What Are the Different Kinds of External Value Metrics, Available for Use by an Investor - Assignment Example

BUSINESS MANAGEMENT] Q1: What are the different kinds of EXTERNAL value metrics, available for use by an investor? In what ways do these metrics differ and what are their principle strengths and weaknesses? Investors have access to various external value metrics. These are normally based on market value and they are ideal reflectors of the changes to the economy and the company. Investors ought to consider timing and volatility when utilising various external value metrics. These metrics include Total Shareholder Return (TSR), Market to Book Ratio (MBR) and Market Value Added (MVA). Total Shareholder Return is a market based metric that measures the percentage return to shareholders over a period of time (Martin, Petty, Wallace, & Coutts., 2009). Given that it is based on traditional accounting methods, this metric is easy to calculate and understand. It relies on simple market figures and allows for separation of the period when value was created. This metric is never exaggerated by being skewed by the size of the firm. It is sensitive to the exact period of time over which it is measured (Kontes, 2010, p, 30). However, total shareholder return is purely based on stock market fluctuations and dividends. Given that the market may be characterised by irrational and emotional behaviour and this metric include them, it can be misleading. It should be noted that there are many other factors that drive share price, apart from management performance. These include market and industry movements, which are outside the control of management. Market to Book Ratio compares the market price of a firm’s common stock with the company’s book value per share. It is therefore, a comparison of an investor’s perception about the value of the company with the company’s worth as per the accounting principles. The metric measures the value that a business creates over time during its life. Market to Book Ratio adjusts for the size of the business and neutralises any leverage differences between companies. However, the metric does not include intangible assets such as intellectual property. It can be distorted by inflation and it is difficult to ascertain when value was created and who created it. Market Value Added is a metric that represents a company’s value in excess of the total investment made on the company. Therefore, this is the difference between the current market value of a company and the value of capital that was contributed by investors. It measures wealth created over a business’ life and measures the absolute gain in money by a business. It makes investors to focus in projects that increase the growth of earnings. However, the metric ignores the time value of money and when the investments were made. Market Value Added might not be a true representative value because an increase in money value may be due to changes in the entire stock market. It is difficult to compare companies that are of different sizes using Market Value Added Q2: What are the different kinds of INTERNAL Value metrics, available for use by an investor? In what ways do these metrics differ and what are their principle strengths and weaknesses? Various internal value metrics are available for investors and these are normally based on accounting measures. They do not rely on the market conditions. These metrics include Discounted Cash Flow Valuation (DCF), Earnings before Interest Tax Depreciation and Amortisation (EBTIDA), Economic Profit (EP), and Economic Added Value (EVA). In estimating investment and enterprise value using the Discounted Cash Flow Value, future cash flows are discounted. This metrics is associated with strengths such as clear definition in terms of specific input variables and assumptions made. A rational value is obtained because the net present value of money is taken into account. It is easy to interpret. However, it may not convert into profit and may be associated with many variations. The results may be unstable because they may be easily manipulated (Price, 2011, p, 190). EBITDA is an external metric that is used to measure an organisation’s earnings before deducting interest, tax, depreciation and amortisation. It is a better measurement for assets whose life is long. However, this metric can be manipulated easily by accounting policies. It ignores the changes in working capital and can be misleading (Kantor, 2008, p, 225). It ignores the quality of earnings. Economic Profit measures the value that has been created in a company after deducting all operating expenses and charging for the opportunity cost of capital. This metric is helpful in evaluating strategic options. The metric is also easier to use because it uses existing accounting and reporting systems and focuses on profit. However, the balance sheet, which is among the financial records that are used, does not reflect invested capital. It can be manipulated because subjective adjustments can be applied. It is also difficult to allocate revenues, cost and capital to business units. Economic Value Added is the value that a company creates for its shareholders. It is the excess of a company’s returns over shareholders. This metric is very helpful in evaluating strategic options. Managers are able to understand the cash consequences of their actions. It is based on accounting concepts and is accurate because it is not similar to traditional accounting figures. It is possible to incorporate value of intangible assets such as intellectual property and social capital. However, there are so many adjustments needed and it is subject to some adjustments by managers. Q3: What is the difference between and a merger and an acquisition? In an acquisition, a company purchases another company. The purchasing company becomes the owner while the purchased company is referred to as the acquisition. The purchased company ceases to exist in an acquisition while the purchaser company’s shares/stock continues to be traded (Machiraju, 2007). Acquisition is attained by a purchase of a controlling amount the stock of an existing company. An acquisition involves purchase of another company’s assets, division or entire company. This means that one firm acquires another firm and the acquired