Managing the marketing mix 295
For example, if the investment rate is 50
per cent of incremental sales, the cost of capital
is 10 per cent and the tax rate is 35 per cent,
then the threshold margin is 7 per cent. So if
managers expect the long-term operating mar-
gin to be above 7 per cent, growth adds value
for shareholders.
The marketing mix is the main way man-
agement seeks increases in sales. It does this
through developing appealing products, com-
petitive prices, and effective promotion and
distribution. Value analysis provides the frame-
work for assessing whether these elements are
optimized. This is illustrated in Table 11.1 for
the Baker Company. Its current sales and net
operating profit after tax (NOPAT) are shown in
the first column. Assume management put in
place a new, modest marketing strategy that
will grow sales by 5 per cent annually. To arrive
at free cash flow we will have to deduct the
investment in working capital and fixed assets
that will be needed to support this growth. This
is forecast to be 50 per cent of incremental sales.
Shareholder value is obtained by discounting
the cash flow by the opportunity cost of capital,
r, which is taken here to be 10 per cent, and
deducting debt. The annual discount factor is
1/(1 + r)i, where i= 1, 2,... is the year.
As discussed, the shareholder value calcu-
lation divides the estimation of the value
created by the strategy into two components.
The first is the forecast managers make over a
5-year planning period. Here the present value
of the cumulative cash flow is forecast to be
£20.1 million. The second component is the
continuing value of the business, which is the
Table 11.1 Baker Company: shareholder value analysis (£ million)
Base Year
12345
Sales 100.0 105.0 110.3 115.8 121.6 127.6
Operating margin 10.0 10.5 11.0 11.6 12.2 12.8
Tax (30%) 3.0 3.2 3.3 3.5 3.6 3.8
NOPAT 7.0 7.4 7.7 8.1 8.5 8.9
Net investment 2.5 2.6 2.8 2.9 3.0
Cash flow 4.9 5.1 5.3 5.6 5.9
Discount factor (r= 10%) 0.909 0.826 0.751 0.683 0.621
Present value of cash flow 4.4 4.2 4.0 3.8 3.7
Cumulative present value 20.1
PV of continuing value 55.5
Other investments 7.0
Value of debt 25.0
Shareholder value 57.6
Initial shareholder value 52.0
Shareholder value added 5.6
Implied share price (£) 2.88
Initial share price (£) 2.60