VD Dissertation

Business School
WELL-BALANCED MANAGEMENT OF KEY FINANCIAL
VALUE DRIVERS THROUGH VALUE CREATION
STRATEGIES AND ITS IMPACT ON SHAREHOLDER VALUE
MAXIMIZATION AND INVESTORS’ APPRECIATION
Teesside University Postgraduate Management (MSc) Dissertation:
H8145246
Ross Novak

AIM:
The purpose of this dissertation is to examine how the key financial value drivers can affect the
shareholder value, what the proper management of these drivers should be implemented in pursuing
value-maximizing goal and to which extend the value-based management is applied within the
current manufacturing industry.
RESEARCH QUESTIONS:
1) Is the shareholder value maximization approach observable from historical performance and
what relationship can be found among the core value drivers?
2) Which metrics can be used in performance targets and performance evaluation?
3) How sensitive to the shareholder value can be a variation of each of value drivers in building
long-term prospect?
4) What factors can cause value destroying and how can the issues defined in ‘Agency Theory’ be
avoided?
5) Can value drivers be used as a benchmark in comparative analysis of strategic position?
6) Do today’s managers use the value-based approach or do they rather focus on enhancing return
on investment?
7) What alternative strategies would improve investors’ anticipation and enhance the shareholder
value added?
8) Which strategy options associated with the key value drivers motivate the greatest corporate
value by selected companies?
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ABSTRACT:
An appropriate management of financial value drivers is crucial for the enhancement shareholder
value and for that reason, the concept of value-based management, which creates a sustainable
competitive advantage and a consistent ‘value culture’ is the principal element of this study. This
managerial approach is contrasted with the profit maximization view, which encourages under-
investment rather than creates long-term value. This research project deals with shareholder value
analysis, financial value driver management and growth-setting objectives with the central goal of
maximizing discounted future cash flow. In particular the cash generating abilities, expected by
investors, have been expressed via calculated shareholder value added serving as a criterion for
consideration of such strategy options that will lead to the greatest corporate value. Calculation
based on estimated cash flows discounted by cost of capital and derived from a perpetuity method
has been also supported by alternative value-creation metrics (valuation through economic profit and
stock market valuation) resulting to similar conclusions with a value creation bias. The ‘Agency
Theory’ (relating to destroying value), the investment appraisal (based on Threshold margin
calculation) and international differences between stakeholders’ view and shareholders’ concerns
have been also included in this work. The hypothetico-deductive research method with
methodological pluralism has been used in this dissertation combining both descriptive and
correlational study for better understanding of the characteristics of variables influencing a
phenomenon of interest - shareholder value of the company.
ACKNOWLEDGEMENTS
This postgraduate dissertation was completed at Teesside University as part of MSc Management
degree. I would like to thank Alexander Finlayson, for his encouragement and help with regards to
his observations that have contributed to the comprehensive concept and methodology as my
dissertation advisor and my daughter Lenka for being so awesome and supportive.
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CONTENTS:
Aim, Research Questions…………………………………………………………………………. і
Abstract, Acknowledgements…………………………………………………………………..….ii
List of Figures……………………………………………………………………………….…..viii
List of Tables, List of Graphs……………………………………………………………………….…….ix
1. Rationale………………………………………………………………………………….. 10
2. Theoretical Underpinning……………………………………………………………….. 12
2.1. Two Concepts: Profit Maximization vs. Value Maximization …..12
2.2. International Diversity in Setting Company’s Goal…..13
2.3. Earnings-Based Management…..13
2.3.1. Shareholder Value Approach and SVA…..16
2.3.2. Principles of Valuation…..17
2.3.3. Financial Value Drivers…..19
2.3.4. The Growth Strategy…..21
2.3.5. Capabilities as the Sources for Creation Value…..22
2.3.6. Growth-Setting Objectives…..23
2.3.7. Value-Creation Metrics…..24
2.3.8. Value Management…..26
3. Methodology…………………………………………………………………………………..27
3.1. Research Method…..27
3.2. Research Design…..29
3.3. Sample Design…..30
3.4. Questionnaire Design…..32
3.5. Statistical Analysis of Data…..33
3.6. Empirical Work…..34
3.6.1. Framework in Part 1…..35
3.6.2. Framework in Part 2…..38
4. Interpretation of the Results…………………………………………………………………39
4.1. Evaluation in Part A…..39
4.2. Evaluation in Part B…..51
4.3. Stock Market Indicators…..54
4.4. Value Destroying Analysis…..55
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4.5. Appreciated Share Price…..57
4.6. Market Position Analysis…..59
4.7. Questionnaire Appraisal…..60
5. Discussion and Conclusion…………………………………………………………………..61
References………………………………………………………………………………………..63
Appendix 1: Tables 1 – 19.11
TABLE 1: Historical secondary data Hamworthy Plc. extracted from FAME
TABLE 2: Identification characteristic value drivers – Hamworthy Plc.
TABLE 3: Assumptions proposed
TABLE 4: Current policy (strategy option ‘zero’) – Hamworthy Plc.
TABLE 5: Value driver management (strategy option 1) – Hamworthy Plc.
TABLE 6: Investing – Threshold Spread
TABLE 7: Management of 3 rd Driver – Investment (strategy options 2,3,4) – Hamworthy Plc.
TABLE 7.1: SVA generated through different investment appraisals – Hamworthy Plc.
TABLE 7.2: Setting objectives (strategy option 5) – Hamworthy Plc.
TABLE 7.3: Setting objectives (strategy option 6) – Hamworthy Plc.
TABLE 7.3.1.: Summary of SVA achieved under different objectives – Hamworthy Plc.
TABLE 7.4: Cutting investment without declining sales growth (strategy 7) – Hamworthy Plc.
TABLE 7.5: Cutting investment with declined sales growth (strategy option 8) – Hamworthy Plc.
TABLE 7.6: Adverse effect of cutting investment (strategy option 9) – Hamworthy Plc.
TABLE 7.7: Rationalization (strategy option 10) – Hamworthy Plc.
TABLE 7.7.1 : Cost reduction alternatives – Hamworthy Plc.
TABLE 7.8: Sensitivity of DCF, NOPAT and SVA (summary) – Hamworthy Plc.
TABLE 8.1: Accounting-led growth (15% cut) – Hamworthy Plc.
TABLE 9.1: SVA maximization - Investment to increase sales growth (25%, 12%, 35%)
TABLE 9.7: SVA maximization - Investment to improve margin (20%, 15%, 35%)
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TABLE 9.11: SVA maximization - Investment to improve margin (20%, 27%,75%)
TABLE 9.13: SVA maximization – Investment to both drivers (20%,15%,35%)
TABLE 9.19: Summary: Value Maximization – Hamworthy Plc.
TABLE 10: The stock market’s valuation – Hamworthy Plc.
TABLE 11.1: EP-valuation using performance spread method (15%,7%,25%)
TABLE 11.2: EP-valuation using performance spread method (predicted performance)
TABLE 11.3: EP-valuation using the profit less capital charges method
TABLE 11.4: EP-valuation under different drivers (20%,12%,25%)
TABLE 11.5: EP calculated for different driver management– Hamworthy Plc.
TABLE 11.6: Two methods in comparison – Hamworthy Plc.
TABLE 12: Comparative analysis of historical performance of selected companies
TABLE 13.1: Historical value drivers within monitoring period – Hamworthy Plc.
TABLE 13.1.1.: Historical value drivers within pre-monitoring period – Hamworthy Plc
TABLE 13.2: Historical value drivers within monitoring period – Spirax-Sarco Engineering Plc.
TABLE 13.2.1: Historical value drivers within pre-monitoring period – Spirax-Sarco Engineering
TABLE 13.3: Historical value drivers within monitoring period – Weir Group Plc.
TABLE 13.3.1: Historical value drivers within pre-monitoring period – Weir Group Plc.
TABLE 13.4: Historical value drivers within monitoring period – HC Slingsby Plc.
TABLE 13.4.1: Historical value drivers within pre-monitoring period – HC Slingsby Plc.
TABLE 13.5: Historical value drivers within monitoring period – 600 Group Plc.
TABLE 13.5.1: Historical value drivers within pre-monitoring period – 600 Group Plc.
TABLE 13.6: Historical value drivers within monitoring period – Clyde Process Solutions Plc.
TABLE 13.6.1: Historical value drivers within pre-monitoring period – Clyde Process Solutions Plc.
TABLE 13.7: Historical value drivers within monitoring period – Pressure Technologies Plc.
TABLE 13.7.1: Historical value drivers within pre-monitoring period – Pressure Technologies Plc.
TABLE 13.8: Historical value drivers within monitoring period –Mount Engineering Plc.
TABLE 13.8.1: Historical value drivers within pre-monitoring period – Mount Engineering Plc.
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TABLE 13.9: Historical value drivers within monitoring period – MS International Plc.
TABLE 13.9.1: Historical value drivers within pre-monitoring period – MS International Plc.
TABLE 13.10: Historical value drivers within monitoring period – Gas Turbine Efficiency Plc.
TABLE 13.10.1: Historical value drivers within pre-monitoring period – Gas Turbine Efficiency
Plc.
TABLES 14.1-14.10: Value drivers predicted – equilibrium position and confidence limits
TABLES 15.1-15.10: Valuation selected companies using anticipated value drivers
TABLE 16.1-16.10: Stock market’s valuation versus calculated value
TABLE 16.11: Summary
TABLE 17: Value-destroying analysis – 600 Group Plc.
TABLES 18.1-18.2: Positioning – strategic control charge (MBR-size relationship)
TABLE 19.1: Share Prices
TABLES 19.2-19.11: Investors fundamentals
Appendix 2: Graphs 1A – 81A
GRAPH 1A: Earning Performance – Hamworthy Plc.
GRAPH 2A: NOPAT – Hamworthy Plc.
GRAPH 3A: Sales Volumes – Hamworthy Plc.
GRAPH 4A: Changes in Incremental Sales - Hamworthy
GRAPH 5A: Total CF from Operative/Investing Activities - Hamworthy
GRAPH 6A: Investing and ROCE - Hamworthy
GRAPH 7A: Historical/Future NCF - Hamworthy
GRAPH 8A: Cumulative and Continuing PV - Hamworthy
GRAPH 9A: Enterprise Value - Hamworthy
GRAPH 10A: SVA within Forecast Period - Hamworthy
GRAPH 11A: SVA Generated from Different Investments - Hamworthy
GRAPH 12A: Cumulative DCF and PV of Continuing Corporate Value - Hamworthy
GRAPH 13A: Proportion of DCF and CV – Hamworthy (in percent)
GRAPH 14A: SVA Creation within Forecast Period - Hamworthy
GRAPH 15A: Economic Profit and DCF Valuation in Comparison
GRAPH 16A: Economic Profit Calculated for Different Drivers
GRAPH 17A: Operating Profit after Tax in Comparison
GRAPH 18A: Free CF in Comparison
GRAPH 19A: 1st
Driver – Sales Growth in Comparison
GRAPH 20A: 2nd
Driver – Operating Profit Margin in Comparison
GRAPH 21A: 3rd
Driver – Investment in Comparison
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GRAPH 22A: Hamworthy – Profit/CF
GRAPH 23A: Spirax-Sarco Engineering – Profit/CF
GRAPH 24A: Weir – Profit/CF
GRAPH 25A: HC Slingsby – Profit/CF
GRAPH 26A: 600 Group – Profit/CF
GRAPH 27A: Clyde Process Solution – Profit/CF
GRAPH 28A: Pressure Technologies – Profit/CF
GRAPH 29A: Mount Engineering – Profit/CF
GRAPH 30A: MS International – Profit/CF
GRAPH 31A: Gas Turbine Efficiency – Profit/CF
GRAPH 32A: Hamworthy–Historic Drivers
GRAPH 33A: Spirax Sarco Engineering-Historic Drivers
GRAPH 34A: Weir Group-Historic Drivers
GRAPH 35A: Slingsby-Historic Drivers
GRAPH 36A: 600 Group-Historic Drivers
GRAPH 37A: Clyde Process Solution-Historic Drivers
GRAPH 38A: Pressure Technologies-Historic Drivers
GRAPH 39A: Mount Engineering-Historic Drivers
GRAPH 40A: MS International- Historic Drivers
GRAPH 41A: Gas Turbine Efficiency- Historic Drivers
GRAPH 42A: Hamworthy-‘Strategy Triangles’
GRAPH 43A: Spirax Sarco Engineering-‘Strategy Triangles’
GRAPH 44A: Weir Group-‘Strategy Triangles’
GRAPH 45A: HC Slingsby-‘Strategy Triangles’
GRAPH46A: 600 Group-‘Strategy Triangles’
GRAPH47A: Clyde Process Solution-‘Strategy Triangles’
GRAPH48A: Pressure Technologies-‘Strategy Triangles’
GRAPH49A: Mount Engineering-‘Strategy Triangles’
GRAPH50A: MS International-‘Strategy Triangles’
GRAPH51A: Gas Turbine Efficiency-‘Strategy Triangles’
GRAPH52A: Hamworthy-‘Value Gaps’
GRAPH53A: Spirax Sarco Engineering-‘Value Gaps’
GRAPH54A: Weir Group-‘Value Gaps’
GRAPH55A: HC Slingsby-‘Value Gaps’
GRAPH56A: 600 Group-‘Value Gaps’
GRAPH57A: Clyde Process Solution-‘Value Gaps’
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GRAPH58A: Pressure Technologies-‘Value Gaps’
GRAPH59A: Mount Engineering-‘Value Gaps’
GRAPH60A: MS International-‘Value Gaps’
GRAPH 61A: Gas Turbine Efficiency-‘Value Gaps’
GRAPH 62A: Stock Market Valuation
GRAPH 63A: MBR-CBR Relationship
GRAPH 64A: 600 Group-Sales Growth
GRAPH 65A: 600 Group-Incremental Increases/Decreases of Sales
GRAPH 66A: 600 Group-Profit Margin
GRAPH 67A: 600 Group-Operating Margin
GRAPH 68A: 600 Group-Investment
GRAPH 69A: 600 Group ROCE (%)
GRAPH 70A: Hamworthy: EPS-Share Price
GRAPH 71A: Spirax-Sarco Engineering: EPS-Share Price
GRAPH 72A: Weir Group: EPS-Share Price
GRAPH 73A: HC Slingsby: EPS-Share Price
GRAPH 74A: 600 Group: EPS-Share Price
GRAPH 75A: Clyde Process Solution: EPS-Share Price
GRAPH 76A: Pressure Technologies: EPS-Share Price
GRAPH 77A: Mount Engineering: EPS-Share Price
GRAPH 78A: MS International: EPS-Share Price
GRAPH 79A: Gas Turbine Efficiency: EPS-Share Price
GRAPH 80A: Strategic Control Charge: MBR-Size
GRAPH 81A: Strategic Control Charge: CBR-Size
Appendix 3: EP – Based Valuation
Appendix 4: Questionnaire Form & Response Analysis
Appendix 5: List of Companies
LIST OF FIGURES
FIGURE 1: Drivers of Value……………………………………………………………………20
FIGURE 2: Two Routes to Value Creation……………………………………………………..22
FIGURE 3: Rappaport’s Free Cash Flow……………………………………………………….25
FIGURE 4: Options Opened to Managers………………………………………………………26
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FIGURE 5: Hypothesised Casual Relationships………………………………………………...34
LIST OF TABLES:
Table 1: Strategy Options Used in Value-Drivers Management……………………………….36
Table 2: Value Maximization Options………………………………………………………….37
LIST OF GRAPHS:
GRAPH 1: Share Price Movement – Hamworthy………………………………………………40
GRAPH 2: Enterprise Values under Different Strategies………………………………………42
GRAPH 3: Shareholder Value under Different Strategies……………………………………...43
GRAPH 4: DCF Profiles within the Planning Horizon ………………………………………..44
GRAPH 5: NOPAT Profiles within the Planning Horizon………………………………….….45
GRAPH 6: SVA under Proposed Strategic Options – Hamworthy ……………………………46
GRAPH 7: Future CF Generated under Different Rationalizations-Hamworthy………………46
GRAPH 8: SVA under Different Cost Reductions-Hamworthy………………………………..47
GRAPH 9: Value Maximizing Options according to the highest SVA-Hamworthy…………...48
GRAPH 10: Valuation Using Economic Profit-Hamworthy…………………………………….49
GRAPH 11: Valuation Methods in Comparison-Hamworthy……………………………………50
GRAPH 12: ‘Strategy Triangles’-Hamworthy…………………………………………………...52
GRAPH 13: ‘Value Gaps’-Hamworthy…………………………………………………………..53
GRAPH 14: ‘Value Gaps’-Gas Turbine Efficiency………………………………………………54
GRAPH 15: ‘Value Gaps’-600 Group……………………………………………………………55
GRAPH 16: Sales Growth/Shrink-600 Group……………………………………………………56
GRAPH 17: Operating Margin-600 Group……………………………………………………….56
GRAPH 18: Investment-600 Group………………………………………………………………56
GRAPH 19: Historical Share Price (LSE)………………………………………………………..57
GRAPH 20: EPS/Share Price Relationship-Hamworthy…………………………………………58
GRAPH 21: P/E Ratio Comparison………………………………………………………………59
GRAPH 22: Strategic Control Charge: MBR-Size……………………………………………….60
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1. RATIONALE:
This dissertation is concerned with the shareholder value creation as a paramount goal of a company
that seeks superior competitive position on the market and long-term success ensuring stability even
in such dynamic time as we are experiencing today. Therefore the key financial factors affecting a
company’s value most will be identified and an efficient driver management will be examined.
Hence, according to this the firm’s aim, hence, must be wealth maximization through financial value
drivers which will ensure the maximal possible total share return in performance. For that reason,
investors could be interested in such study in particular; however executives should be also
concerned since they must handle the value drivers a day-to-day basis. Based on an assumption that
many companies are driven by profit and short-run ‘effects’ rather than by long-term sustainability,
this work emphasises managers’ own interest in the ‘always the best results’ approach and
recognises profit maximization under short-term strategies in companies operating in real business
environment. Furthermore, some managers’ conviction that maximizing profitability under earnings-
based approaches pursues maximizing shareholder value is supposed by the researcher to be as quite
often a conjecture that should be tested, proved and explained. The importance of this research area
is great since managers could realise through dissertation findings that although their actions are
evaluated on the base of annual performance the investors’ value anticipation will finally determine
the success achieved by these managers. Thus they should be focusing on consequences arriving
from their decisions in a longer than annual period. The useful demonstrations of value driver
handling containing in this project can be beneficial to them as guidance in decision making. On the
other hand, shareholders’ benefit for shareholders from this project can be seen in helping to
understand and appreciate the ‘real’ performance of their investment related to stock price. In
particular the shareholder approach to strategy will be investigated in this essay by seeking the
historical performance of selected companies and predicting companies’ capabilities to govern such
value drivers that may generate future net cash flow (NCF) and maximize the profit over the long
term. However, creating value is more than just an acceptance of value maximization as the
organizational objective. This is the corporate scorecard that managers use to assess a success or
failure of the company. It must, in any case, be complemented by a corporate vision and strategy.
This project is based on the researcher’s conviction that an organization can only maximize value if
