Part 2 - Value-based management

Question 1

Definition and characteristics of VBM

Answer 1

• The value of a company is measured by its DISCOUNTED FUTURE CASH FLOW. Value is created only when companies invest capital at RETURN that exceed the COST OF CAPITAL.
• Ensure all activities and decisions are to CREATE VALUE for shareholders
• Considering VALUE DRIVERS, may be NON-FINANCIAL, such as the customer satisfaction

Question 2

Other measures not create value

Answer 2

• ROCE at historic levels, but this does not necessarily create value for shareholders => acceptable ROCE, but may have a negative net present value
• Increases in bank interest rates will increase cost of capital => reduce the net present value
• The objective of maintaining NET PROFIT MARGINS. => avoid activities which reduce profits in the short term, but which have future long-term benefits and create value for shareholders, such as investment in staff training.

Question 3

Adopting VBM

Answer 3

• EVA is a suitable measure
• Managers would be given targets according to their areas of responsibility
• To identify value drivers, Bazeele will need good information which is accurate, reliable and timely

Question 4

Why is (EVA™) a suitable measure of VBM?

Answer 4

• EVA™ does encourage managers to make decisions, such as undertaking staff training, which have FUTURES LONG-TERM VALUE
• A positive EVA™, value will be created for shareholders