of business and its
-Start-up: emphasis on growth-development financing to secure firm’s future
-Midlife (plateau): incremental capital for investment to hold off growing number of
competitors, selective acquisitions
-‘Fully mature’– SOLVENCY
RIM, Nokia, HMV
c. MUCH Easier Expressed Than Actually Achieved
i. Arnold’s Case 1.1 re Cadbury: (now Kraft)
Balanced delivery of strong growth in revenues and margins
Cadbury management are asserting that they can juggle two sometimes conflicting objectives in its business-financing plan–
(1) EQUIVALENT UNIT VOLUME GROWTH
Why isn’t this simply turnover (revenue)?
(2) MARGIN MANAGEMENT Gross or net?
Why is it not as easy to achieve both as Cadbury seems to imply in its statement?
What are the FD/CFO’s primary roles in advancing each of the two different objectives?
Arnold eventually acknowledges the primacy of MSV, for both
the FD and the corporation overall
But how do each of the following potentially complicate the FD/CFO’s MSV mission?
Continuing versus speculative (ST) investors
Activists self-serving (and not necessarily accurate) interpretation of ‘improvement’
Financial exotic theory, accepted until it crashes, e.g., MTM, ‘valuation’ by revenue multiple, tranches of deadbeat mortgages, bitcoin?