Chapter 12. Value Enhancement

In all the valuations so far in this book, we have taken the perspective of an investor valuing a firm from the outside. The question we have asked is: Given how their existing management run Cisco, Motorola, Amazon, Ariba, and Rediff, what value would you assign them? In this chapter, we look at valuation from the perspective of the managers of the firms. Unlike investors, who have to take the firm's actions and policies as given, managers can change the way a firm is run. We examine how the actions and decisions of a firm can enhance value.

For an action to create value, it has to affect one of four inputs into the valuation model: the cash flows generated from existing investments; the expected growth rate in earnings, which determines the cash flows looking forward; the period for which the firm can sustain above-normal growth (and excess returns); and the cost of capital that gets applied to discount these cash flows. In the first half of this chapter, we look at the different approaches to value enhancement and the link to management actions, with an emphasis on technology firms. In the second half of the chapter, we look at economic value added (EVA) and cash flow return on investment (CFROI), which are the two most widely used value enhancement tools, and examine their strengths and weaknesses in the context of technology firms.