its managers do not ignore the interest of its shareholders.
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Like the rest of us, corporate managers have many personal goals and ambitions, only
one of which is to get rich. The way they try to run their companies reflects these
personal goals. Shareholders in contrast, deprived of the pleasures of running the
company, only care about getting rich from the stock they own. Hence, when managers
ignore profits to keep up traditional lines of business, conflicts are bound to arise. Where
other checks on management failed, hostile takeovers could now wrest control from
managers who ignored the interests of their shareholders. More so than ever before, fear
of such disciplinary takeovers has forced managers to listen to shareholder wishes.
Ironically, making acquisitions is often just the quickest and easiest way for managers to
expand the scope of their control by directing the firm’s cash flows into new ventures.
Shleifer and Vishny (1988, p. 7)
This dissertation provides the clarification what is the proper link is between value drivers related to
the value added and how to deal with them to maximize shareholder value in an efficient way. This
is done through proposals of strategic options designed by researcher and via the value-based
management (VBM) aiming to achieve a maximal shareholder value. This framework will allow
managers to understand how their activities are directly linked to company’s cash flows and how
these cash flows, in turn, determine the long term value of the company appreciated by investors.
VBM combines financial and strategic management techniques to create sustainable competitive
advantage based on corporate capabilities and consistent ‘value culture’ with singular focus on
value. The ‘know-how’ acquired from dissertation findings can be useful in making future decisions
related to the proposed strategy options and in comparative analyses of value indicators. The
solution leading to an investors’ satisfaction should be in encouraging of managers to find the best
VBM by using measures of the value drivers effectively and by an ability to foresee those drivers
that will affect the future business operations and value anticipation.
Many companies now acclaim the virtues of maximizing shareholder value in their
mission statements, annual reports, and investor communications but fail to fully exploit
the potential wealth creation from a value-based perspective. Many fail to see any direct
connection between their businesses. Understanding the relationship between strategy,
finance, and company value is the key to making consistent value-enhancing decisions.
Morin and Jarrell ( 2001)
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Nevertheless, the main challenger is a ‘stakeholder theory’, which argues that a corporation exists
for benefit not only investors but all its major constituencies—employees, customers, suppliers, the
local community, and the government, as well as shareholders. The success of a corporation under
VBM could be assessed simply by its long-run return to shareholders, whereas under stakeholder
theory a company's success would be judged by taking into account of its contributions to all its
stakeholders (Wallace, 2005). Various measures of corporate success in satisfying non-investor
stakeholders can be investigated by future research as an extension to this dissertation as well as an
investigation whether a broader focus on multiple stakeholders is necessarily inconsistent with the
pursuit of long-term shareholder value. Cassidy reminds that in order to rebuild the trust of the
individual shareholders, employees, and the public, corporations must focus less on maximizing
shareholder value in the short-term and more on optimizing shareholder value through building
strong relationships with all the stakeholders avoiding to sacrifice them. The critical relationships
with employees, customers, suppliers and the community involved in its business will only destroy
the long-term shareholder value (2003). Also, this work may be a complementary work to a previous
study "Corporate governance, managerial strategies and shareholder wealth maximization: a study
of large European companies" undertaken by Dockey and Herbert, who refer to research on
managerial attitudes for maximizing shareholder value and pressures to align the interests of
directors and shareholders. It reports a survey of executives in 175 large firms in seven EU countries
and it analyses their strategies (2000).
2. THEORETICAL UNDERPINNING:
Grant states that business is about creating value that can be created by the physical transformation
of products and commerce creates value by repositioning them in space and time. He also explains
that the difference between value of a firm’s output and the cost of its inputs is value added which is
then distributed among stakeholders - owners, lenders, employees, government (2002). This is the
first issue, with which a successful management will have to deal in order to balance the interest of
the different stakeholders. The stakeholder approach, which tries to balance often conflicting
interests of multiple groups, can be found, for example, in continental Europe (Germany, France).
This approach sees the firm as a social institution. However, in Anglo-Saxon countries (UK, US) the
shareholder approach prevails differing in companies’ legal obligations – management is required to
act exclusively in the interest of company’s owners.
2.1. Two Concepts: Profit Maximization vs. Value Maximization
Firstly, a clear explanations of the shareholder value (SV) concept, value creation mechanism and
especially a fundamental difference between two distinctive strategies pursued by managers
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(maximizing profitability under earnings-based management and maximizing shareholder value
implemented by value-based managerial approach) is necessary. Value-based management is
founded on the assumption that investors value shares according to the strategy of the firm, its
organizational capabilities and its financial functions (Arnold, 2008). The share price starts to rise as
investors perceive a greater shareholder value focus. Hence the primary objective should be long-
term value maximization (consequently leading to shareholder wealth maximization), focusing on
identifying growth opportunities and building competitive advantage. (Doyle, 2000). It should be
pointed out that shareholders are interested in the flow of dividends over a long time horizon and not
necessarily in a quick payback. Retaining profit within the business invested in firm’s development
via, for example R&D programme, will produce higher dividends associated with a long-term
perspective. In contrast the short-term attitude of maximizing profitability is aimed at cutting costs
and reducing assets to produce quick improvements in earnings, which fails to invest and erodes a
company’s long-term competitiveness and destroys its economic value (2000).
2.2. International Diversities in Setting the Company’s Goal:
The key role of an effective management is to balance the interest of different groups involved in a
business. According to the stakeholder approach the goal of a firm should be based on the
recognition that the company pursues the interest of multiple parties. In some countries such as
Japan, France, or Germany, the notion of corporations balancing the multiple interests has a long
tradition (Grant, 2002). The differences between stakeholder view and the shareholder approach are
reflected in international issues and firms’ legal obligations. Grand further demonstrates that
executives in UK or US are required to act in the interest of shareholders, French boards are required
to pursue the national interest, and successful German managers are required to include
representatives of main parties, shareholders and employees (38). Wheeler argues two forms of
power sharing developed in North American and European board rooms. The first is the growth of
non-executive directorship ensuring the accountability of the executive to the investors. The second
form of formal power sharing, according to Wheeler, inclines the balance away from the shareholder
control model through the development of supervisory councils – most notably in Germany. The
continental European Supervisory Council model is made more powerful by including not only
representatives of workers and trade unions, but also the banks. In Scandinavian corporations there
will be a unitary board rather than a separation of executive and supervisory functions where
directors sit on boards alongside nonexecutives from outside the company (1997).
2.3. Earnings-Based Management
The ambiguity of the maximizing-accounting-profit concept is apparent immediately after a
consideration of what kind of profit should be used in calculations, and how it is to be measured – to
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maximize total profit, margin on sales (profit as a ratio), return on assets, or return on equity.
Ranking of companies by performance depends on how profitability is measured. The goal to
maximize total profit may encourage investment in activities that are profitable but returns usually
fall below the cost of capital (Grant). Maximizing the rate of profit, on the other hand, encourages a
reduction of assets focusing only on a few profitable activities. A company must also consider
several issues before profit can be measured with regards to which items it expenses and which it
capitalizes, the depreciation methods uses, how it values its assets, and how it deals with
extraordinary items (2002). Arnold cites that reasons why accounting profit may not represent the
shareholder wealth and why it cannot be a sufficient benchmark for comparative analyses. He argues
that the profit figures fail to reflect the potential of the firm and that stock market will give a higher
share value to the company which will show the greater future growth outlook. A company’s
prospect must be at the forefront of managerial decisions over short-term approaches causing
sacrificed long-term prospect. Organizations may report identical historic profit figures, although
they can have both different future prospects anticipated through share price and the same
accounting returns. A company’s performance can indicate the volatile profit figures which are
subject to much greater risk than steady returns. Investors are likely to value the firm with stable
income flows more highly than volatile one (2008). A big issue is, according to Arnold, that earnings
are arbitrary and easily manipulated by management and thereby profit can vary depending on
multitude of judgements resulting in completely different ‘bottom line’ figures. These results then
provide distorted views of the potential of the firm. For instance earning per share as an indicator of
success fails since the investment needed to generate the growth is excluded from the calculation.
The additional debtors and inventory are included as an asset in the balance sheet yet not as a cost in
the profit and loss account. The time value of money is also excluded from the calculation and even
growth in earnings can destroy the value if the rate of return earned on additional investment is less
than the required rate. Managers should not forget that money has a opportunity cost and that
investors will always value shares by the estimation of discounted cash flows. What shareholders
want is a return greater than the return available elsewhere for the same level of risk (2008). Focus
entirely on earnings fails because of another aspect - a risk that is ignored in calculations. Some
business activities that generate growth in earnings are subject to higher level of risk requiring a
higher discount rate. For investors these risky strategies are worth less than safe ones (less-earning
based). The Financial Time’s Lex column interpreted a view about the measure of earning per share
(EPS):
“ EPS is the main valuation yardstick used by investors……but EPS is not a holy grail in
determining how well a company is performing….it is because EPS growth says little
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about whether a company is investing well and managing its assets effectively….but unless
the return on investment exceeds the cost of capital, a company will be destroying value”.
Financial Times (1996, Lex column)
The column has also expressed the major problem with using return on capital employed within
metrics of performance when the profit figure are combined with balance sheet asset figures:
“The figures for return on capital employed that can be derived from a company’s
accounts are virtually useless. Here the biggest problem is not so much the reported
operating profit as the figures for capital employed contained in the balance sheet. Not
only are assets typically booked at historic cost, meaning they can be undervalued if
inflation has been high since they were acquired; the capital employed is also often
deflated by write offs.
Financial Times (1996, Lex column)
A further problem, according to Arnold, is the way of capitalization, when an item of expenditure
(for instance spending on R&D) can be written off against profit as an expense or taken on to the
balance sheet and capitalised as an asset. Finally, he has concluded that it is not true that
shareholders do focus on EPS because they are primarily interested in the long-term cash flows
returns in the future (2008, 632). He also stated that over two-thirds of the value of a company’s
share is determined by income to be received in a couple years hence and he even stated that many
of the quoted companies are not expecting any positive earnings in the next a few years yet they are
highly valued in the market (634). If investors examine the cash flow they are able to recognize
whether shareholder value is created. Doyle says: “Profits are an opinion, cash is a fact” (2000, 26).
He continues that none of the manipulations and adjustments made in accountant procedures has any
effect on the company’s cash flow or economic value, which is the discounted value of the
anticipated cash flows. Shareholder value, therefore, will increase only if return on investment will
exceed the cost of capital used in the discounted process (2000). Unfortunately, despite this,
managers still erroneously believe that if they focus on enhancing return on investment (ROI) and
return on equity (ROE) the share price will automatically increase its value. Nevertheless, it is wrong
to concentrate exclusively on profits producing a short-term view ignoring the future implications in
sense of boosting current earnings. This approach will consequently erode market share, future
earnings and the company’s prospect entirely. Finally, this managerial attitude finally discourages
growth-oriented strategies that may increase long-term competitiveness. ROA is not correlated with
value and ROE has yet another one problem when it is calculated as the proportion of assets
financed by debt rather than equity (28). Managers are familiar more with accounting earnings since
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they are easy to calculate, however all valuation measures based on earnings data (EPS, P-E,
margins) and performance standards (ROCE, ROA, ROE) have fundamental weaknesses, according
to Doyle. Their measurement is then subjective and conceptually inappropriate because they do not
measure changes in value taking in the account results from past activities. Value changes are
principally based on future activities with predicted cash flows.
2.3.1. Shareholder Value Approach and SVA
When a company pursues a strategy that will build a sustainable competitive advantage, the
investors will appreciate it and the firm’s value will rise. The stock market value of corporation’s
shares is based on investors’ expectations of the cash generating abilities and a judgement on the
expected financial performance is reflected on its market-to-book ratio (MBR). This ratio measures
how successful management has been in maximizing shareholder value. Value is created when the
market value of the shares exceeds its book value stated in the balance sheet. Doyle explains that the
main determinant of market value is the ability of managing profitable investment opportunities
(2000). When a weak MBR indicates a ‘value gap’ (difference between the appreciated value and
current value) the existing management is not doing well and requires alteration. Lowell suggests
that companies can be categorized into four groups: the vulnerable group (with small amounts of
financial capital and generating low returns), the complete control group (generating high returns
and with high market shares), the group with limited control through performance (high returns from
relatively small amounts of invested capital), and the group with limited control through size (large
companies producing low returns on capital, but difficult to acquire) (1998). Shareholder value
analyses (SVAs) allow the determination of which strategy is more likely to increase the market
capitalization and help explore where a particular strategy lies on the strategic vulnerability map.
The issue is whether a planned strategy moves the firm towards the area of ‘complete control’ or
increased ‘vulnerability’. SVAs are becoming the new standard as opposed to a short-term view of
accountant-based management encouraging an under-investment, and ignoring intangible assets. It
provides an effective tool for investigating shareholder value added from given value drivers:
growth, profit margin and investment. The core of SVA is the principle that economic value is
created purely when operations earn a return on investment that exceeds its cost of capital (Doyle,
2000). SVA is future oriented with a tendency to encourage the long-term effects of investment
projections. Maximization of shareholder value means maximization of future net cash flow and
minimization of cost of capital. Discounting reflects that money has a time value and also allows for
risk that is reflected in the cost of capital. The current share price reflects both the values derived
from past decisions (profit in time before plan period) and shareholders’ expectations (predicted cash
flow from future activities). Grant said that the key merit of the shareholder value approach is its
consistency (2002, 48).
17

