VALUE-CREATING AND VALUE-NEUTRAL ACTIONS

The value of a firm is the present value of the expected cash flows from both assets in place and future growth, discounted at the cost of capital. For an action to create value, it has to do one or more of the following:

• Increase the cash flows generated by existing investments.
• Increase the expected growth rate in earnings while generating excess returns.
• Increase the length of the high growth period.
• Reduce the cost of capital that is applied to discount the cash flows.

Conversely, an action that does not affect any of the above cannot affect value.

While this might seem obvious, a number of value-neutral actions taken by firms receive disproportionate attention from both managers and analysts. Consider four examples: