Valuation Measuring and Managing the Value of Companies 7th.pdf
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In this seventh edition, we continue to expand the practical application of
finance to real business problems, reflecting the economic events of the past
decade, new developments in academic finance, and the authors’ own experi-
ences. The edition is organized into five parts, each with a distinct focus.
Part One, “Foundations of Value,” provides an overview of value cre-
ation. We make the case that managers should focus on long-term value
creation for current and future shareholders, not just some of today’s share-
holders looking for an immediate pop in the share price. We explain the two
core principles of value creation: (1) the idea that return on invested capital
and growth drive cash flow, which in turn drives value, and (2) the con-
servation of value principle, which says that anything that doesn’t increase
cash flow doesn’t create value (unless it reduces risk). We devote a chapter
each to return on invested capital and to growth, including strategic prin-
ciples and empirical insights.
Part Two, “Core Valuation Techniques,” is a self-contained handbook for
using discounted cash flow (DCF) to value a company. The reader will learn
how to analyze historical performance, forecast free cash flows, estimate the
appropriate opportunity cost of capital, identify sources of value, and inter-
pret results. We also show how to use multiples of comparable companies to
supplement DCF valuations.
Part Three, “Advanced Valuation Techniques,” explains how to analyze
and incorporate in your valuation such complex issues as taxes, pensions, re-
serves, capital-light business models, inflation, and foreign currency. It also
discusses alternative return-on-capital measures and applications.
Part Four, “Managing for Value,” applies the value-creation principles to
practical decisions that managers face. It explains how to design a portfo-
lio of businesses; how to run effective strategic-planning and performance
management processes; how to create value through mergers, acquisitions,
and divestitures; how to construct an appropriate capital structure and pay-
out policy; and how companies can improve their communications with the
financial markets.
Part Five, “Special Situations,” is devoted to valuation in more complex
contexts. It explores the challenges of valuing high-growth companies, com-
panies in emerging markets, cyclical companies, and banks. In addition, it
shows how uncertainty and flexibility affect value and how to apply option-
pricing theory and decision trees in valuations.
Finally, our nine appendixes provide a full accounting of our methodol-
ogy in this book. They provide theoretical proofs, mathematical formulas, and
underlying calculations for chapters where additional detail might be helpful
in the practical application of our approach. Appendix H, in particular, pulls
into one place the spreadsheets for the comprehensive valuation case study of
Costco featured in this edition.
ValuaTion sPreadsheeT
An Excel spreadsheet valuation model is available via Web download. This
valuation model is similar to the model we use in practice. Practitioners will
find the model easy to use in a variety of situations: mergers and acquisi-
tions, valuing business units for restructuring or value-based management,
or testing the implications of major strategic decisions on the value of your
company. We accept no responsibility for any decisions based on your in-
puts to the model.
v
Contents
About the Authors ix
Preface xi
Acknowledgments xv
Part One Foundations of Value
1 Why Value Value? 3
Review Questions 16
2 Finance in a Nutshell 17
Review Questions 26
3 Fundamental Principles of Value Creation 27
Review Questions 54
4 Risk and the Cost of Capital 55
Review Questions 68
5 The Alchemy of Stock Market Performance 69
Review Questions 83
6 Valuation of ESG and Digital Initiatives 85
Review Questions 100
7 The Stock Market Is Smarter Than You Think 101
Review Questions 129
8 Return on Invested Capital 131
Review Questions 158
9 Growth 159
Review Questions 178
vi Contents
Part Two Core Valuation Techniques
10 Frameworks for Valuation 181
Review Questions 209
11 Reorganizing the Financial Statements 211
Review Questions 245
12 Analyzing Performance 247
Review Questions 267
13 Forecasting Performance 269
Review Questions 295
14 Estimating Continuing Value 299
Review Questions 318
15 Estimating the Cost of Capital 321
Review Questions 350
16 Moving from Enterprise Value to Value per Share 353
Review Questions 374
17 Analyzing the Results 377
Review Questions 387
18 Using Multiples 389
Review Questions 412
19 Valuation by Parts 415
Review Questions 434
Part Three Advanced Valuation Techniques
20 Taxes 439
Review Questions 453
21 Nonoperating Items, Provisions, and Reserves 455
Review Questions 471
22 Leases 473
Review Questions 486
23 Retirement Obligations 489
Review Questions 498
24 Measuring Performance in Capital-Light Businesses 499
Review Questions 514
Contents vii
25 Alternative Ways to Measure Return on Capital 515
Review Questions 524
26 Inflation 525
Review Questions 539
27 Cross-Border Valuation 541
Review Questions 559
Part Four Managing for Value
28 Corporate Portfolio Strategy 563
Review Questions 583
29 Strategic Management: Analytics 585
Review Questions 608
30 Strategic Management: Mindsets and Behaviors 609
Review Questions 623
31 Mergers and Acquisitions 625
Review Questions 653
32 Divestitures 655
Review Questions 674
33 Capital Structure, Dividends, and Share Repurchases 675
Review Questions 708
34 Investor Communications 709
Review Questions 731
Part Five Special Situations
35 Emerging Markets 735
Review Questions 752
36 High-Growth Companies 753
Review Questions 768
37 Cyclical Companies 769
Review Questions 777
38 Banks 779
Review Questions 805
39 Flexibility 807
Review Questions 841
Appendix A Discounted Economic Profit Equals Discounted Free
Cash Flow 843
Appendix B Derivation of Free Cash Flow, Weighted Average Cost
of Capital, and Adjusted Present Value 849
Appendix C Levering and Unlevering the Cost of Equity 855
Appendix D Leverage and the Price-to-Earnings Multiple 863
Appendix E Other Capital Structure Issues 867
Appendix F Technical Issues in Estimating the Market Risk
Premium 873
Appendix G Global, International, and Local CAPM 877
Appendix H A Valuation of Costco Wholesale 885
Appendix I Two-Stage Formula for Continuing Value 909
Index 911