BCG’S VALUE MANAGEMENT FRAMEWORK AN OVERVIEW FOR M

THEBOSTONCONSULTINGGROUPP:\MasterDk\BCG’sValueManagementFramework-AnOverviewforMBAStudents.PPTRtrt(Ppt)Slide1March2,19982:01PM-1-Copyright1996BCG/HOLTPlanningAssociatesAllRightsReservedBCG’SVALUEMANAGEMENTFRAMEWORKANOVERVIEWFORMBASTUDENTSByRawleyThomasDirectorofResearchTheBostonConsultingGroup200SouthWackerDriveChicago,[e-mail]OUPP:\MasterDk\BCG’sValueManagementFramework-AnOverviewforMBAStudents.PPTRtrt(Ppt)Slide2March2,19982:01PM-2-Copyright1996BCG/HOLTPlanningAssociatesAllRightsReservedWHATGETSMEASUREDGETSDONETHEBOSTONCONSULTINGGROUPP:\MasterDk\BCG’sValueManagementFramework-AnOverviewforMBAStudents.PPTRtrt(Ppt)Slide3March2,19982:01PM-3-Copyright1996BCG/HOLTPlanningAssociatesAllRightsReservedTraditionalValuationTechniquesVersusBCG’sValuationFrameworkTraditionalValuationTechniquesForecastnominalcashflowsbyestimatingP&LlineitemsandchangestothebalancesheetEstimateterminalvaluewithaperpetuityoftheforecastedlastyear’snetcashflowDeterminecostofcapitalbyweightingequityCAPMcostwithdebtcostDiscountthecashflowsandterminalvaluetopresentvaluewiththeweightedaveragecostofcapitalObservationsonMissingElementsNoperformancemeasuretodetermineifthebusinessisachievingreturnsaboveorbelowthecostofcapitalorifthetrendinthosereturnsisupordownNofadeinperformancetodeterminelikelycashflowsinacompetitiveenvironmentDiscountratesdeterminedbypastpricechanges,notfuturelikelycashflowsNoextensiveempiricaltestingBCG’sValuationFrameworkTranslateaccountingstatementstogrosscashflowsandgrosscashinvestmentsinconstantdollarstoproducecashoncashreturnsTranslatecashoncashreturnstoeconomicperformancemeasures(CFROIs)byadjustingforassetlifeandmixofdepreciatingversusnon-depreciatingassetsDeterminesustainableassetgrowthratesFadeCFROIsandassetgrowthratestowardcorporateaveragesconsistentwithlifecycletheoryandempiricalevidencetoestimatefuturecashflows(replacesterminalvaluation)EstimatemarketderivedrealdiscountratebyequatingthepresentvalueofthecashflowsforalargeaggregatetothesumofthepricesofdebtandequityApplythemarketderiveddiscountratetothecashflowsderivedfromfadingeconomicperformancetodeterminemarketvaluation;subtractdebttodetermineequityvaluationTestmodelvaluesagainstactualstockpricesforthousandsoffirmsfor10-40yearsacrossmanycountries;refine,refine,refineTHEBOSTONCONSULTINGGROUPP:\MasterDk\BCG’sValueManagementFramework-AnOverviewforMBAStudents.PPTRtrt(Ppt)Slide4March2,19982:01PM-4-Copyright1996BCG/HOLTPlanningAssociatesAllRightsReservedMANYASSETSFOLLOWTHESAMEUSEFULOUTPUTPATTERNASACAR...0.00.10.20.30.40.50.60.70.80.91.001234567YearUsefulOutput(orSurvivors)ConstantDollarLevelAnnuityEconomicLifeLikelyActualOutputOutputDeclinewithStraightLineDepreciationTHEBOSTONCONSULTINGGROUPP:\MasterDk\BCG’sValueManagementFramework-AnOverviewforMBAStudents.PPTRtrt(Ppt)Slide5March2,19982:01PM-5-Copyright1996BCG/HOLTPlanningAssociatesAllRightsReservedISSUESWITHTRADITIONALRETURNMEASURES(*)Economicdepreciation=amountofannualsinking-fundpaymentearningCOCrequiredtoreplaceassets($357={0.1/[1.114-1)](12,000-2,000)})InvestmentprofileofanewplantSubsequentannualmeasurementYr1Yr6Yr12Income843843843Depreciation714714714Cashflow1,5571,5571,557Cashinvested12,00012,00012,000Bookcapital11,2867,7163,432ROCE(%)7.510.924.6ROGI(%)131313CFROI(%)101010ROCE=Income/bookcapitalROGI=Cashflow/cashinvestedCFROI=(Cashflow-economicdepreciation(*))/cashinvested$12,000$1,557$2,000IRR=10%THEBOSTONCONSULTINGGROUPP:\MasterDk\BCG’sValueManagementFramework-AnOverviewforMBAStudents.PPTRtrt(Ppt)Slide6March2,19982:01PM-6-Copyright1996BCG/HOLTPlanningAssociatesAllRightsReservedYr1Yr6Yr12NOPAT(1)843843843Bookcapital(2)11,2867,7163,432Costofcapital(3)x10%x10%x10%Capitalcharge(4)1,129772343EVA(1-4)(286)71500Cashflow(6)1,5571,5571,557Cashinvested(7)12,00012,00012,000Costofcapital(8)x10%x10%x10%Capitalcharge(9)1,2001,2001,200Economicdep.(*)(10)357357357CVA(6-9-10)000VALUE-ADDEDMEASURESREFLECTRETURN,COSTOFCAPITALANDSIZEReturnonNewPlant—MeasuredOverTime(*)Economicdepreciation=amountofannualsinkingfundpaymentearningCOCrequiredtoreplaceassets($357={[0.1/(1.114-1)](12,000-2,000)})Investmentprofileofanewplant$12,000$1,557$2,000IRR=10%THEBOSTONCONSULTINGGROUPP:\MasterDk\BCG’sValueManagementFramework-AnOverviewforMBAStudents.PPTRtrt(Ppt)Slide7March2,19982:01PM-7-Copyright1996BCG/HOLTPlanningAssociatesAllRightsReservedAccountingMeasuresFail(E.P.S.Growth)ValueLineIndustrials-1994R2=0.0705101520253035404550-100-80-60-40-20020406080100E.P.S.Growth1993-1994Price/EarningsAccountingMeasuresFail(ROESpread)ValueLineIndustrials-1994R2=0.330.1110-50-40-30-20-1001020304050ROEminusCAPMCostofEquityPrice/EquityBookAccountingMeasuresFail(ROCESpread)ValueLineIndustrials-1994R2=0.320.1110-20-15-10-5051015202530ROCEminusCAPMCostofCapitalTotalCapitalPrice/BookEconomicCashFlowMeasuresDoubleAbilitytoExplainValueCFROISpread-V/LIndustrials-1994R2=0.610.1110-10-5051015202530CFROIminusDiscountRateValue/CostTHEBOSTONCONSULTINGGROUPP:\MasterDk\BCG’sValueManagementFramework-AnOverviewforMBAStudents.