Chapter 2 - Goals, values and performance. In this chapter, the following content will be discussed: Strategy as a quest for value, what is profit? the shareholder value approach, the shareholder value and strategy formulation, mission and values. | Goals, Values and Performance Strategy as a quest for value What is profit? The shareholder value approach The shareholder value and strategy formulation Mission and values OUTLINE Strategy as a Quest for Profit The stakeholder approach : The firm is a coalition of interest groups—it seeks to balance their different objectives. The shareholder approach : The firm exists to maximize the wealth of its owners. Why is profit maximization a reasonable goal? (1) Boards of directors legally obliged to pursue shareholder interests. (2) To replace assets, firm must earn return on capital > cost of capital (difficult when competition intense). (3) To avoid acquisition, firm must achieve stock-market value > break-up value. 13 What is Profit? Profit maximization an ambiguous goal Total profit vs. Rate of profit Over what time period? Accounting profit versus Economic profit Economic Value Added (EVA) as a measure of economic profit: — Post-tax operating profit less cost of capital From profit maximization to value maximization —Net present value of firm = Discounted future profits over the life of the firm Net Inc. ROS ROE EVA Market Return to Value Added Shareholders ($m) (%) (%) ($m) ($m) (%) General Motors 2,956 -5,525 -17,943 General Electric 6,573 4,370 285,320 Exxon 6,370 -2,262 114,774 Philip Morris 5,450 5,180 98,657 IBM 6,328 2,541 -5,878 Coca-Cola 3,533 2,194 157,356 Wal-Mart 4,430 1,159 159,444 Procter & Gamble 3,780 61,661 102,379 Microsoft 4,490 3,776 328,257 Hewlett-Packard 2,945 -593 45,464 How . Companies Perform Under Different Profitability Measures, 1998 Value Maximization Maximizing the value of the firm: Max. net present value of free cash flows : max. V = (1 + re)t Ct Where: V market value of the firm. Ct free cash flow in time t re+d weighted average cost of capital t Applying Shareholder Value Maximization . | Goals, Values and Performance Strategy as a quest for value What is profit? The shareholder value approach The shareholder value and strategy formulation Mission and values OUTLINE Strategy as a Quest for Profit The stakeholder approach : The firm is a coalition of interest groups—it seeks to balance their different objectives. The shareholder approach : The firm exists to maximize the wealth of its owners. Why is profit maximization a reasonable goal? (1) Boards of directors legally obliged to pursue shareholder interests. (2) To replace assets, firm must earn return on capital > cost of capital (difficult when competition intense). (3) To avoid acquisition, firm must achieve stock-market value > break-up value. 13 What is Profit? Profit maximization an ambiguous goal Total profit vs. Rate of profit Over what time period? Accounting profit versus Economic profit Economic Value Added (EVA) as a measure of economic profit: — Post-tax operating profit less cost of capital From profit .
