Derived Inputs

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Net Operating Profit Less Adjusted Taxes (NOPLAT) Free Cash Flow (FCF) Tax Shield (TS) Invested Capital (IC)
Return on Invested Capital (ROIC) Net Investment (NetInv) Investment Rate (IR) Enterprise Value (EV)
Weighted Average Cost of Capital (WACC) Operating Margin (M) Depreciation/Amortization Rate (D) Total Equity (TE)
Economic Profit (Eπ)

Asset and Equity Input and Model Comparison

The valuation model and multiples inputs used in this study are largely derived from Primary Input Data and vary based on the firm’s capital structure and the valuation model employed. Certain inputs differ in form based on the firm’s capital structure and whether or not the firm relies on its assets or equity to generate cash flow.  See the Asset/Equity Input and Model Comparison for input and model form details.

Following are discussions of each derived input employed in this study, in most cases including both the asset and equity based forms of the input. A brief description of the input, how it is calculated, and its relevance in the study’s subject models are presented, as well as how the inputs are calculated, and their relevance in the subject models in this study.


Net Operating Profit Less Adjusted Taxes (NOPLAT)  –  for use in asset based models

NOPLAT\,=\,EBIT\,x\,(1-Tax\,\,Rate)

Net Income (NI)  –  for use in equity based models

NI\,=\,EBIT\, - \,Interest \,Exp\, - \,Taxes\, Paid

Description1

Net Operating Profit Less Adjusted Taxes (NOPLAT) is a favored cash flow variable employed by valuation consultants and market analysts.  It represents the operating income of the firm (earnings before interest and taxes or EBIT), less the tax liability that would be applicable to that income were it exposed to state and federal corporate income tax.   NOPLAT’s popularity reflects the versatility of the variable in that it may be applied to something as broad as the entirety of the firm’s operations or so finely focused as to carve out a select portion of the firm’s operations attractive to a potential investor in an M&A transaction2.

NOPLAT is calculated as EBIT x (1-T) in which EBIT is specific to the subject firm’s core operations and T (Average Tax Rate on EBIT) is equal to the adjusted tax liability3 divided by the subject EBIT.  Within the world of finance, EBIT is held as a key indicator of a firm’s cash flow with respect to its core operations.  It is a considered a superior measure of a firm’s income than Net Income in that it does not include interest expense arising from discretionary decisions on the part of management with respect to the firm’s capitalization or taxation resulting from non-operating activities or policy maker influences.  Similarly, EBIT is preferred to EBITDA (earnings before interest, tax, depreciation and amortization) as depreciation and amortization are critical values accounting for the cost of the firm’s productive operating assets (tangible and intangible).

Along with Invested Capital (IC), Return on Invested Capital (ROIC), Weighted Average Cost of Capital (WACC) and the expected average long-run growth rate of the subject cash flow variable (g), NOPLAT is held as a Key Value Driver by select management and valuation consultancies.

1Richard Haskell, PhD (2017), Associate Professor of Finance, Bill & Vieve Gore School of Business, Westminster College, Salt Lake City, Utah, rhaskell@westminstercollege.edu, www.richardhaskell.net. Bryce Nieberger (2017), Student, Bill and Vieve Gore School of Business, Westminster College, Salt Lake City, Utah, https://www.linkedin.com/in/bryce-nieberger-91571ab7

2Koller, T. Goedhart, M.H, Wessels, D., & Copeland, T.E.(2010), Valuation: Measuring and managing the value of companies (5th Edition), pp. 38, Hoboken, NJ John Wiley & Sons

3The adjusted tax liability may be calculated through the following free online tax calculator: www.richardhaskell.net/resources/Income+Tax+Calculations.xlsx

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Free Cash Flow (FCF)  –  for use in asset based models

FCF\,=\,NOPLAT\,+\,Non\,Cash\,Expenses-\Delta NWC\,-\,NCS

Cash Flow From Equity (CFE)  –  for use in equity based models

CFE\,=\,NI\,+\,\Delta\,TE\,+\,OCI

Description1

Among discounted cash flow models, those using Free Cash Flow (FCF) as the cash flow variable are most commonly used by analysts and practitioners.  FCF is considered by some to be a more reliable performance measure than other income variables.  It is also more reflective of the cash flow form for which the owners of the firm’s capital structure hold future rights.  Further, FCF may be disaggregated such that it’s possible focus specifically on the operational structure of the firm.

