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Valuation Measuring and managing the value ofpanies - Koller T.

Koller T., Murrin J. Valuation Measuring and managing the value ofpanies - Wiley & sons , 2000. - 508 p.
ISBN 0-471-36190-9
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The MM formula is defined as follows:
Value of enterprise = Value of assets in place+Value of growth
NOFLAT
WACC
+ K<NOPI AT}N
ROIC - WACC WACC (1+WACC)
Where NOPLAT Expected level of net operating profits less adjusted taxes in the first
= projected period
WACC = Weighted average cost of capital
ROIC = Expected rate of return on invested capital
K = Investment rate, the percentage of NOPLAT invested for growth in new projects
N = Expected number of years that the company will continue to invest in new projects and earn the projected ROIC, also called the interval of competitive advantage
Summary
This chapter described the most common DCF valuation models, with particular focus on the enterprise DCF model and the economic profit model. We explained the rationale for each model and discussed the economic drivers of a company's value. The remaining chapters in Part Two describe a step-by-step approach to valuing a company:
• Chapter 9—Analyzing Historical Performance.
• Chapter 10—Estimating the Cost of Capital.
4 M. Miller and F. Modigliani, ''Dividend Policy, Growth, and the Valuation of Shares," Journal of Business (September 1961), pp. 411-433.
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• Chapter 11—Forecasting Performance.
• Chapter 12—Estimating Continuing Value.
• Chapter 13—Calculating and Interpreting Results.
These chapters explain both the technical details, such as calculating free cash flow from complex accounting statements, and interpreting the valuation through careful financial analysis.
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9—
Analyzing Historical Performance
This chapter begins the step-by-step valuation process. While we present this process sequentially, valuation is typically more of an iterative process. As you learn more, you develop new questions and insights that require revisiting earlier work.
The first step in valuing a business is analyzing its historical performance. A sound understanding of the company's past performance provides an essential perspective for developing and evaluating forecasts of future performance. (This assumes that the company has a history, which is not always the case. See the discussion on valuing Internet stocks in Chapter 15, when you don't have historical information.)
Historical performance analysis should focus on the key value drivers discussed in Chapter 8: namely, return on invested capital and growth. The rate of return on invested capital (ROIC) is the single most important value driver. A company creates value for its shareholders only when it earns rates of return on new invested capital that exceed its cost of capital. Return on invested capital and the proportion of its profits that the company invests for growth drive free cash flow, which in turn drives value.
Historical analysis, done well, is an integrated process. ROIC and growth are broken down into their component drivers (for example, ROIC is driven by capital turnover and operating profit margins). Financial ratios that do not contribute to understanding ROIC and growth or that largely duplicate other ratios need not be used. For example, the return on total assets (ROA) is not used because everything that can be learned from ROA is incorporated into the ROIC analysis.
In addition to analyzing the value drivers, you should analyze the company from a credit or liquidity perspective. Is the company generating or consuming cash? How much debt does the company employ relative to
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equity? What margin of safety does the company have with respect to its debt financing? The organization of this chapter follows:
• Reorganizing the accounting statements to gain greater analytical insights and to calculate ROIC and economic profit.
• Calculating free cash flow.
• Breaking down ROIC and developing an integrated perspective.
• Analyzing credit health and liquidity.
• Dealing with more advanced issues in analyzing financial performance.
At the end of the chapter, we begin a detailed case study and valuation of Heineken, the Dutch brewer, where we apply the principles described in the chapter. The Heineken case is extended at the end of each of the next four chapters.
Reorganizing the Accounting Statements
To analyze a company, we begin by reorganizing its accounting statements to estimate ROIC, free cash flow, and economic profit. We do this reorganization
Exhibit 9.1 Hershey Foods—Historical Income Statement
r \
\$ million 1995 1996 1997 1998
Revenues 3,691 3,989 4,302 4,063
Cost of goods sold (1,992) (2,168) (2,336) (2,142)
Selling, general, and administrative expenses (1,054) (1,124) (1,183) (1,168)
Depreciation expense (119} (118) (137) (142)
Amortization of goodwill (15) (16) (16) (16)
Interest expense, net (45) Ha; (76) (36)
Total costs and expenses i.S ,11% (3,474) (3.748) (3,554)
Income before non-operating items 466 515 554 509
Non-operating income 0 33 0 40
Income before taxes 466 4H(> 554 5i7
Provision for income taxes (184) (207I (218) {216]
Net income 282 273 336 341
Reconciliation of equity
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