Alcar Approach
ALCAR approach: the Alcar Group Inc. a management education and software company, developed an approach to VBM which is based on discounted cash flow analysis Determinants of shareholder value: according to Alfred Rappaport author of creating share holder value; a guide to managers and investors, who is regarded as father of share holder value, the following seven factors called “value drivers” affect shareholder value
1. Rate of sales growth
2. Operating profit margin
3. Income tax rate
4. Investment in working capital
5. Fixed capital investment
6. Cost of capital
7. Value growth duration
While first six “value drivers” are self explanatory, last one value growth duration represents the period over which investments are expected to earn rates of return in excess of cost of capital. It is an estimate reflecting the belief of management that competitive advantage will exist for a finite period Thereafter competitive edge would be lost causing the rate of return to regress to the cost of capital Assessment of the shareholder value impact of the business unit (strategy) Procedure suggested by Alcar approach for assessing shareholder impact of a strategy
Step 1: Forecast the operating cash flow stream for the business unit (strategy) over the planning period
The annual operating cash flow is defined as: cash inflow [(sales)(operating profit margin)(1-effective tax rate)] –cash outflow [fixed capital investment + working capital investment]
Step 2: Discount the forecasted operating cash flow stream using the weighted average cost of capital
The weighted average cost of capital is: (post-tax cost of debt) (market value weight of debt) + (post-tax cost of equity) (market value weight of equity)
Step 3: Estimate the residual value of the business unit (strategy) at the end of the planning period and find its present value
The residual value is: (perpetuity cash flow)/ (cost of capital)
Step 4: Determine the total shareholder value
The total shareholder value is: present
1. Rate of sales growth
2. Operating profit margin
3. Income tax rate
4. Investment in working capital
5. Fixed capital investment
6. Cost of capital
7. Value growth duration
While first six “value drivers” are self explanatory, last one value growth duration represents the period over which investments are expected to earn rates of return in excess of cost of capital. It is an estimate reflecting the belief of management that competitive advantage will exist for a finite period Thereafter competitive edge would be lost causing the rate of return to regress to the cost of capital Assessment of the shareholder value impact of the business unit (strategy) Procedure suggested by Alcar approach for assessing shareholder impact of a strategy
Step 1: Forecast the operating cash flow stream for the business unit (strategy) over the planning period
The annual operating cash flow is defined as: cash inflow [(sales)(operating profit margin)(1-effective tax rate)] –cash outflow [fixed capital investment + working capital investment]
Step 2: Discount the forecasted operating cash flow stream using the weighted average cost of capital
The weighted average cost of capital is: (post-tax cost of debt) (market value weight of debt) + (post-tax cost of equity) (market value weight of equity)
Step 3: Estimate the residual value of the business unit (strategy) at the end of the planning period and find its present value
The residual value is: (perpetuity cash flow)/ (cost of capital)
Step 4: Determine the total shareholder value
The total shareholder value is: present