The advantage to this approach is obvious in that it allows for the calculation of a firm’s value based on that which the firm produces for its debt and equity stakeholders: free cash flow.  The FCF valuation model considers the firm’s weighted average cost of capital (WACC) as the discounting factor and like other discounted cash flow models in this study is comprised of the sum of the present value of the discounted cash flows over an explicit forecast period and the present value of the firm’s continuing value using a Free Cash Flow augmented form of the Dividend Yield model.

1Richard Haskell, PhD (2017), Associate Professor of Finance, Bill & Vieve Gore School of Business, Westminster College, Salt Lake City, Utah, rhaskell@westminstercollege.edu, www.richardhaskell.net.   Beau Lewis (2017), Student Research Associate, Bill and Vieve Gore School of Business, Westminster College, Salt Lake City, Utah, https://www.linkedin.com/in/beau-lewis-5068a5120

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Tax Sheild (TS) – for use in asset based models

TS\,=\,interest\,paid\,\,x\,\,Average\,\,Tax\,\,Rate

Description1

A tax shield is exactly what its name implies. It is a protective shield against potential income tax expense businesses enjoy as the result of paying interest expense on debt capital.   In other words, it’s a reduction in taxable income – by incurring interest expense on debt capital firms lower their taxable income and income tax liability.  The Tax Shield is used in the Adjusted Present Value model (APV) as a cash flow based on the recognition that a reduction of expense has the same effect on a firm’s value as an increase in income.  Firms choose between the use of equity and debt capital and often seek to re-engineer the capital structure to obtain the lowest weighted average cost of capital (WACC).  While not expressly an input to WACC, the appropriate use of the firm’s Tax Shield may aide in providing or increasing value to the firm’s stakeholders.

1Richard Haskell, PhD (2017), Associate Professor of Finance, Bill & Vieve Gore School of Business, Westminster College, Salt Lake City, Utah, rhaskell@westminstercollege.edu, www.richardhaskell.net.   Beau Lewis (2017), Student Research Associate, Bill and Vieve Gore School of Business, Westminster College, Salt Lake City, Utah, https://www.linkedin.com/in/beau-lewis-5068a5120

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Invested Capital (IC) – for use in asset based models

IC\,=\,Fixed\,\,Operating\,\,Assets\,\,+\,\,NWC

Total Equity (TE) – for use in equity based models

TE\,=\,Paid-in\,\,Equity\,\,Capital\,\,+\,\,Accumulated\,\, Retained\,\, Earnings

Description1

Invested Capital (IC) represents the cumulative amount the business has invested in its core operations – primarily Property, Plant and Equipment (PPE) and working capital.2  IC is calculated and observed from two equivilent approaches: financing (ICFIN) and operations (ICOPS).

ICOPS is equal to the firm’s fixed operating assets plus its net working capital (NWC), or current assets less current liabilities.  Operating assets most commonly include PPE (machinery, property, factories, warehouses, etc.), but may also include patents and other investments on which the firm depends for operating income.  This calculation of IC is most useful in valuation modeling as it allows for a delineation of the capital used in the firm’s core business operations.

ICFIN is equal to the firm’s Total Equity (TE) plus Total Long-Term Debt (TD) and is useful when seeking to apply valuation modeling and multiple concepts to the entire firm.  The difficulty associated with separating those portions of the firm’s TE and TD used in support of its core operations is worth noting and forms the rational for the use if ICFIN only when seeking to apply valuation metrics to the entire firm or asset.

1Richard Haskell, PhD (2017), Associate Professor of Finance, Bill & Vieve Gore School of Business, Westminster College, Salt Lake City, Utah, rhaskell@westminstercollege.edu, www.richardhaskell.net. Bryce Nieberger (2017), Student, Bill and Vieve Gore School of Business, Westminster College, Salt Lake City, Utah, https://www.linkedin.com/in/bryce-nieberger-91571ab7

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Return on Invested Capital (ROIC) – for use in asset based models

ROIC\,=\,\frac { NOPLAT }{ IC }

Return on Equity (ROE) – for use in equity based models

ROE\,=\,\frac { NI }{TE }

Description1

Return on Invested Capital (ROIC) measures the efficiency of firm management in utilizing the capital with which stakeholders have entrusted them.  As a stand-alone ratio it has limited value, but when compared to a similar measure for other firm’s it is highly useful.  Its utility is extended to its role as a key value driver (KVD) for firms and is central to valuation models and multiple construction. ROIC’s role as a key value driver is the result of it’s relationship with the firm’s Weighted Average Cost of Capital (WACC) in the value creation metric.  When a firm’s ROIC > WACC, growth adds value to the firm.  When ROIC < WACC growth destroys value.

