1. 1 FINANCE FOR EXECUTIVES Managing for Value Creation FINANCE FOR EXECUTIVES Managing for Value Creation Gabriel Hawawini Claude Viallet Gabriel Hawawini Claude Viallet MANAGING FOR VALUE CREATION

2. 2 EXHIBIT 14.1a: InfoSoft’s Managerial Balance Sheets on December 31, 1996 and 1997. Figures in millions of dollars UNADJUSTED MANAGERIAL BALANCE SHEETS DEC. 31, 1997 Invested capital Cash$5$10 Working capital requirement 1 (net)100100 Gross working capital requirement$105$110 Accumulated bad debt allowance(5)(10) Net fixed assets185190 Property, plant, & equipment (net)95110 Goodwill (net)9080 Gross goodwill$100$100 Accumulated amortization(10)(20) Total$290$300 1 Working capital requirement = (Accounts receivable + Inventories + Prepaid expenses) – (Accounts payable + Accrued expenses). DEC. 31, 1996

3. 3 EXHIBIT 14.1b: InfoSoft’s Managerial Balance Sheets on December 31, 1996 and 1997. Figures in millions of dollars UNADJUSTED MANAGERIAL BALANCE SHEETS DEC. 31, 1997 Capital employed Short-term debt$40$20 Long-term debt4040 Lease obligations4040 Owners’ equity170200 Total$290$300 DEC. 31, 1996

4. 4 EXHIBIT 14.1c: InfoSoft’s Managerial Balance Sheets on December 31, 1996 and 1997. Figures in millions of dollars ADJUSTED MANAGERIAL BALANCE SHEETS DEC. 31, 1997 Invested capital Cash$5$10 Working capital requirement 105110 Net fixed assets235260 Property, plant, & equipment (net)$95$110 Gross goodwill100100 Capitalized R&D4050 Total$345$380 DEC. 31, 1996

5. 5 EXHIBIT 14.1d: InfoSoft’s Managerial Balance Sheets on December 31, 1996 and 1997. Figures in millions of dollars ADJUSTED MANAGERIAL BALANCE SHEETS DEC. 31, 1997 Capital employed Total debt capital$120$100 Short-term debt$40$20 Long-term debt4040 Lease obligations4040 Adjusted equity capital225280 Book value of equity170200 Accumulated bad debt allowance510 Accumulated goodwill amortization1020 Capitalized R&D4050 Total$345$380 DEC. 31, 1996

6. 6 EXHIBIT 14.3a: Comparison of Value Creation for Two Firms with Different Growth Rates. Dollar figures in millions EXPECTEDMARKET VALUE GROWTHEXPECTEDESTIMATEDADDED ACCORDINGIS VALUE FIRMRATEROICWACCTO EQUATION 14.3CREATED? 7%10%13%–3% × $100No 13% – 7% AEXPECTEDINVESTED RETURNCAPITAL–$30 SPREAD(MILLIONS)0.06 –3%$100 == – $500

7. 7 EXHIBIT 14.3b: Comparison of Value Creation for Two Firms with Different Growth Rates. Dollar figures in millions EXPECTEDMARKET VALUE GROWTHEXPECTEDESTIMATEDADDED ACCORDINGIS VALUE FIRMRATEROICWACCTO EQUATION 14.3CREATED? 4%13%10%+3% × $100Yes 10% – 4% BEXPECTEDINVESTED RETURNCAPITAL+$30 SPREAD(MILLIONS)0.06 +3%$100 == +$500

8. 8 EXHIBIT 14.4: The Drivers of Value Creation.

9. 9 EXHIBIT 14.5a: Financial Statements for Kiddy Wonder World. BALANCE SHEETS ON DECEMBER 31 1996 1997 ActualExpected Invested capital Cash$100$60 Working capital requirement 1 600780 Net fixed assets300360 Total$1,000$1,200 Capital employed Short-term debt$200$300 Long-term debt300300 Owners’ equity500600 Total$1,000$1,200 1 Working capital requirement = (Accounts receivable + Inventories + Prepaid expenses) – (Accounts payable + Accrued expenses).

10. 10 EXHIBIT 14.5b: Financial Statements for Kiddy Wonder World. INCOME STATEMENTS FOR THE YEAR 1996 1997 ActualExpected Sales$2,000$2,200 less operating expenses(1,780)(1,920) less depreciation expenses(20)(50) Earnings before interest and tax (EBIT)$200$230 less interest expenses (10% of debt)(50)(60) Earnings before tax (EBT)$150$170) less tax expenses (40% of EBT)(60)(68) Earnings after tax (net profit)$90$102

11. 11 EXHIBIT 14.6a: Comparative Performance of Kiddy Wonder World. PERFORMANCE PERFORMANCEOF LEADING INDICATOR19961997COMPETITORS Growth in sales % change from previous year5%10%9% Growth in earnings (net profit) % change from previous year5%13.3%10% Growth in operating expenses % change from previous year6%7.9%8.8% Growth in invested capital % change from previous year8%20%10% Growth in WCR % change from previous year8%30%25%

12. 12 EXHIBIT 14.6b: Comparative Performance of Kiddy Wonder World. PERFORMANCE PERFORMANCEOF LEADING INDICATOR19961997COMPETITORS Liquidity position Short-term debt20030025% WCR600780 Operating profitability Aftertax EBIT200(1 – 40%)230(1 – 40%)14% Average invested capital9801,100 ROIC = = 33.3% = 38.5% = 12.2% = 12.5%

13. 13 EXHIBIT 14.8: The Financial Strategy Matrix.

14. 14 EXHIBIT A14.1 Infosoft’s Income Statement for 1997. Figures in millions of dollars INCOME STATEMENT 1997 UNADJUSTEDADJUSTED Sales$1,000Sales$1,000 Cost of Goods Sold500Cost of Goods Sold500 SG&A expenses382SG&A expenses382 Lease expense3Lease expense3 Depreciation expense15Depreciation expense15 R&D expense30Amortization of R&D expense20 Bad debt provision5 Goodwill amortization10 Earnings before interest and tax$55Earnings before interest and tax$80 Interest expenses8Interest expenses8 Tax expense (36% of pretax profit)17Tax expense17 Earnings after tax$30Earnings after tax$55