firm ceases to exist (Machiraju, 2007, p, 2). One company takes controlling interest in another firm or subsidiary or selected assets of another company. On the other hand, a merger normally involves the formation of one new company by two companies that are of the same size. Share/stocks of both companies are surrendered and new company shares are issued. Therefore, a merger involves joining together of the two companies involved to make management and operations efficient. According to Sherman (2011, p, 3), a merger involves fusion of two or more companies, whereby assets and liabilities of the selling companies are absorbed by the purchasing firm. The original identity of the purchasing firm is retained, even though the purchasing firm may be a considerably different organisation after the merger. Fr instance, if AB Ltd and OP Ltd form an equal’s merger, the resultant firm will be called AB OP Ltd. The main difference between a merger and an acquisition is that in a merger the two companies continue existing while in an acquisition, one company, the purchased company, ceases to exist. Therefore, shares are exchanged in mergers while shares are bought in acquisitions (Sherman, 2011). In a merger, two companies of equal stature come together while an acquisition involves the fitting of a smaller company into an existing acquiring firm (Weber, 2013, p, 152). Q4: How can Mergers and Acquisitions add value to a company? Mergers and acquisitions add value to a company in various ways. For instance, many companies seek to acquire other firms so as to pursue and attain a growth strategy while others engage in mergers and acquisitions to utilise financial opportunities. Therefore, through mergers and acquisitions, a company grows its turnover, market share and profits. In cases where a company has more businesses than it wants, it sells off the unwanted businesses and remains with businesses that add value by fitting into the company’s strategic objectives. Mergers and acquisitions eliminate over-capacity of a company. Mergers and acquisitions also provide a company with opportunities to achieve a better growth rate, adding value to a company. This is made possible when a company is able to refinance its debts at a lower interest cost (Coyle, 2000, p, 8). Acquisitions add value to a company when acquiring companies seek to use culture in creating value through the use of high-visibility retention, promotion and structural organisational design decisions. This is because mergers and acquisitions enable companies to execute key components of their strategies as two companies work together, adding value (Vadapalli, 2007, p, 27). Pertaining to the market, mergers and acquisitions increase market power in the product market, especially to the acquiring firm. It is possible to coordinate prices across product lines, leading to an increase in joint profits (Jagpal & Jagpal, 2008, p, 507). In addition, it is possible to cut costs by reducing the prices that a merged firm incurs by reducing the prices that it pays to the firms from which it buys its raw materials and other inputs. This leads to an achievement of market power over suppliers, leading to an increase in profits. Firms that participate in mergers and acquisitions can increase their market power in the supply chain. This is possible when the acquired firm happens to control a scarce resource (Jagpal & Jagpal, 2008, p, 507). Acquiring firms normally add value to their acquisitions. This is because most acquiring firms are active portfolio investors. Such companies portray a high level of managerial improvement by offering general advice and reviewing capital expenditure decisions (Connell, 2008, p, 187). This is achieved when such companies exercise more leadership power due to synergy and adding personnel to underperforming companies that they acquire. In addition, acquiring companies develop and implement strategies at product line and strategic business unit levels to improve performance (Connell, 2008, p, 187). When companies engage in mergers and acquisitions, value is added in terms of the number of customers that such companies can reach out to (Frankel, 2013). For instance, before acquisitions, a firm usually has its own customer base, which might be limited. However, after a merger or acquisition, the number of customers increases because the acquiring firm can reach out to its own customers and the acquired firm’s customers. This means that mergers and acquisitions boost sales and increase profit, thus adding value to business. Some acquiring companies add value to the target company by improving its performance as a value-creating acquisition strategy. Such companies purchase another company and radically reduce costs so as to improve margins and cash flows. Sometimes, the acquiring companies take steps to accelerate revenue growth (Koller, Goedhart, & Wessels, 2010). According to Ray (2010), mergers and acquisitions have a main objective of producing synergy. Therefore, it is expected that after an acquisition or merger, overall efficiency should be improved. Value is added when both companies are able to reduce costs by using the same production facilities, for example. Mergers and acquisitions provide financial synergies by spreading the risk of the buyer’s investment portfolio, via acquisition of a new business area (Ray, 2010). Financial opportunities emerge because mergers and acquisitions extend companies, adding value. Mergers and acquisitions add value by creating operating synergies. For instance, two production facilities can be merged while knowledge can be transferred to create an operative synergy as know-how is increased. This is due to the combination of competencies and abilities of different corporate divisions (Ray, 2010). Value is also added as the strength of innovation increases by bringing company experts together at one location. Management synergies, which arise from mergers and acquisitions, also add value to an organisation. This is because competencies that can contribute to efficiency in an organisation are gained (Ray, 2010, p, 3). The acquiring firm’s management is believed to have superior capabilities, which can be used in adding value to a company after a merger or acquisition (Schiereck & Schertzinger, 2009, p, 29). Therefore, mergers