While ROIC is the preferred metric in value assignment for the firm, three other firm metrics are similarly useful in considering returns on the firm’s capital: Profit Margin (PM), Return on Equity (ROE), and Return on Assets (ROA).

1Richard Haskell, PhD (2017), Associate Professor of Finance, Bill & Vieve Gore School of Business, Westminster College, Salt Lake City, Utah, rhaskell@westminstercollege.edu, www.richardhaskell.net. Bryce Nieberger (2017), Student, Bill and Vieve Gore School of Business, Westminster College, Salt Lake City, Utah, https://www.linkedin.com/in/bryce-nieberger-91571ab7

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Net Investment (NetInv) – for use in asset based models

NetInv\,=\,{{IC}_{1}}-{{IC}_{0}}+Depreciation

Net Investment (NetInv) – for use in equity based models

NetInv\,=\,{{TE}_{1}}-{{TE}_{0}}

Description1

Net Investment (NetInv) measures changes in a firm’s Invested Capital (IC) in the case of asset based firm’s and Total Equity (TE) in the case of equity based firms.  Invested Capital, the sum of a firm’s fixed assets plus  net working capital,  forms the capital asset from which the asset-based firm creates cash flow.  Total Equity, the firm’s total Assets less Total Liabilities,  serves a similar purpose for equity-based firms.

1Richard Haskell, PhD (2017), Associate Professor of Finance, Bill & Vieve Gore School of Business, Westminster College, Salt Lake City, Utah, rhaskell@westminstercollege.edu, www.richardhaskell.net.

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Investment Rate (IR) – for use in asset based models

IR_{ASSET}\,=\,\frac {NetInv}{NOPLAT}

Investment Rate (IR) – for use in equity based models

IR_{EQUITY}\,=\,\frac {NetInv}{NI}

Description1

A firm’s Investment Rate (IR) measures the firm’s change in Invested Capital (IC) as a function of its Net Operating Profit Less Adjusted Taxes (NOPLAT) for asset-based firms.  For equity-based firms IR measures the firm’s change in Total Equity (TE) as a function of its Net Income (NI).  It provides an understanding of what percentage of the firm’s income is being reinvested in those resources from which the firm creates cash flow for its stake holders.

1Richard Haskell, PhD (2017), Associate Professor of Finance, Bill & Vieve Gore School of Business, Westminster College, Salt Lake City, Utah, rhaskell@westminstercollege.edu, www.richardhaskell.net.

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Weighted Average Cost of Capital (WACC) – for use in asset based models

WACC\,=\,\frac { E }{ V } { R }_{ E }\,+\,\frac { P }{ V } { R }_{ P }\,+\,\frac { D }{ V } { R }_{ D }\left( 1-Tax\,\,Rate \right)  \,in \,which\, { R }_{ E }=R_{F}+(R_{M}-R_{F})Beta

Cost of Equity Capital (COE) – for use in equity based models

COE\,=\, { R }_{ E }=R_{F}+(R_{M}-R_{F})\,x\,Beta

Description1

The firm’s Weighted Average Cost of Capital (WACC) is the opportunity cost associated with holding or investing in the firm’s equity and debt capital debt.  It is calculated as a market-based opportunity cost for this study, but both market based and book value based values for WACC are included in the study’s year-end values for 2015 and 2016.  Book-value-based WACC is somewhat of a misnomer in that the firm’s equity capital components and taken at their market values, interacted with observable market opportunity costs, while the firm’s debt capital, cash and cash equivalents are taken at book value.

