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UNLOCKINGUNLOCKINGTHETHE
MAGIC OF NUMBERSMAGIC OF NUMBERS
2 = 3-1+ 42-22+32-3DR. GEORGE WEBSTER
EXECUTIVE EDUCATION PHARMACEUTICAL MARKETING
ST. JOSEPH’S UNIVERSITY
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VALUE CREATIONVALUE CREATION IN IN
THE PHARMACEUTICALTHE PHARMACEUTICALINDUSTRYINDUSTRY
•What is value creation?
•What are the drivers of value creation ?
•How do we measure value creation?
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WHAT IS VALUE CREATION?WHAT IS VALUE CREATION?
• Process
• Involves decision making– Financing
– Investing
– Operating
• Includes all stakeholders
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THE F-I-O MODELTHE F-I-O MODEL
• FINANCING - the process of obtaining capital for the business
• INVESTING - the process of asset acquisition to operate the business
• OPERATING - using resources to maximize shareholder wealth
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““THE SCORECARDS”THE SCORECARDS”
• BALANCE SHEET - a statement of position at a point in time– Shows what we own and what we owe
– Of particular interest to the CFO
• INCOME STATEMENT - a statement of value creation over time– Measures how well we operated
– Of particular interest to the CEO
• CASH FLOW STATEMENT - puts operations on a cash basis– Gives sources and uses of cash
– Of particular interest to the COO
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BALANCE SHEET- FACSIMILE COMPANY DECEMBER 31, 19XX
ASSETS LIABILITIES & O.E.CURRENT ASSETS CURRENT LIABILITIES Cash 3000 Accts. Payable 2000 Accts. Rec. 2000 Wages Payable 1000 Inventory 8000 13000 Rent 1000 4000
LONG TERM LONG TERM P & E 25000 Long Term Debt 7000 Other 4000 OWNER’S EQUITYTOTAL 29000 Common Stock 5000 Ret. Earnings 26000 TOTAL 31000
TOTAL ASSETS 42000 TOTAL LIAB. & OE 42000
INCOME STATEMENT- FASCIMILE CO.FOR THE YEAR ENDED 12/31/XX
NET SALES 55000
LESS: COST OF GOODS 35000
GROSS MARGIN 20000
LESS: OPERATING EXPENSES
Salaries 5000
Rent Expense 1000
S.,G., & A. 4000 10000
OPERATING PROFIT 10000
LESS: INCOME TAX (.40) 4000
NET INCOME AFTER TAX 6000
STATEMENT OF CASH FLOWS-FASCIMILE CO.
FOR THE YEAR ENDED 12/31/XX
•CASH FROM OPERATIONS
Net Income 2000
Depreciation 500 2500
•CASH FROM INVESTING ACTIVITIES
Capital Expenditures 5000
Acquisitions 15000 20000
•CASH FROM FINANCING ACTIVITIES
Issuance of Long Term Debt 700
Sale of Common Stock 11500
Cash Dividends 400 11800
•NET CHANGE IN CASH -5700
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WHAT ARE THE DRIVERS OF WHAT ARE THE DRIVERS OF VALUE?VALUE?
• EFFECTIVENESS - How much revenue do we generate from the assets we have?
• EFFICIENCY - How well do we use the assets we own?
• LEVERAGE - How much debt do we have in the capital structure?
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EFFECTIVENESSEFFECTIVENESS
EFFECTIVENESS =Total SalesTotal Assets
BMS -1998 =$18,284,000,000$16,272,000,000
BMS - 1998 Effectiveness is 1.12
BMS - 1996 Effectiveness is 1.03
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EFFICIENCYEFFICIENCY
EFFICIENCY =Net IncomeTotal Sales
BMS -1998 = $3,052,000,000$18,284,000,000
BMS - 1998 Efficiency is .167
BMS - 1996 Efficiency is .187
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LEVERAGELEVERAGE
LEVERAGE = Total AssetsOwner’s Equity
BMS -1998 =$16,272,000,000$7,576,000,000
BMS - 1998 Leverage is 2.15
BMS - 1996 Leverage is 2.24
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HOW WE MEASURE VALUE HOW WE MEASURE VALUE CREATIONCREATION
• ROI - Return on investment
• ROE - Return on equity
• EPS - Earnings per share
• EVA - Economic value added
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RETURN ON INVESTMENTRETURN ON INVESTMENT
RETURN ON INVESTMENT = Net IncomeTotal Assets
ROI =Net Income
SalesX
Sales
Total Assets
ROI = Net Margin X Asset Turnover
BMS 1998 ROI = .167 X 1.12 = .187
BMS 1996 ROI = .187 X 1.03 = .193
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RETURN ON EQUITYRETURN ON EQUITY
RETURN ON EQUITY = Net IncomeOwner’s Equity
(Effectiveness) X (Efficiency) X (Leverage)
Total Assets
Owner’s Equity
Sales
Total AssetsX
Net Income
SalesX
BMS 1998 ROE = $3,052,000,000 / $7,576,000,000 = .40
= 1.12 X .167 X 2.15 = .40
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THE F-I-O MODELTHE F-I-O MODEL
• FINANCING - the process of obtaining capital for the business
• INVESTING - the process of asset acquisition to operate the business
• OPERATING - using resources to maximize shareholder wealth
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(Effectiveness) X (Efficiency) X (Leverage)
HOW WE MEASURE VALUE HOW WE MEASURE VALUE CREATIONCREATION
Total Assets
Owner’s Equity
Sales
Total AssetsX
Net Income
SalesX
Investing Operating Financing
FIO MODELFIO MODEL
(Asset Turnover) X (Net Margin) X (Degree Financial Leverage)
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EARNINGS PER SHAREEARNINGS PER SHARE
EARNINGS PER SHARE =Earnings
Shares of Common Stock Outstanding
BMS 1998 EPS = $1.54
BMS 1996 EPS = $2.81
•Market Measure
•External to the Firm
•Unambiguous
•Represents per Share Value Creation
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ACTIVITY/PERFORMANCE/ACTIVITY/PERFORMANCE/LEVERAGE MEASURESLEVERAGE MEASURES
BMS SCHERING P&G
ACTIVITY
Total Asset Turnover 1.12 1.03 1.20
PERFORMANCE
Net Margin (%) 16.7 21.7 10
Return on Equity (%) 40 44 31
LEVERAGE
Total Assets/ Equity 2.15 1.96 2.53
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ECONOMIC VALUE ADDEDECONOMIC VALUE ADDED
•Measures real profitably- on a cash basis
•Measures the cost of equity- not shown on balance sheets
•Cost of equity is its opportunity cost- what the investors
could do in their next best alternative
•Capital includes long term debt, preferred stock, and common stock
•Cost of capital is its weighted average
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ECONOMIC VALUE ADDEDECONOMIC VALUE ADDED
ECONOMIC VALUE ADDED =[Net Operating Profit After Tax - After Tax Dollar Cost of
Capital]
Net Operating Profit After Tax = Operating Profit - Income Tax
Cost of Capital = Weighted After Tax Cost of Capital
Capital = Total Capital Employed = Common and Preferred Stock + Long Term Debt
After Tax Dollar Cost of Capital= Cost of Capital (%) X Capital
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Economic Value Added ExampleEconomic Value Added ExampleBMS, 1998BMS, 1998
NOPAT
Operating Profit 14026
Less: Income Tax -1127
Equals: NOPAT =12889
EVA
EVA = NOPAT - $ CC
= 12889-1394
=11495
WACC
Debt 1846 @.06
Equity [email protected]
WACC = .148
$ CC = 9422(.148)
= 1394