and acquisitions provide opportunities that leverage synergies to increase shareholder value (Abrams, 2013, p, 8). Q5: What are the internal and external strategic options that companies can use to grow their business and create individual value? Growing a business and creating value for accompany is among the main growth objectives of most companies. Therefore, companies have to meet financial and strategic threshold standards so as to ensure that the business is creating value and pursuing an adequate strategy. For instance, companies use gold strategies as they pursue growth of their business and creation of value. This means that they focus on offering superior quality (Kontes, 2010, p, 37). Through acquisitions, companies that have been in the industry for long and whose demand has declined, reduce their excess capacity through sensible reallocation of resources. Acquisitions are external methods of enhancing growth and adding value for companies because they enable such companies to reduce excess capacity or put such companies in the hands of better owners or managers. This creates value of substantial nature for investors and for the economy, as a whole. Combination of cash flows leads to an increase in value through acquisitions (Koller, Goedhart, & Wessels, 2010, p, 431). However, to create value from mergers and acquisitions, the present value of synergies should be greater than the premium paid (Rappaport, 1999, p, 146). According to Business Standards (2009, p, 119), mergers and acquisitions allow companies to develop the capability to identify, evaluate, acquire and create value over a period of time. Merging with other companies or acquiring companies in part or whole adds value to a company because it provides an organisation to be led by knowledgeable people who are dedicated to ensure success (Johnson, 2001, p, 325; Saint-Onge & Chatzkel, 2009, p, 5). Divestitures add value to companies just like acquisitions. Therefore, managers should not delay divesting because this leads to loss of potential value creation. Instead, they should devote much of their time to divestments because divestitures create value during the time of announcement and in the long term. Owing to the “best owner” principle, the owner’s culture or expertise is not well suited for the needs of the divested business; value is created (McKinsey & Company, 2011, p, 82). Thus, general managers of various companies should seek to engage in divestitures when they want to create value. Selling off businesses that no longer fit the firm’s strategy, but are more worth to other businesses is a strategic goal. When a divested business emerges from under the umbrella of a larger corporate structure, it becomes profitable to the new owners and creates value (Colley, 2007, p, 372). In terms of internal strategic options that are available for the growth of business and creation of individual value, some firms add value by making timely decisions, pertaining to new product development so as to convert customer orders into deliveries earlier than their competitors. This creates value or the business and contributes to growth. Such companies provide unique value in the markets that they service. This value can translate into faster growth and higher profits (Clark, 2007, p, 43). In addition, some companies improve the quality of services and products that they offer to the market as an internal strategy of adding value and achieving growth for the company. When products and services are of high quality, customers purchase more of such products or demand more of the services. This in turn, leads to increased profits, which add value to a company and contribute to growth. Separately, other companies increase their size so as to add value and achieve growth. When company size increases, efficiency increases because operations are made more functional and effective. In additional, quantity produced increases as organisational size increases. This means that such companies will sell more by offering more variety to the market. More profits will be earned and this will help in adding to value that will translate to organisational growth. Increase of company size is associated with improvement of operations within a company. When operations are improved, productivity is also increased and these are vital elements of addition of value and company growth. A company’s workforce plays a significant role in production. Therefore, by ensuring that workers’ welfare is well managed. This increases productivity, which adds value to the organisation and contributes to growth. Consolidation is another internal strategy that companies use to add value and promote individual growth. Consolidation involves holding of market share in existing markets or expanding existing capacity. To hold the market, firms cut costs and prices in mature or declining marketing while expanding the existing capacity aims at pre-empting competition (Kachru, 2005, p, 235). Some companies opt to employ the strategy of market penetration to add value and achieve individual growth. Market penetration involves an increase in the market share of the same market. It involves investment in product improvement, advertising and channel development. At times, it is beneficial to acquire the businesses of competitors who are withdrawing from the market (Kachru, 2005, p, 235). Q6: What are the key factors that define strategy of an organisation? What is a strategy? Strategy is a pattern or plan that integrates a company’s major goals and defines the approaches that should be employed to achieve such goals (Letto-Gillies, 1996). Strategy is the determination of basic long-term goals and objectives that an organisation can adopt, together with courses of action and allocation of resources that are necessary to carry out these goals (Heracleous, 2003, p, 4). Strategy enables an organisation to compete effectively with its rivals in the market. It also contributes to the attainment of objectives and adds value, as well as, contributes to growth. However, various organisations adopt various strategies, as determined by unique factors. These factors are unique because they affect different organisations in different ways. Factors such as the organisation’s operating business environment influence organisational strategy. An organisation’s business environment is made up of political, economic, social, technological and legal factors, which influence the operation and performance of an organisation (Cadle, Paul, & Turner, 2010, P, 2). Companies do not operate in a vacuum, but rather in a market, which is characterised by factors such as competition, customer behaviour and resources. These factors form the main determinants of an organisation’s strategy. External factors such as competition and resources determine how the strategy of an organisation is designed. An organisation’s strategy is influenced by interactions of an organisation with its external environment, and this determines performance. In consideration of the external environment, an effective external strategy is designed to make use of an organisation’s capability and exploit the most favourable positions for the organisation in its environment. Competition pushes an organisation to design a strategy that will guarantee competitive advantage (Coffey, 2010, p, 89). Public policy influences an organisation’s strategy and the direction of such an organisation. Other factors such as legislation, firm investments and consumer spending may determine the kind of strategy an organisation has to adopt (Kliewe, Meerman, & Baaken, 2013). Availability of resources as major inputs for production purposes influences organisational strategy. Another factor that determines an organisation’s strategy is the mission of the organisation. By analysing the external and internal environment in consideration of an organisation’s mission, an organisation has to employ various components in designing a relevant strategy. This means that an organisation has too design a strategy that is consistent with conditions in the competitive environment, which should be realistic with the internal resources and capabilities of an organisation. In addition, an organisation should ensure that it formulates and implements its strategy carefully so that it can be possible to control the execution of the strategy (Hiriyappa, 2008, p,19). Customers are present a very crucial factor that determines an organisation’s strategy. Success of an organisation is majorly determined by its ability to satisfy its customers. Therefore, a strategy that guarantees high responsiveness and flexibility should be formulated and implemented so as to achieve organisational effectiveness. Given the global competition, reliability on performance and a need for precise methods of production, an organisation should treat its people as a key factor. This means that formulated strategies should incorporate development of people, allow for cooperation and teamwork, foster commitment and increase flexibility and responsiveness (ACAS, 2012). Q7: What is a value manager and how can he implement the value based approach? A value manager is a manager who focuses on cash flow returns in the long run. A value manager is also value oriented in corporate activities. This ensures that business activities generate more earnings than their opportunity cost of capital. Therefore, value managers focus on maximizing wealth creation and shareholder value in the long run. A value manager analyses the functions of systems and facilities of an organisation to achieve the essential functions at the lowest life-cycle cost, consistent with the required performance and quality (Stanford Linear Acceleartor Center, 2007, p, 3). Value managers are required to identify and utilise key value drivers in each business activity that they engage in, act on any opportunities that create incremental value and ensure that value is the main philosophy that an organisation pursues. Value managers can implement a value based approach by employing various techniques. First, they should understand activities, competencies and resources as the key value generators. A value manager then seeks to invest in opportunities that enable him or her to integrate organisational resources, competencies and activities so as to add value. A value manager improves and maintains a desirable balance between stakeholders’ needs and wants and the resources required to satisfy them. A value manager should focus on objectives before solutions and take more time in enhancing innovation. A value manager implements a value based approach by applying human talent and other resources to address diverse changes within the environment and organisation. Therefore, a value manager should strike a balance between the organisational environment and its people (The Institute of Value Management, 2013). A value manager implements a value based approach in an organisation by making viable, long term investment decisions. These decisions include acquisitions, divesture and adoption of internal strategic approaches. These approaches contribute increase in productivity, improvement of quality and performance, elimination of waste and enhanced competitiveness and profitability, which add value to value to an organisation (Bone & Law, 2013). A value manager makes better strategic decisions for an organisation. When a manager makes strategic decisions for the good of the organisation, it is possible to exploit a company’s resources and capabilities to deliver value for the customer. This contributes to creation of value in the long run. Finally, a value manager implements the value based approach by seeking to achieve company profitability, growth and value creation. Profitability contributes to long term sustenance of organisational performance. In turn, this leads to organisational growth and addition of value. Therefore, a value manager plays a very crucial role implementing a value based approach in an organisation. References Abrams, H., 2013. Mergers and Acquisitions: How do you Increase the Value of Two Companies Joined Together? eprentise , 1-8. ACAS., 2012. Effective Organisations: The People Factor. [Online] Available at: [Accessed 24 April, 2014]. Bone, C., & Law, M., 2013. Value Management - The Best Practice Approach for Maximising Productivity Performance & Value for Money. Department of Trade and Industry, 1-12. Business Standards., 2009. Business Standard India 2009. New Delhi: Business Standard Books. Cadle, J., Paul, D., & Turner, P., 2010. 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