2.3.2. Principles of Valuation
Most companies pay only a fraction of net profits (or none) in dividends. According to Grant,
shareholders are concerned more with the total return on their share (dividends plus stock market
valuation). The major part of shareholder return is the appreciation on the market value of those
shares. Hence, shareholders are more interested in maximizing the stock market value than in annual
payment of dividends (2002, 44). The shareholder return provides an indicator of the success of the
management effort in increasing the discounted cash flow and valuation is strongly influenced by
perceptions, ‘market psychology’ and market dynamics. ROCE (or alternative ROA, ROI) remains
the predominant measure of the past performance and cash flow rather than profit being the relevant
performance measure. Valuing companies by discounting economic profit, in practice, should give
the same result as by discounting net cash flow. The difference only consists of the treatment of the
capital consumed (seen in economic profit calculation presented in Appendix 3). Discounting cash
flow methods are the most satisfactory approach to pursuing shareholder value maximization,
although expected cash flow far into the future may be difficult to estimate for inexperienced
managers. The most feasible approach is to recognize and understand the factors that determine a
firm’s future cash flow in order to select the strategy that offers the best prospect of maximizing
shareholder wealth (Grant, 2002). The central concept of valuation of companies, according to
Doyle, is in the determination of a company’s share price as the sum of all its anticipated future cash
flows, adjusted by the cost of capital. If generating more cash is expected due, for example, to a new
growth strategy, its share price will increase. Doyle remains that the crucial task of management is to
maximize the sum of these future cash flows for generating new assets. The cost of capital is the rate
of return expected to be received by investors if they invested elsewhere in assets of similar risk
(2000). The sum of the cash flows discounted by cost of capital is called present value (PV) which is
calculated as:
PV(DCF) =∑ Ct / (1+r)t
…………t – years within cash flow occurs (33)
r – discount rate
Ct – expected cash flow occurring in particular year
The net present value (NPV) is the present value (PV) plus the initial investment (Co) to acquire the
asset and is usually negative because it is cash out.
NPV=Co + ∑ Ct / (1+r)t
(33)
18

