The Value Equation

Chapter 5The Value Equation

Any business model that can be done on a brief spreadsheet, such as our restaurant model in the previous chapter, can be done shorthand. In 1999 I developed the Value Equation, or V-Formula, a tool that incorporates the Six Variables into a shortcut designed to compute corporate pre-tax current equity returns (ROE) as follows:¹

The V-Formula

Now, here is the V-Formula applied to the restaurant business case study from the prior chapter:

The Case Study V-Formula

EVA and EMVA

The idea for creating a value equation came from my appreciation for the concept of economic value added (EVA), which was developed by consulting firm Stern Stewart & Co. and detailed by G. Bennett Stewart in his 1991 book The Quest for Value. The basic idea behind EVA was to take a financial approach to a corporate income statement, much as we did in the previous chapter. However, when computing EVA, you would not simply have a cost of OPM, but would also have an equity charge for the expected cost of equity. Then, to the extent you still had a profit from operations, that profit would be the amount by which your results from business operations exceeded your cost of capital (OPM and equity). The result is EVA. Over time, EVA accumulation translates into ...