Market based WACC uses only market values for the firm’s equity and debt capital components and results in a true opportunity cost of capital as of year-end 2015 and 2016.  While book value based WACC is collected for each firm through Bloomberg, market based WACC is calculated using the market value of the firm’s capital components as noted in the Methods section

1Richard Haskell, PhD (2017), Associate Professor of Finance, Bill & Vieve Gore School of Business, Westminster College, Salt Lake City, Utah, rhaskell@westminstercollege.edu, www.richardhaskell.net. Bryce Nieberger (2017), Student, Bill and Vieve Gore School of Business, Westminster College, Salt Lake City, Utah, https://www.linkedin.com/in/bryce-nieberger-91571ab7

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Economics Profit (Eπ) – for use with asset based models

E\pi\,=\,IC\, x\, (ROIC\, -\, WACC)

Economics Profit (Eπ) – for use with equity based models

E\pi\,=\,TE\, x\, (ROE\, -\, COE)

Description1

A firm’s Economics Profit (Eπ) is the difference between the returns it receives from the productive use of its capital resources less the cost of those resources.  It is not explessly a cash flow in that the cost of its equity capital is expressed as an opportunity cost.  The Eπ relation of return versus cost forms the basis for decisions with respect to growth for firms in that growth creates value for the firm when return is greater than cost and destroys value for firms when return is less than cost.

1Richard Haskell, PhD (2017), Associate Professor of Finance, Bill & Vieve Gore School of Business, Westminster College, Salt Lake City, Utah, rhaskell@westminstercollege.edu, www.richardhaskell.net.

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Enterprise Value (EV) – for use with asset based models

EV_{ASSET}\,=\,Market\,Cap\,Equity\,+\,Market\,Value\,Long\,Term\,Debt\,- \,Cash\,and\,Equivilants

Enterprise Value (EV) – for use with equity based models

EV_{EQUITY}\,=\,Market\,Cap\,Equity\,-Cash\,and\,Equivalents

Description1

Enterprise Value (EV) represents the capital outlay required to acquire the rights to a firm’s future cash flows and is the metric most closely associated with the firm’s calculated value through the use of valuation models and multiples.  When interacted with a firm’s income, expense or cash flow variables EV represents a useful measure of a firm’s management efficiency and managment’s use of the capital entrusted to them by firm stakeholders.

While EV is most commonly calculated using a combination of the market value of a firm’s equity shares and the book value of its debt capital, less cash and cash equivilents, it is most effectively utilized when calculated from a market value perspective (EVMARKET).

1Richard Haskell, PhD (2017), Associate Professor of Finance, Bill & Vieve Gore School of Business, Westminster College, Salt Lake City, Utah, rhaskell@westminstercollege.edu, www.richardhaskell.net. Bryce Nieberger (2017), Student, Bill and Vieve Gore School of Business, Westminster College, Salt Lake City, Utah, https://www.linkedin.com/in/bryce-nieberger-91571ab7

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Margin from Operations (M)

M\,=\,\frac {EBIT}{SALES}

Description1

Margin from operations (M) is primarily used as an efficiency measure and indicates the firm’s success in deriving operating profits or earnings before interest and taxes (EBIT) from its sales or total revenues.  As a stand-alone metric it has limited value, but when compared to the same metric as applied to other firms, or other time periods, it can be a useful tool for managers seeking to create value for firm stakeholders.

1Richard Haskell, PhD (2017), Associate Professor of Finance, Bill & Vieve Gore School of Business, Westminster College, Salt Lake City, Utah, rhaskell@westminstercollege.edu, www.richardhaskell.net.

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Depreciation/Amortization Rate (D)

D\,=\,\frac {(D\,\,+\,\,A)}{EBITDA}

Description1

A firm’s depreciation and amortization rate is a non-cash expense ratio reflecting some notion of the depletion of value of a firm’s assets.  Though not a cash expense, depreciation and amortization are nonetheless important in considering a firm’s return on capital.   Based on the premise that a firm would be less able to create cash flow, and thereby profit or investor returns, without its capital assets, the firm’s depreciation and amortization expense is an input to EBIT.  When taken as a ratio against EBITDA (earnings before interest, expense, depreciation and amortization) it becomes a useful component in forming a firm’s target valuation multiple.

1Richard Haskell, PhD (2017), Associate Professor of Finance, Bill & Vieve Gore School of Business, Westminster College, Salt Lake City, Utah, rhaskell@westminstercollege.edu, www.richardhaskell.net.

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