Doyle has also explained why the cash flows are discounted. There are two reasons: first, cash today
is worth more than tomorrow, and second, more risky returns are penalised by a higher discount rate.
He concludes that investors should only invest in assets with positive NPV and that investors’
anticipation of cash flow will be mainly based on their views on the effectiveness of the future
strategies. The shareholders return comes normally in two forms, first as dividend payment (DIV)
and second, as value of share appreciated. The share price (Po) is essentially the discounted value of
forecast dividends, and dividends per share are the same as cash flow per share. Therefore it may be
possible to value shares by using forecast of per share revenues, costs and investments:
Po=∑DIVt / (1+r) t
= ∑ (CF per share) t / (1+r) t
(36)
This formula calculates implied share value (if the actual share price is below the implied value than
the ‘buy’ recommendation should be made). This demonstrates that stock market is not short-term
oriented since the value of shares is determined by forecasting dividends, and short-term earnings do
not have much impact on the share price (Doyle, 2000). However, a failure in delivering the
expected earnings may lead investors to reconsider their long-term forecast of company’s prospect,
hence short-term earnings are an important source of information for investors, but shareholder value
is not determined by it. The total value is called enterprise value and consists of both shareholders’
debt and shareholder value (equity):
Enterprise value (EV) = Debt + Shareholder Value (37)
The valuation of enterprise value is divided into two parts: valuation within a forecast period where
the predicted cash flows from operations are discounted to the PV, and a calculation of the
continuing value where the PV of cash flows generated after the planning period must be derived.
The investment, as a third component, may be also added to the enterprise value. Doyle explains that
cash inflows are a function of sales and the operating profit margin. On the other hand, cash
outflows are a function of taxes and additional investments on incremental sales that will inevitably
be required by the growth strategy. The management should estimate an additional working capital
(debtor, cash, stock less creditors) and capital expenditures (fixed capital investment) as a percentage
of sales that will grow in the future activities. The continuing value can be estimated via the
perpetuity method, assuming that after the planning period competition will force the return down to
the cost of capital with the implication that further investments do not change its value (2000). As a
result the cash flow generated after the forecast period will be treated as an infinitive stream of
identical CF.
19

Continuing value (CV) = NOPAT / Cost of Capital (42)
Then the enterprise value:
Enterprise value = ∑ CF t / (1+r)t
+ CV t / (1+r)t
(41)
An alternative method of valuation, according to Doyle, is the market-to-book ratio (M/B)
measurement where a value is given by multiplying the projected book value of assets by an average
M/B ratio for similar companies. Nevertheless, this method is criticized since the book value is a
poor measure of the company’s real value (2000). However, the perpetuity value calculation depends
on judgement and alternative methods enable testing the validity of more scientific methods of
valuation.
The continuing value figure is a very significant element of company’s value in SVA since it is
the largest part of a company’s total value, especially for growing businesses with only little profit in
the early years. They absorb cash flow rather than generate it by aggressive strategies, but they are
creating enormous value, which is reflected in the high figure for the continuing value and share
price. In contrast, mature businesses create high profits and levels of cash flow within the planning
period, where management is more concerned with reducing costs, working capital expenditure and
fixed investment. Its continuing value will then be than only a small proportion of the entire
company’s value, recognizing that the future competitive position will not be strong with a relevant
investors’ appreciation (Doyle, 2000).
2.3.3. Financial Value Drivers
The value-based management starts with establishing a primary financial goal to increase the
economic value and the recognition that free cash flow and economic profit are better indicators of
the firm’s efforts to create shareholder value than accounting profit. The basis for strategy
formulation and the first step in applying a suitable strategy to pursue the shareholder-oriented
mission is to identify the financial value drivers that will determine the estimated cash flow
associated with the strategy (Doyle). Also, if the business performance is unsatisfactory the sources
of poor results need to be diagnosed, focusing on the fundamental value drivers. The financial
drivers are the objectives of the business and achieving growth depends largely on the strategy of
how to manage four key financial factors: level of cash flow, timing of cash flow, sustainability of
cash flow and risk of future cash flow (2000, 48). There are three key financial drivers that
executives need to manage: sales growth, operating profit after tax and investment requirements.
This is important to realize that in achieving faster sales growth, higher profit margin and good
20

investment we need to manage all financial drivers, marketing drivers, and organizational drivers
(core capabilities) need to be managed. This is essential to gain a required financial performance
(FIGURE 1).
Figure 1: Drivers of Value (Source: Doyle, 2000, p.38)
The most fundamental determinant of SV, anticipated level of cash flow, is generated through sales
growth, which is used to calculate additional cash flow by subtracting it by additional cost and
investment:
Additional CF = Sales Growth – Added (Costs+ Investment) (48)
Therefore, increasing cash flow without sales growth by cutting costs and investment is possible in
the short run, but, as Doyle explains, it leads to a decline in cash flow in the consequent years.
Improving net operation profit margin (NOPAT) has a positive impact on SV and there are three
ways how it can be improved: first, through higher prices applied without loosing significant
volume; second, cost reduction through a more effective use of resources or reengineering, and third,
a volume growth improving the operating margin since overhead costs do not increase
proportionately (49). Although reducing investment produces sharp increase in cash flow in the
short-term, in the long-term it could be very counterproductive. Namely, investments namely may
Financial Value Drivers
SHAREHOLDER VALUE
(Capital growth and dividends)
Sales
growth
Operating
margin
Investment
Risk
Duration
Timing
Level of CF
21

increase the long-run growth and the level of NPV of the cash flow, which creates the shareholder
value in future. Nevertheless, executives have to avoid wasteful investment that could be value
destroying equally as the avoidance to invest sufficiently in profitable opportunities. Therefore, it is
useful to calculate the Threshold margin (TM) evaluating the relationship between the three drivers
of cash flow. It is the minimum pre-tax profit margin on additional sales that is necessary to finance
value-creating growth.
TM = (Incr. Investment Rate) x (WACC) / (1 + WACC) x (1-Tax Rate) (51)
The key rule is if the actual operating margin on the additional growth exceeds the TM, the growth
will add value for shareholders. The higher incremental capital invested for financing growth, the
higher the cost of capital, the higher the tax rate and the higher the minimum operating margin which
is required on additional sales (102). The difference between actual margin and TM is Threshold
Spread (TS). Investors give extraordinary high valuations to high-growth companies. Nevertheless,
they have to be aware of excessive investment and negative sales-earning Threshold Spread, which
would be value destroying. TM is in any case a key determinant of value creation.
SVA = (Incr. Sales in period t) x (TS in t) x (1-Tax Rate) / (WACC) x (1+WACC) t-1
(52)
Timing is also crucial to manage since the faster high positive cash flow occurs the greater the
shareholder value. It can be achieved, for example, by faster a new product development, or an
acceleration of market penetration. Sustainability of cash flow means that the more lasting the CFs
are, the greater value is created. Investors’ appreciation attributes to the continuing value of the firm.
It depends upon their perception of sustainability of the company’s differential advantage and its
ability to innovate. The last factor, riskiness attached to the future CFs, is seen as a difficult
prediction of the cash flow because of the volatility and vulnerability which are penalised by a
higher discount rate (52). Therefore, growth can also create SV by reducing the volatility of cash
flow and so cutting the cost of capital based upon a growing score of satisfied customers (103).
2.3.4. The Growth Strategy
The primary determinant of future cash flow is profitable sales hence growth has a clear effect on the
SV in terms of long-term perspectives (Doyle, 2000). In spite of this, some managers still believe
that there is an alternative to market growth strategy for a value enhancement. They frequently apply
a strategy of rationalization focusing on cutting costs, reducing working capital, rising prices and
divestment. They are often motivated by managerial incentives subjected to short-term targets.
Unfortunately rationalization and growth strategies have different impacts on future cash flow.
22

Cutting either costs or investments immediately affects increases in profit and cash flow. In
contrast, building a profitable growth is costly in present time and usually takes years before the
positive outcomes. Doyle adds that it is easy to implement the rationalisation strategy since it is
about reconfiguring the firm’s internal resources, and because this strategy can be directed from the
top. On the other hand, a success in the growth strategy is determined externally due to the need to
convince customers of its superior value as opposed to the competitors, reinforcing of loyalty and
developing new businesses via new distribution channels or extensions to international markets. This
requires having necessary capabilities for the creation of competitive advantage and investing in
product, skill, marketing etc. [FIGURE 2]. Management should take into consideration growth
opportunities that match its organizational capabilities and the firm’s unique competencies. Thus
having identified the sources of poor performance that might destroy shareholder wealth they should
look into the changes in market positioning, resource deployment, and operational policies (Grant,
2002). Rationalization sacrifices long-term investment for shot-term improvements in profitability
and cash flow. However, Doyle maintains that, if sales are declining, no amount of cost cutting or
price increases will prevent a decline in the future cash flow (2000, 107).
Figure 2: Two Routes to Value Creation (Source: Doyle, 2000, p.106)
2.3.5. Capabilities as the Sources for Creation Value
Grant cites that the value added is derived from two sources: from location within an attractive
industry and from competitive advantage over rivals that the company possesses. Due to
internationalization deregulation and other forces, the competitive pressure has been increased hence
development and deployment of resources and capabilities have become the most important goal for
Rationalise
Creating
shareholder
value
Growth
Cut costs
Cut investment
Cut costs
New products
New
customers
New
businesses
23

strategy-following value-based approach. He regards the resource-based view as emphasising the
uniqueness of each company, suggesting that the key to success is through doing rather through
exploiting differences and unique capabilities (2002). Unfortunately, the balance sheet provides only
a limited view of a firm’s resources and it is focused merely on financial and physical resources.
Further, he emphasises that resource analysis is not simply the valuation of a company’s assets
recorded in balance sheet, since intangible assets are undervalued or even excluded. This
circumstance is a major reason for the large difference between balance sheet valuations (‘book
value’) and stock market valuation (‘market value’). Nevertheless, the key, according to Grant, is not
only the identification of unique resources but also leveraging its resources into capabilities. “Why
has Sonny, with a much smaller research budget than Philips, produced so many more successful
innovations?”(2002, 151). Finally, he concludes that a successful company has recognized what it
can do well and has its strategy based on it. “One reason for lack of success is not an absence of
distinctive capabilities, but a failure to recognize what they are and to design strategy to use them
most effectively” (161). The main concern is to reveal a resources’ potential to establish sustainable
competitive advantage. The appraisal of company’s capabilities twill then provide the basis for
reconsidering of the strategy aiming to maximize the shareholder value via deployment and use its
strength to its maximum advantage. Managers should be encouraged to focus on a company’s major
strengths in resources and avoid the risk included in calculation of cost of capital. The key to
creating value, according to Grant, is the ability to share company’s resources and transfer
capabilities more efficiently, where the additional costs do not outweigh the value created (451). He
explains that growth is usually pursued by managers at the expense of profitability since the
company size is more closely linked with management bonuses than profitability (453). It implicates
a tendency to invest at a greater rate than is consistent with a shareholder value, because such
overinvestment reduces the associated market value. Risk reduction is the second purpose of the
diversification strategy that avoids cyclical fluctuations of profits, leading to stability in the cash
flow and it may reinforce independence from external capital markets. Hence financing investment
internally is better than resourcing to external capital markets. Grant finally evaluated diversification
as a strategy that is likely to destroy rather than create shareholder value because of the divergence
between managerial and shareholder goals. Due to many competitors appearing within industry and
the internationalisation of businesses it exerts the pressure for cost reduction, divesting poorly
performing assets, organizational changes to eliminate inefficiencies and applying rigorous financial
targets and control. Managers need to look behind the cost accounting data and be able to identify
cost drivers for each firm’s activity, seek opportunities for innovation, and exploit new sources of
dynamic efficiency (2002, 337).
2.3.6. Growth-Setting Objectives
24

The planning process must start with growth-objectives settings especially margin improvements
achieving higher productivity, incremental investments to support sales growth, and the level of
sales growth. Managers should understand that the growth of the equity value depends on strategies
to improve present value of future cash flows. Arnold discuses the objectives, such as maximum
sales, market share and customer service excellence, and concludes that these are not the company’s
true objectives although they are important in helping to achieve the maximum of shareholder
wealth. He states that only the goal of maximizing discounted future cash flow creating shareholder
value is a company’s actual objective (2008, 649). Each project appraisal should be carried out using
discounted cash flow techniques and budgeting should not rely solely on accounting background but
it should have value-based metrics a enabling view from ‘other perspectives’. Strategic analysis,
Arnold cites, is having three steps: the first step is a strategic assessment of external environment
and internal resources to find the key influences on the value-creating potential. Also, as Arnold
adds, there are also three strategic determinants of value creation that have to be identified: industry
attractiveness, the strength of unique resources and life-cycle stages of value potential responsible
for the longevity of the competitive advantage. The second step of strategic analysis is the strategic
choices after strategic options are developed, based on cash flow valuation methods. The objective
is, according to Arnold, to find a competitive advantage within attractive markets yielding positive
performance spreads. Finally, as Arnold concludes, the third step is strategic implementation.
2.3.7. Value-Creation Metrics
Executives need to know how value drivers should be managed for creating growth and long-term
success and how to establish strategy for future actions aiming to increase an enterprise’s value. The
reliable measures of value need to be used in order to be able to consider projected alternatives such
as the optimal levels of working capital investment, or percentage of targeted margins. The metrics
quantify the plan, desired targets and incentives to encourage high performance and also they are
used in the judgement of valuation processes of the entire firm. There are three basic value-creation
metrics, according to Arnold: discounted cash flow method (DCF) to measure value, Rappaport’s
shareholder value analysis (SVA) for strategy valuation and performance targeting, and the
measurement of economic profit, which enables managers to review a firm’s performance (2008).
They are all based on estimated cash flows discounted by opportunity cost of capital. For instance,
the value of an investment-encouraging sales growth is related to the sum of cash flow discounted to
its present value. If this investment, for example used for promoting sales growth, produces a rate of
return greater than the finance provider’s cost of capital then value added exists. In the calculations
there are forecasted profit figures estimated based on both the firm’s historical performance and its
capability to exploit its resources. Also the number of adjustments are included amending the cash
flow figures. We need to know how to extract the net (free) cash flow figures (NCF). They represent
25

