Ravi’s Hardware Stores <ul><li>Evaluating performance </li></ul><ul><li>Return on invested capital </li></ul><ul><li>Net o...
Economic Profit <ul><li>One store earned only 14% </li></ul><ul><li>Maximise average ROIC vs increase economic profit </li...
 
Comparison with Rita <ul><li>Sister Rita growing aggressively – Increase in sales and operating profit </li></ul><ul><li>C...
Discounted Cashflow <ul><li>Investment in new hardware store </li></ul><ul><li>Initial decline followed by greater economi...
Fundamental Principles of Value Creation <ul><li>Value is created by earning a return on invested capital greater than opp...
 
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Cf Value Creation 10 1

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Cf Value Creation 10 1

  1. 1. Ravi’s Hardware Stores <ul><li>Evaluating performance </li></ul><ul><li>Return on invested capital </li></ul><ul><li>Net operating profits after tax (NOPAT) divided by capital invested </li></ul><ul><li>Opportunity cost of capital </li></ul><ul><li>ROIC = 18%. RROR = 10% </li></ul>
  2. 2. Economic Profit <ul><li>One store earned only 14% </li></ul><ul><li>Maximise average ROIC vs increase economic profit </li></ul><ul><li>Economic profit equals ROIC less COC multiplied by invested capital </li></ul>
  3. 4. Comparison with Rita <ul><li>Sister Rita growing aggressively – Increase in sales and operating profit </li></ul><ul><li>Comparison with economic profit – Higher growth based on higher investment </li></ul><ul><li>Low ROIC and declining economic profit </li></ul>
  4. 5. Discounted Cashflow <ul><li>Investment in new hardware store </li></ul><ul><li>Initial decline followed by greater economic profits later </li></ul><ul><li>DCF value equals initial investment plus PV of future economic profit </li></ul>
  5. 6. Fundamental Principles of Value Creation <ul><li>Value is created by earning a return on invested capital greater than opportunity cost of capital </li></ul><ul><li>Cost of capital depends on the risk involved in a specific investment </li></ul><ul><li>The more you can invest at returns above cost of capital, the more value you create </li></ul><ul><li>Growth on the basis of large investments where returns are lower than cost of capital destroys value </li></ul><ul><li>Objective should be to maximise the present value of expected cashflows or economic profit </li></ul>

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