Value-Based Management 451
enough. However, the effect can be negative if growth requires a great deal of capital,
and the cost of that capital is high. Second, operating profitability, which measures the
after-tax profit per dollar of sales, always has a positive effect—the higher the better.
Third, the capital requirements ratio, which measures how much operating capital is
needed to generate a dollar of sales, also has a consistent effect—the lower the CR the
better, since a low CR means that the company can generate new sales with smaller
amounts of new capital. Finally, the fourth factor, the WACC, also has a consistent ef-
fect—the lower it is, the higher the firm’s value.
TABLE 12-8 Initial FCF Valuation of Each Division (Millions of Dollars)
PANELA: FCFVALUATIONOFTHEBELLMEMORYDIVISION
Actual Projected
2002 2003 2004 2005 2006 2007
Calculation of FCF
Net operating working capital $280.0 $294.0 $308.7 $ 324.1 $ 340.3 $ 357.4
Net plant 590.0 619.5 650.5 683.0 717.1 753.0
Net operating capital $870.0 $913.5 $959.2 $1,007.1 $1,057.5 $1,110.4
Investment in operating capital $43.5 $45.7 $48.0 $50.4 $52.9
NOPAT $78.6 $82.5 $86.7 $91.0 $95.5 $100.3
Free cash flo w$39.0 $41.0 $43.0 $45.2 $47.4
Growth in FCF 5.0% 5.0% 5.0% 5.0%
Value of Operations
Horizon value $905.7
Value of operations $709.6
Divisional MVA (Value
of operations capital) ($160.4)
PANELB: FCFVALUATIONOFTHEBELLINSTRUMENTSDIVISION
Calculation of FCF
Net operating working capital $ 50.0 $ 52.5 $ 55.1 $ 57.9 $ 60.8 $ 63.8
Net plant 150.0 157.5 165.4 173.6 182.3 191.4
Net operating capital $200.0 $210.0 $220.5 $231.5 $243.1 $255.3
Investment in operating capital $10.0 $10.5 $11.0 $11.6 $12.2
NOPAT $36.0 $37.8 $39.7 $41.7 $43.8 $45.9
Free cash flo w$27.8 $29.2 $30.6 $32.2 $33.8
Growth in FCF 5.0% 5.0% 5.0% 5.0%
Value of Operations
Horizon value $645.1
Value of operations $505.5
Divisional MVA (Value of
operations capital) $305.5
Notes: The WACC is 10.5 percent for each division. The horizon value (HV) at 2007 is calculated using Equation 12-2, the constant growth formula for
free cash flows: HV 2007 [FCF 2007 (1 g)]/(WACC g). The value of operations is the present value of the horizon value and the free cash flows dis-
counted at the WACC, calculated in a manner similar to Figure 12-1. See the file Ch 12 Tool Kit.xls on the textbook’s web site for details.
448 Corporate Valuation, Value-Based Management, and Corporate Governance