the amount which is available to pay out to the company’s stakeholders without affecting any future
operating cash flow (2008). When an item is depreciated profit is reduced but no cash is lost. Hence
to move toward to cash flow we have to add depreciation that was deducted in the calculation of the
future profit figures. Also the accountant does not recognize in profit figures the cash expenditure
when inventory or debtors are increased. The analyst of cash flow identifies cash being used for
these items and can amend the profit figures when deriving the cash flows figures. Similarly, the
cash flow analyst needs to make adjustments in the cases where the supplier sends input goods for
payment on ‘cash on delivery terms’ or ‘credit terms’. The accountant treats this as an expense and
deducts it from the profit and loss account in the year of delivery. The adjustment must be made by
cash flow analysts since the amount of expense may not yet have been paid out in cash yet. We also
need to return back the interest charged to profit since the discount rate already includes an
allowance for return to lenders (670). The total of discounted cash flows represents a value of a firm,
and managers can be judged on the basis of performance targets embodied in cash flow terms.
During strategy valuation the current strategy expressed in the value term could be compared with
new alternatives embracing different predicted value drivers or marketing schemes.
Rappaport has established a basic concept of a simplifying method of shareholder-value
analysis. It assumes a relatively smooth change in the various factors correlated with the cash flow
float and with the sales level. He introduced seven key factors that determine value as follows: sales
growth rate, operating profit margin, tax rate, fixed capital investment, working capital investment,
the forecast horizon and the required rate of return (1998). He calls them value drivers and he
assumes that both have a constant percentage rate of growth in sales and the same percentage of
profit margin. Fixed capital and working capital investments are related to the additional sales and
these are called the incremental (additional) investment. Thus free cash flow, as Arnold defines, is
the operating cash flow after both incremental fixed and incremental working capital investment,
coming from the operations and it excludes cash flows arising from the sales of shares and payments
of dividends (FIGURE 3). Nevertheless, the disadvantage of using SVA lies in simplified
assumptions that may lack realism (2008, 682).
Figure 3: Rappaport’s Free Cash Flow (Source: Arnold, 2008, p.677)
26

Nevertheless, Doyle quotes that the SVA is superior to conventional accounting approaches in that it
avoids the short-termism in targeting earnings and not focusing to a book value. On the other hand,
managers need to be aware of the assumptions and approximations correlated with forecasts of
prospective cash flows depending on the right judgement, and appraising the weighted average cost
of debt and equity. This is not particularly easy to do since it depends on the estimation of business
risk exposure and the amount of debt. However, SVA becomes the most effective method for
evidencing effectiveness of a company’s strategy as well as for evaluating alternative repositioning
strategies (2000, 66).
2.3.8. Value Management
Arnold also discusses third value driver stating that the value is created when an investment
produces a rate of return greater than required for the time of money and, where the level of risk is
linked to the business activities. According to him, shareholder value is driven, according to him, by
four factors: the first is the amount of capital invested; the second is the actual rate of return; the
third is the required rate of return; and the last one is the planning period. The difference between the
actual rate and the requested rate of return is called the performance spread and is measured as the
percentage spread above or below the required rate of return.
Annual Value Creation = Investment x (Actual Return % – Required Return %) (635)
Value destruction occurs when the performance spread becomes negative and indicates the necessity
to take an action to prevent the incurred losses. Otherwise, bad growth arises if the focus is purely on
sales and earnings growth (operations do not produce a return sufficient to justify its additional
investment) - FIGURE 4
Figure 4: Options opened to managers (Source: Arnold, 2008, p.637)
Operating costs
SALE
S
Tax
Incr. investment in FC
Incr. investment in WC Free
CF
from
operatio
ns
less
Operating profit
27

The incremental investment to the business is a crucial value driver necessary for initiating sales
growth. Arnold notices that at the corporate level the knowledge of potential good and bad growth
investment can assist in an appropriate allocation of resources and a selection of portfolio of
businesses helping to find out which unit becomes a value destroyer due to its negative return spread
occurred by overinvestment (or bad investment). Finally, he introduces five modes of action
available to enhance the corporate value: the first is to increase the return on existing capital by
improving the efficiency of the operations. The second is raising investments in a unit, which
performs a positive spread. For the third action, Arnold suggests to divest assets of units showing
negative spread and thereby to release capital for more productive operations. Also, there is a
possibility, as the fourth action, to extend the planning horizon over a longer period than expected.
The last action can be applied through reducing business risk lowering the required rate of return
(even by shifting to a higher proportion of debt). Arnold also observes that some companies are
financing its business entirely through its shareholders’ equity trying to reduce the risk and avoiding
financial distress. In the end, he concludes that managers can become too cautious and sacrifice the
opportunity of lowering the cost of capital by not using a higher proportion of cheaper debt finance.
3. METHODOLOGY:
3.1. Research Method
The aim of this study is to examine the trends in managerial approaches prevailing within industrial
companies and operating in the recession period we experience today. Taking into account the
shareholder wealth maximization the investigation was aimed to focus to find out how the key
financial drivers should be managed by executives, what impact they have on the company valuation
and what strategy options could be applied to maximize shareholder value added. Correlation
between value drivers and other various factors related to the company’s value and long-term
strategies has been showed on samples of selected enterprises. The historical data have been
Value creation Value
opportunity
forgone
Value
destruction
Value creation
Positive
performance
spread
Negative
performance
spread
Growth
28
Shrink

obtained from the public corporate documentation, company reports, Financial Times business
newspaper and by accessing the London Stock Exchange website. However, the major source of
secondary data is provided from the FAME database available on the Teesside University’s network
containing comprehensive relevant information about past performances of UK-based organizations.
These and other empirical data have formed the basis of this project and been used to test the
linkages to the observable phenomena. Propositions have been made to assess relationships of
identified variables and commonalities within a predetermined sample size representing the entire
population of the interest. This research has been designed above all to test specific hypothesized
predictions using a hypothetico-deductive method, and mostly a scientific approach based on a
collection of facts and observable phenomena. However, strategic options proposed are based on
predicted financial drivers, which need to be evaluated and considered using a qualitative analysis. A
deductive approach to the relationship between theory and data relies on what is already known
about a particular field and after a consideration it deduces hypotheses which must be subjected to
empirical scrutiny (Bryman, 2007). Cooper explains that deduction is the process by which we test
whether the hypothesis is capable of explaining the fact. It is associated with a quantitative research
approach (2008). There is known presumption that financial value drivers are sensitive factors
affecting a company’s value and that they should be managed to achieve long-term benefits
appreciated by investors. There are the hypotheses which have been all subjected to testing through
large analyses provided by this study:
• The hypothesis about the current trend of short-termism spread over many recent businesses
which operate within selected industry sector
• The hypothesis that some businesses changes its strategies in order to offset their
performance declined due to recent adverse economic situation or increased competition
• The hypothesis that current businesses do not invest efficiently to increase future cash flows
• The hypothesis that some financial outcomes can be manipulated in order to impress
shareholders (‘Agency Theory’)
• The hypothesis that some managers simply prefer the accounting-based measurement over
NCF methods
• The hypothesis related to a need to keep balance in value driver management in order to
achieve the value enhancement
• The hypothesis that too rigorous cost management will lead to a value destruction
• The hypothesis which confirms investors’ anticipation of share price with a long-term
strategy options which encourage CF generating in the future regardless current profitability
29

In line with positivism, the researcher intended to produce a general implication that can be used to
predict certain circumstances avoiding unfavourable business outcomes in terms of shareholder
wealth and draw attention to the managers, who maintain and develop financial tools to create the
value added for shareholder benefit. Also, a case study has been included in the project, where more
extensive study of a single organization has been examined (Hamworthy Plc). This model has been
used not to generate theory but rather to test a theory to see if it occurs and applies in the current
business environment. A specific company’s policy and performance has been related to other
companies’ financial results by a simplification and generalization of some external and internal
business environments. The methodological pluralism has then been then included to combine
quantitative and qualitative techniques that will add credibility to the study by providing a cross-
checking tool - triangulation. According to Bryman, triangulation entails using more than one
method of source of data in a study, which improves the reliability and validity of the study (2007).
There is a multi-step process involved in this research, where the results obtained in the study
should help the researcher to logically deduce or conclude his findings. It stands for that researcher
having begun with the observation of broad a problem area to focus on real success of companies
and managerial manners in industrial business environment affected by a recession period. The large
literature review has been surveyed in the preliminary data collection stage to acquire a sufficient
background for a later theory formulation. Data, such as published records, have been provided to
having secondary data available and information to know more about what researcher observed.
Then the problem has been defined and explained with proposals how it can be solved. The next
step, the theory formulation, has been deducted from earlier stages and formed into the framework
how to find the correlations among the variables identified as important to the problem. From this
conceptual model the testable hypothesis has been developed to see whether the theory formulated is
valid. The hypotheses, such as that declining sales growth strongly affects a company’s created value
and thereby investors’ anticipation and that trend of short-term actions boosting profitability will
hugely destroy shareholder wealth, are derived from situations especially present in the recent
adverse environment. The hypothesized relationships have been tested through descriptive statistical
analysis - relationships of both the criterion variables and the predictor variables. Then the research
design needed to be done as well as sampling design, data collection and establishment of measure
methods and analysing techniques to test the hypotheses. Also, a questionnaire has been compiled to
survey attitudes and opinions of managers referred to the aspects associated with the company’s
value, an evaluation of performance and managerial trends. The data generated from the
administered survey has been used as primary supportive data. The phenomenalist element has been
implemented by interpreting and explaining the questionnaire’s responses and the findings have been
used to support or reject hypotheses resulted from quantitative analyses.
30

