Thursday, May 21, 2020

Value Creation and Enhancement Back to the Future

1 Value Creation and Enhancement: Back to the Future Aswath Damodaran Stern School of Business 44 West Fourth Street New York, NY 10012 adamodar@stern.nyu.edu 1 2 Abstract In recent years, firms have turned to their attention increasingly to ways in which they can increase their value. A number of competing measures, each with claims to being the best approach to value creation, have been developed and marketed by investment banking firms and consulting firms. In this paper, we begin with a generic discounted cash flow model, and consider the ways in which value can be created or destroyed in a firm. We then look at two of the most widely used value enhancement measures, Economic Value Added and Cash Flow Return on†¦show more content†¦This process is complicated by the fact that while some of the assets of a firm have already been made, and are thus assets-in-place, a significant component of firm value reflects expectations about future investments. Thus, to value a firm we need to measure not just the cash flows from investments already made, but also estimate the expected value from future growth. In the following section, we will consider some of the basic principles that should guide our estimates of cash flows, growth and discount rates. 1 . Cash Flow to the Firm The cash flow to the firm that we would like to estimate should be both after taxes and after all reinvestment needs have been met. Since a firm includes both debt and equity investors, the cash flow to the firm should be before interest and principal payments on debt. The cash flow to the firm can be measured in two ways. One is to add up the cash flows to all of the different claim holders in the firm. Thus, the cash flows to equity investors (which take the form of dividends or stock buybacks) are added to the cash flows to debt holders (interest and net debt payments) to arrive at the cash flow. 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