Chapter 10: Components of Value

Overview

IN THE PREVIOUS SECTION, we discussed statistical methods that are used to understand relationships that influence assessment of Strategic Alternatives (SAs). In this chapter, we will begin to lay the foundation for the valuation filter—a quantitative analysis of the value derived from SAs. In Chapter 1, we presented the following rendering of intrinsic value:

Here we discuss intrinsic value in a more formal sense. Our purpose is to understand the components of intrinsic value. The mathematical formula for intrinsic value is:

The formula's variables are represented as follows:

• NPV equals net present value, or the sum of all the cash flows generated by a strategic alterative.

• CF equals cash flow for a single period of time, normally a year.

• r equals the discount rate or the adjustment for risk.

• t equals the time frame in which a cash flow occurs.

While there are many analytical models that can be used to estimate the future value created from a Strategic Alternative, the four fundamental elements that form the foundation of these models are: 1) cash flow, 2) risk, 3) discount rate, and 4) time. It is critical to understand each of these elements in order to carry out a meaningful analysis of shareholder value.