3.2. Research Design
This dissertation is designed as a descriptive study aiming to understand the characteristics of
variables and to describe relevant aspects of the phenomena of interest, when the characteristics (the
key value drivers) are known to exist and the researcher wanted to describe them better (Sekaran,
1992). This research is also a correlational study where shareholder value (a phenomenon of interest
to the shareholders) has been found to be sensitively influenced by such variables as sales growth,
operational profit margin and an incremental investment and even more factors and managerial
attitudes (100). There are three major stages in this study. The first stage is an exploration in which
hypotheses have been formulated, in the second stage data were collected, and the third stage is
analysing of results that are discussed and evaluated. ‘A research design is the strategy for a study
and the plan by which the strategy is to be carried out. It specifies the methods and procedures for
the collection, measurement, and analysis of data’ (Cooper, 2008, 156). The project has identified
important variables changing phenomenon (the value drivers), proved impact on this phenomenon (a
different valuation and decision making process) and tried to explain relationships among both these
variables and other ones. In seeking the reliable and representative results the researcher expected
both an identification of potential trends and a proving the hypotheses by using diverse models of
research methodology. Triangulation has been achieved by combining methods together via a variety
of approaches such as quantitative and qualitative techniques of data collection and by mixing of
explicatory method, concerning issues in the past in order to understand the present and predict the
future-making judgements based on findings (Jankowicz, 2005) and comparative case study method.
A case study method has been used when the researcher’s thesis has been focused on a set of issues
in a single organization (Hamworthy Plc.), and the factors involved in this base-case have been
identified. The investigated outcomes from the case study have been consequently compared with
relevant results and examined in analysis of other companies (ten selected companies). Although the
case study looks at only one example, it is essential that its context and background are described in
order to provide a full picture of the situation under investigation (White, 2002). In the case study
the researcher has achieved the results through a comparison of the company with others in a
systematic way, exploring different possible stances to the issues, or examining different levels of
the variables involved. In contrast from the historical review, a survey method (also used in the
study) derives most of its data from the present when a survey is conducted in order to establish
respondents’ views of what they think, believe, or value. The administered questionnaire has
surveyed opinions of managers about a particular aspect associated with the change.
3.3. Sample Design:
31

Jankovicz said that empirical work is only worth doing if the findings are organized in such a way
that they can be generalised and used by other companies. He defines the sample as a deliberate
choice of a number of units providing the researcher with data from which conclusions about some
larger group (population) can be drawn (2005, 202). The sample has been selected and designed to
be as truly representative as possible. Before the researcher has selected the sample the population of
interest has been defined, the sampling frame identified and also the sampling size determined
through appropriate sampling methods. The population of interest of this study is defined as all
middle and large-size companies from manufacturing industry sector listed on the stock market and
the sample frame has been compiled based on ‘SIC(2003)’ codes of FAME database (Bureau van
Dijk Electronic Publishing, database of listed companies available as university’s facilitates)-
http://www.fame.bvdep.com/version-2010608/cgi/template.dll. The sampling frame includes 86,283
companies that have been derived from the database through fives codes related to the specific
manufacturing field of industry (SIC codes with first two numbers have been opted for: 28-
manufacturing of fabricated metal products, 29- manufacturing of machinery and equipment, 33-
manufacturing of precision and optical instruments, 34-manufacturing of motor vehicles and trailers,
35-manufacturing of other transport equipments). An accurate sampling frame is very important,
according to White (61) since it helps to reduce bias, and ensures that the used sample truly
represents the population from which it is taken. For the purpose to determine the sample size, a
non-probability sampling technique with purposive sampling method, has been used. Also, a ‘dual’
sampling technique has been applied when the researcher combined two samples sizes using
triangulation method. The first group of sample units has been designed to find out the companies’
values and proposing strategy options. For the comparative purpose ten enterprises under SIC Code
in FAME beginning 28xx, 29xx have been chosen. They represent a standard peer group of
companies operating in manufacture of fabricated metal products and manufacture of machinery and
equipment. As a selection criteria before the final determination of the sample units the researcher
had to opt for industry sector (28 code represents fabricated metal products, and 29 code represents
machinery and equipment), ‘active only’ status and ‘public quoted’ legal form criterion. After these
preferences 86 companies have been generated from the original 68, 520 - firm before search criteria
selection. This size served for an individual judgemental selection of the case study, ‘master’
company, and next 9 enterprises for comparative analysis. The second sampling method has been
decided for investigation in qualitative research via the questionnaire engaged in individual
managers’ attitudes in the handling of the current firms. A purposive homogeneous sampling, also
called judgemental sampling, has been used for a decision about the sample size. This method is
used, according to White (2002), when the researcher needs to examine one issue in detail, and then
search for samples that are more or less the same. The sample size decided for survey of managers’
views has been designed through the London Stock Exchange database published on actual official
32

website 30th
April 2010 (http://www.londonstockexchange.com/exchange/prices-and-news/stocks). It
has indicated list of 2747 listed companies of all industry sectors. After selected the required criteria,
the ‘industrial engineering’ and the sub-sector ‘industrial machinery’, 57 companies have been
displayed. When sampling the researcher has decided to exclude for sampling corporations
performing market capitalization under £ 5 million and PSM companies (Professional Security
Market). Consequently, 49 enterprises generated from UK Main Market and AIM (Alternative
Investment Market) have been left as a sample size designed for purpose of the survey.
3.4. Questionnaire Design and Analysis Responses:
A fully structured e-mail questionnaire has been used in the project to test out hypotheses when a
content, question sequence and answer format have been determined in advance. The main
advantage of the e-mail questionnaire is, as Sekaran explains, that a wide geographical area can be
covered in the survey over a short time period (1992). Although sample units represent the
population of corporations listed on the UK market, they have mostly subsidiaries operating abroad
thus this technique of collection data is very suitable. However, it can be difficult to ensure
anonymity and another disadvantage can be found that any doubts the respondents might not be able
to be clarified. For improving the rate of responses a covering note has been enclosed, containing the
researcher’s name and the purpose of the questionnaire, a possible benefit to the respondent and a
brief description of the confidentiality and security arrangements. Also simple wording of the
questions and keeping the questionnaire as short as possible will help to increase return rates as well
as sequencing of questions where early questions have been simple, constructed with a high interest
value first (questions 1, 2 in questionnaire). More technical questions succeeded in the middle
(questions 3, 4) demanding for higher expertise and the last two questions (questions 5, 6) have
again had a high interest value. The inquiries have been designed as semi-closed type questions
helping to respondents to make a quick decision by making a choice among the given alternatives in
multiple-choice format where respondents have been asked to choose a single alternative from a list
of four which have been provided in each question (Jankowicz, 2005). The suggested ‘other, please
specify’ option has been added as an opportunity to make additional comments. The simple
instruction how to complete the questionnaire has been provided for the respondent starts the reading
of questions (an explanation: insert marks “x” to grey boxes). The questionnaire and its analysis
have been included in the Appendix 4. The ethical goal of in this research is to guarantee that no
participant is harmed or suffers adverse consequences from research activities. Cooper identified
several ethical considerations to be balanced: to protect the rights of the participant, to follow
ethical standards when designing research, to protect the safety of the researcher and team and to
33

ensure the research team follows the design (2008, 51). This research is designed so that the
participant (respondent in questionnaire) does not suffer discomfort, embarrassment, or loss of
privacy. The researcher will progress according to ‘UK Data Protection Act 1998 Chapter 29’.
According to Bryman, reliability of measurement refers to the consistency of measures. Therefore,
for example questions designed in the questionnaire, should be clear with no ambiguity, so that the
respondent immediately recognises the researcher’s intention. The researcher was also concerned
with the maximum possibility to generalize the findings, so that the sample would be as
representative as possible (2007).
The measurement of the variables and the analysis of its findings to test the hypotheses have
been done through a descriptive statistical analysis. Each research question has been subjected to its
own analysis when a relationship among variables has been described, and decision making criteria
have been stated. Both the criterion variables (dependent) and the predictor variables (independent),
which influence the dependent variables, have been introduced in the analysis as well as the
preliminary analytical steps of editing and coding. Coding is the technical procedure, by which data
are transformed into symbols that are often numerals, because they can be tabulated and counted
more easily. The information extracted from the questionnaire in form of ticks in boxes has been
transposed into numbers. Each set of the six questions contains four plus one alternatives from which
only one option purely matches with shareholder value approach. The numerical symbol 1 is
allocated to the ‘hidden right option’ whereas other alternatives indicate a zero code (obviously it is
not visible to the respondents). After respondent provided his/her opinions through marking
applicable preferences (x into box), the simple tabulation has been created with a single variable and
the distribution of feedback has been visualized through a histogram and frequency polygon. This
quantitative analysis has been combined with qualitative technique where all opinions replied in the
questionnaire have been surveyed and explained regarding to diverse approaches used in replied
answers.
3.5. Statistical Analysis of Data
Descriptive statistics involve describing and displaying numerical results in the form of tables
and diagrams. Arithmetical calculations are also a part of the examination of selected companies
when both the shareholder value added and the economic profit have been computed. Statistical data
processing helps to convert numerical data into tables and graphs, which have been numbered in an
appropriate way and given a self-explanatory title. Most figures have been attached in Appendix 1
and Appendix 2, although, some of them have been included in the main body of the dissertation too.
Tables used to display numbers help reveal trends and patterns and the reader can easily identify
particular values. Diagrams are not as precise as tables, but they do have a more visual impact when
they display data. The number of graphs used in this study visualise the numerical data in a tabular
34

form to indicate the relationship between variables and the consequences of their variation. The
independent variables are usually plotted on the horizontal axis with regular intervals (mostly an
annual scale), while the dependent variable has been plotted on the vertical axis with more irregular
intervals.
Easterby claims that if there is an association between two variables, then knowing how someone
responds to changes of one variable can carry information that may help to predict their response to
the other. The association between variables can be tested through a Chi-square test (χ 2
) or through a
correlation coefficient (Pearson correlation, Kendal correlation) (2008, 261). However, an effect of
interrelated influences is not always easy to measure and multivariate analysis dealing with many
interrelated variables must, in many cases, be firmly rooted in predictions of relationships rather than
associations as measured by correlations. All predictions of trends, especially for determination of
the cash flow generated in the future, have been estimated rather cautiously since all historical data
have been found as not very reliable and incomplete. The purpose of multivariate analysis has been
to find the reciprocal relationship between variables and suppositions of fundamental factors
affecting the valuation of the business. In section A of the analysis, multivariate statistical methods
have been used to test casual models dealing with many interrelated variables and their relationships
that have been estimated rather than measured through a correlation method. Easterby explains that
statistical methods offer a specific testing method of hypotheses, which helps to the researcher in his
or hers judgement. However, what casual modelling methods cannot do is to prove a hypothesis of a
casual relationship- only disprove or support it (2008). In the case-study section a normative casual
model has been used where the links between the shareholder value maximization and corporate
strategy have been considered. This model states that looking after the interests of shareholders is the
best approach to how the company should be managed and that the strategic goals set by
management is determined by a need to protect and promote the interests of their shareholders (282).
This principle governs how the corporate strategy is formulated, and how the strategy in turn
influences the future financial performance. FIGURE 5 shows the normative model of key variables
to show the hypothesised casual relationships among them.
Figure 5: Hypothesised casual relationships (Source: Esterby, 2008, p. 282)
3.6. Empirical Work
35
Shareholder wealth
interest
Corporate strategy
Corporate market value
and expected financial
performance

