bcg’svaluemanagementframeworkanoverviewformbastudents.ppt

BCG’S VALUE MANAGEMENT FRAMEWORKAN OVERVIEW FOR MBA STUDENTS
By
Rawley Thomas
Director of Research
The Boston Consulting Group
200 South Wacker Drive
Chicago, Illinois 60606
312-627-2618
Thomas.
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WHAT GETS MEASURED GETS DONE
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Traditional Valuation Techniques Versus BCG’s Valuation Framework
Traditional Valuation Techniques
Forecast nominal cash flows by estimating P&L line items and changes to the balance sheet
Estimate terminal value with a perpetuity of the forecasted last year’s net cash flow
Determine cost of capital by weighting equity CAPM cost with debt cost
Discount the cash flows and terminal value to present value with the weighted average cost of capital
Observations on Missing Elements
No performance measure to determine if the business is achieving returns above or below the cost of capital or if the trend in those returns is up or down
No fade in performance to determine likely cash flows in a competitive environment
Discount rates determined by past price changes, not future likely cash flows
No extensive empirical testing
BCG’s Valuation Framework
Translate accounting statements to gross cash flows and gross cash investments in constant dollars to produce cash on cash returns
Translate cash on cash returns to economic performance measures (CFROIs) by adjusting for asset life and mix of depreciating versus non-depreciating assets
Determine sustainable asset growth rates
Fade CFROIs and asset growth rates toward corporate averages consistent with life cycle theory and empirical evidence to estimate future cash flows (replaces terminal valuation)
Estimate market derived real discount rate by equating the present value of the cash flows for a large aggregate to the sum of the prices of debt and equity
Apply the market derived discount rate to the cash flows derived from fading economic performance to determine market valuation; subtract debt to determine equity valuation
Test model values against actual stock prices for thousands of