A Trinity: DCF, P/L-Accounts & Shareholder Value - User-Friendly Tools of Management
30 Pages Posted: 7 Dec 2005 Last revised: 10 Jun 2016
Date Written: November 5, 2014
A series of anticipated (extra) period profits is the ultimate result of a strategic investment. It starts with generating cash and after deduction of value differences and taxes, net profit remains. Period profit, share capital (embedded value - what really is present), shareholder value (economic value - what might happen, additional to the existing activities or 'the market value of the company's shares') and cash flows, are all inter-related.
DCF (Discounted Cash Flow), P/L-accounts and shareholder value form a trinity, exemplified by an integral calculation. Anyone can learn to put this trinity to one's good use. All can be understood easily. The problem definition in this paper is exceptionally simple really, but is nevertheless realistic. It is inclusive of interest costs and tax costs but price changes are disregarded. The aim is to present the core of the algorithm, to teach what and how in order to perform basic computations, starting from scratch. It ends up in user-friendly tools of management that are applicable also in small and medium-sized undertakings. This paper contains usage instructions, indicates some refinements and offers various starting-points to make calculations as far as one likes to go. Of course in practice, compilations must cope with all economical and other insights, with the whole reality. No matter how complex the reality is (for instance 'profit' is a N-dimensional quantity), one cannot deviate an inch from it. However unlikely something may be, if it cannot be excluded beforehand then the solution to the problem in hand must be prepared for it. In fact account must be taken for everything imaginable. Reality indeed is complex and complicated. The problem area is immense and is seemingly a deterrent. Difficult? On the contrary, it is simple. Anyone can understand what it is all about by just counting money.
On the basis of basic data concerning tax rate, standard gearing, standard cost of capital, and other necessary starting data, including of course the expected cash flows, one can quite easily determine the extra value of a company and equivalently NPV (Net Present Value) of an additional investment as well as resulting P/L-accounts, balance sheets and statements of source and use of funds. Shareholder value can also be calculated. All can be done in a very easy way.
Keywords: Discounted Cash Flow, P/L-accounts, Shareholder Value, Firm Value, Net Present Value, Net Value Added, Value Based Management
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