Historical secondary data has been mostly extracted from the FAME database where the financial
fundamentals are summarized for ten years. An alternative source of information amending missing
figures and verifying uncertain information has also been used (The Financial Times
-http://www.ft.com/markets/company). For example, the missing figures ‘Investing activities’ in the
Hamworthy Plc database (row 223, annual year 2005 and 2006) has been replaced by figures ‘Total
Cash from Investing’ found in section ‘Financials’ – ‘Cash Flow’ stated in The Financial Times. It
has also been revealed that the information presented in The Financial Times is more recent than
figures in the FAME database because of the relatively frequent additional adjustments made in
particular cases. It has been found that, for instance, profit before taxation (row 40, annual year
2006) displayed in FAME for Clyde Process Solution, has been restated from negative 153 thousand
pounds (loss) to positive 711 thousand pounds recorded in The Financial Times (the section
‘Financials’ – ‘Income Statement’). The historical price data movement representing investors’
perception about the company’s value over a few past consequent years has been taken from the
London Stock Exchange (http://www.advfn.com/lse/londonstockexchange.asp) and has been used to
look at interactive share charts.
3.6.1. Framework - Part 1
In the first step of Part A of the analysis chapter the historical performance of the case study
company (‘master’ company) has been recorded in Table 1/Ap1 and exhibited in Graphs 1A – 7A
/Ap 2. The trends and relationships of value drivers have been illustrated in these figures and the
performance profile of the base-case company has been revealed (Hamworthy Plc). The aim of the
eleven-step procedure of analysing in Part A is to identify the historical value drivers and the
company’s capabilities to improve its value, forecast its future performance, and to evaluate the
future value drivers. The predicted value drivers have been then used in calculation of company’s
value. The principle that value drivers are designed from figures extracted from the past performance
(to gain equilibrium of drivers) has also been applied in Part B in the valuation of peers selected for
the comparative analyses. The assessment of the value drivers, based on secondary data, has been
recorded in Table 2/Ap1 (the second step). In the third step a few assumptions have been made such
as determining constant tax rate, discount rate, and incremental investment (Table 3/Ap1). Based on
these preliminary steps and the recognition of the current company’s policy, revealing its typical
percentage of sales growth, the profit margin and the investment, the first calculation the SVA has
been performed (‘strategy option zero’) (Table 4/Ap1) as the fourth step using the cash flow
discounting method. The ‘heart’ of the calculations is the basic model, which employs all three key
value drivers under ‘strategy option 1’ (the fifth step). The predicted sales growth and the requested
margin have been identical as in the case ‘strategy zero’, even though the additional total investment
calculated as a percentage from incremental sales has been proposed at 25 per cent. This level of
36

investment has been assumed to maintain long-term company growth and the percentage has been
decided on the researcher’s judgement. The Table 5/Ap1 contains the figures for calculating the
present value of both forecasted cash flows needed to be discounted (DCF) and the perpetuity value
after the five-year planning horizon. Alternatively, a ten-year forecast horizon has been examined.
The results have been summarised in Tables 5.1/Ap1 - 5.3/Ap1 and visualised via Graphs 8/Ap2 –
10/Ap2. Step six has been focused on the determination of the third value driver – the level of
investment, when the Threshold spread has been investigated (Table 6/ Ap1). A large part of the
empirical work containing, in step seven aims to propose strategic alternatives related to the key
value drivers’ changes and to investigate the effect of these variations on a company’s value. Table
7.1/Ap1 includes the calculation the SVA for different levels of investments and Table 7.1.1/Ap1
reviews the results for ‘strategy options 2,3 and 4’, which are displayed in Graph 11A/Ap2. Further
‘strategy options 5’ deals with setting objectives to accelerate the growth effect through a margin
improvement performed due to either reducing costs or by a productivity enhancement. The level of
investment is identical with the level in the base model (strategy 1), but the sales growth has been
increased by 5 per cent. The difference between ‘strategy option 5’ and ‘strategy option 6’ is the
way of spreading improvements of margins over a forecasting period (Table 7.2/Ap1; 7.3/Ap1). The
summarized results of an enterprise’s values and SVA for diversely proposed drivers against the
current company’s policy have been recorded in Table 7.3.1/Ap1. Following ‘strategic options 7,8
and 9’ both decreases the investment and declines the sales growth (Tables 7.4/Ap1 - 7.6/Ap1).
Next ‘strategy option 10’ proposes to reduce costs which increase the profit margin (14 per cent
estimated average), when this accounting-led rationalisation causes a decline in the sales growth.
(Table 7.7/Ap1; 7.7.1/Ap1). The summarized strategies proposed for the management of value
drivers pursuing maximal SVA have been recorded in Table 1 (Table 7.8/Ap1), and displayed in
Graphs 12A/Ap2; 13A/Ap2.
Table 1: Strategy Options Used in Value-Drivers Management
Strategy
Options
Key Value Drivers
Growth/Margin/Investment
Index
strategy 1 15%,7%25% Table 5.1
strategy 2 15%,7%,35% Table 7.1
strategy 5 20%,12%(incr.),25% Table 7.2
strategy 10 (5%),14%,0%,(20%) Table 7.7
37

Step eight contains Tables 8.1/Ap1 - 8.4/Ap1 providing analysis of the value sensitivity in the
process rationalization on the SVA. This examination is focused on an investigation of the effect of
the different levels reducing of costs on the future cash flow. However, the most comprehensive
calculation has been undertaken in step nine in seeking the value maximization. The structure of the
calculations has been based on the ‘strategy option 6’ providing maximal SVA with a comparison
with other alternatives (in the previous seven step). The investigation has been split into three phases
in which the researcher was looking for the best value performed by different value driver
management and also under various purposes to invest. In fist part of this investigation the
investment has been assumed to increase sales growth - Tables 9.1/Ap1 – 9.6/Ap1. In second part of
the analyses the incremental investment has been aimed to invest for an improvement of the
operational margin via higher efficiency and an appropriate cost management (Tables 9.7/Ap 1 –
9.12/Ap1). The last stage of this examination has been concerned with both the purposes of the
additional investment-enhancing growth and the improving margin (Tables 9.13/Ap1 – 9.18/Ap1).
The findings of the analysis of the key-financial-driver management seeking value maximization
have been outlined in Table 2 (Table 9.19/Ap1), where the best strategies targeting maximum
shareholder value added, has been identified.
Table 2: Value Maximization Options
Purpose of
Investment
Driver Management Index
Increasing
Growth
25%,12%,35% Table 9.1
30%,12%,45% Table 9.2
35%,12%,55% Table 9.3
40%,12%,65% Table 9.4
45%,12%,75% Table 9.5
50%,12%,85% Table 9.6
20%,15%,35% Table 9.7
38

Improving
Margin
20%,18%,45% Table 9.8
20%,21%,55% Table 9.9
20%,24%,65% Table 9.10
20%,27%.75% Table 9.11
20%,30%,85% Table 9.12
Enhancing
Both
25%,15%,35% Table 9.13
30%,18%,45% Table 9.14
35%,21%,55% Table 9.15
40%,24%,65% Table 9.16
45%,27%,75% Table 9.17
55%,30%,85% Table 9.18
The evaluation of Hamworthy’s performance and the value created has also been considered through
the 'market-based' measures, using the stock market’s perception of the expected value and the
prospects of the corporations. In step ten the market-to-book ratio (MBR) and market-to-book added
(MVA) have been calculated - Table 10/Ap1. The book value, stated in a company’s balance sheet
(whttp:www.hamworthy.com) and market capitalization (derived from London Stock Exchange in
the section A Company Profile generated on 08-Apr-2010 at 12:25 from
http://www.londonstockexchange.com/exchange/prices-and-news/stocks/) have been the key
determinant of the company’s valuation. Finally, in step eleven of the analysis section the alternative
valuation using economic profit (EP) has been considered. Table 11.1/Ap1 displays the economic
profit and the value created in the past, whereas Table 11.2/Ap1 shows the projected economic profit
and the value created based on discounted future profits to the present using the spread method in the
valuation. However, Table 11.3/Ap1 includes the results of EP calculation using the profit-less-
capital-charge method. Tables 11.4/Ap 1; 11.5/Ap1 provides the shareholder values for different
value drivers with and without additional investment (16A/Ap2) and the method of valuation, using
the economic profit has then been compared with valuation via the DCF method for the same five-
year forecast period Table 11.6/Ap1; Graph 15A/Ap2.
3.6.2. Framework - Part 2
The comparative analyses in Part B have used the value drivers as a benchmark to compare
diverse ways of value-driver management identified within the ten selected corporations. This
examinations contain eight further steps of the analytic process and starts by contrasting the
Hamworthy Plc with its ‘closest’ competitors the Spirax-Sarco Engineering Plc and the Weir Group
Plc, operating in the similar market sector (in the FAME database they have the same UK SIC code
2912). In the comparative analysis historical performance and value drivers extracted from the
FAME database have been recorded in Table 12/Ap1 as the initial twelfth step. The graphical
illustration of the relative relationships has been drawn in Graphs 17A/Ap2 – 21A/Ap2. In the
following step (step thirteen), the historical data of ten selected enterprises operating within the
same industrial machinery sector have been extracted from the FAME database for the monitoring
39

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