Investment Valuation: Tools and Techniques for Determining the Value of Any Asset, Third Edition

CHAPTER 31

Value Enhancement: A Discounted Cash Flow Valuation Framework

In much of this book, we have taken on the role of a passive investor valuing going concerns. In this chapter, we switch roles and look at valuation from the perspective of an investor who can make a difference in the way a company is run and hence its value. Our focus is therefore on how actions taken by managers and owners can change the value of a firm.

We will use the discounted cash flow framework developed in earlier parts of the book to explore the requirements for an action to be value creating, and then go on to examine the different ways in which a firm can create value. In the process, we also examine the role that marketing decisions, production decisions, and strategic decisions all have in value creation.

VALUE-CREATING AND VALUE-NEUTRAL ACTIONS

The value of a firm is the present value of the expected cash flows from both assets in place and future growth, discounted at the cost of capital. For an action to create value, it has to do one or more of the following:

• Increase the cash flows generated by existing investments.
• Increase the expected growth rate in earnings while generating excess returns.
• Increase the length of the high growth period.
• Reduce the cost of capital that is applied to discount the cash flows.

Conversely, an action that does not affect any of the above cannot affect value.

While this might seem obvious, a number of value-neutral actions taken by firms receive disproportionate ...