Corporate Value Creation. Karlson Lawrence C.

Скачать книгу

and cash flow, the rate at which they are made is of interest. For example, if a project that involves $1,000,000 of investment is completed in three years, its impact on the company's growth will be different than if it was completed in two years, all other things being equal. Hence, the rate at which a company invests money or the “Investment Rate” is a concept that needs to be explored.

      ⧉ Investment Rate

      There is a strong correlation between investments and Net Income in most companies. Therefore, rather than think of Net Investments as an absolute number, it is often more convenient to think of it as a percentage of net income, especially when preparing pro-forma financial statements for business plans, preparing cash flow streams for present value analysis, and so forth.

      This is done by defining the Investment Rate IR in Year n as the ratio of NetInvestn in Year n to Net Income NIn in Year n (Equation [2-7]).

      [2-7]

      Rearranging, Equation [2-7] becomes:

      [2-8]NetInvestn = (NIn)(IRn)

      Equation [2-8] is the First Envelope Equation. It is the cornerstone of the Net Investment Version of the Envelope Equations because it defines Net Investment in terms of Net Income and the Investment Rate and will surface many times in the following sections.

      Special Case: Constant Investment Rate

      Equation [2-7] is a solid definition for the Investment Rate under all circumstances. As will be seen, its more useful form is Equation [2-8].40 However, in many companies the Investment Rate doesn't change much from one year to the next and, therefore, in numerous situations or as a first approximation the IR can be viewed as a constant. Dropping the subscript on IR accomplishes this. Hence, under these conditions Equation [2-8] becomes

      [2-9]NetInvestn = (NIn)(IR)

      ⧉ Incorporating the IR and NiROCE into the Expression for Net Income 41

      To a significant extent, this book is about Cash Flow since cash is the basic resource required by a business. In the long run Net Income is the only source of cash and so its importance cannot be overemphasized.

      Having made an unequivocal statement about the source of cash, the next step in understanding the power of the Envelope Equations is to incorporate IR and ROCE into the Net Income and Cash Flow equations, which is done by starting with the ultimate driver of Cash Flow – Net Income.

      The assumptions are: The Net Income for Year n is NIn and during the year the company makes NetInvestn at a rate of IRn of Year n's Net Income. Since it takes time for investments to produce results this investment provides a return of ROCEn _{+ 1} in the following year.42 Given these assumptions and Equation [2-8], the amount of Year n's Net Income invested in assets that will generate future cash flows is:

      [2-8]NetInvestn = (NIn)(IRn)

      Since NetInvestn provides a return of ROCE₍n _{+ 1)} the following year, then the Incremental Net Income in Year n + 1 will be:

      [2-10]ΔNI₍n _{+ 1)} = (NetInvestn)(NiROCE₍n _{+ 1)})

      The NI in Year n + 1 is the sum of the NI from Year n and ΔNI in Year n + 1. Therefore, the NI in Year n + 1 is:

      [2-11]NI₍n _{+ 1)} = NIn + ΔNI₍n _{+ 1)}

      Substituting the results of Equation [2-10] into Equation [2-11] creates an expression for NI in terms of NetInvest and ROCE:

      [2-12]NI₍n _{+ 1)} = NIn + (NetInvestn)(NiROCE₍n _{+ 1)})43

      Equation [2-12] is the Second Envelope Equation. It enables the calculation of Any Year's Net Income by simply knowing the Current Year's Net Income, Net Investment, and Net Income Return on Capital Employed, thus enabling the calculation of the Cash Flow after Investing Activities for the year in question.

      The Investment Rate IR can be incorporated into Equation [2-12] by substituting the results of Equation [2-8] for the term NetInvest in Equation [2-12].

      [2-13]NI₍n _{+ 1)} = NIn + (NIn)(IRn)(NiROCE₍n _{+ 1)})

      Factoring [2-13] gives an equation that defines NI in terms of IR and NiROCE.

      [2-14]NI₍n _{+ 1)} = (NIn)[1 + (IRn)(NiROCE₍n _{+ 1)})]

      Equation [2-14] is the Third Envelope Equation and differs from Equation [2-12] in the sense that it calculates a Future Year's Net Income by using the Current Year's Net Income in combination with the Investment Rate and Net income Return on Capital Employed.

      In Year n + 1, investments are also being made and the magnitude of the NetInvest in Year n + 1 is:

      [2-15]NetInvest₍n _{+ 1)} = (NI₍n _{+ 1)})(IR₍n _{+ 1)})

      which will prove to be a useful expression when estimating the Incremental Net Income and so forth in Year n + 2.

      Equations [2-12] and [2-14] are powerful tools for doing quick estimates of a stream of Net Incomes that are the result of investments with expected returns. These equations together with Equation [2-8] constitute three of a set of five equations that are useful for predicting Net Income. The other two equations have to do with Cash Flow. They will be derived in the following section.

      ⧉ Incorporating IR into the expression for Cash Flow after Investing Activities

      Incorporating the Investment Rate, IR, into the expression for Cash Flow is done as follows.

      Recall Equation [2-5]:

      [2-5]CFaIA = NI − NetInvest ± NetInt ± ΔWC

      This equation can be generalized by defining CFaIA for Year n as a function of the NI and NetInvest in Year n:

      [2-16]CFaIAn = NIn − NetInvestn ± NetIntn ± ΔWCn

      Equation [2-16] is the Fourth Envelope Equation and is very significant because it allows the user to calculate the Cash Flow after Investing Activities directly by knowing the Net Income, Net Investment, Net Interest, and Change in Working Capital.

      Substituting the results of Equation [2-8] for NetInvestn in Equation [2-16] gives CFaIA for Year n as a function of NI, the Net Income in Year n, and IR, the Investment Rate.

      [2-17]CFaIAn = NIn − (NIn)(IRn) ± NetIntn ± ΔWCn

      Factoring,

Скачать книгу