454 CHAPTER 12 Corporate Valuation, Value-Based Management, and Corporate Governance
below its 10.5 percent WACC. Thus, growth doesn’t help Bell Memory—indeed, it
lowers the division’s value.
Based on this analysis, Bell Memory’s managers decided not to request funds for a
marketing campaign. Instead, they developed a plan to reduce capital requirements.
The new plan called for spending $50 million on an integrated supply chain information
system that would allow them to cut their inventories/sales ratio from 30 percent to 20
percent and also reduce the net plant/sales ratio from 59 percent to 50 percent. Table
12-10 shows operating results based on this new plan. The value of operations increases
from $709.6 million to $1.1574 billion, or by $447.8 million. Because this is well over
the $50 million required to implement the plan, top management decided to approve
the plan. Note also that MVA becomes positive at $287.4 million, and the divisional ex-
pected ROIC rises to 13.0 percent, well over the 10.5 percent WACC.
Bell Instruments’ managers also used the valuation model to assess changes in
plans for their division. Given their high expected ROIC, the Instruments Division
proposed (1) an aggressive marketing campaign and (2) an increase in inventories that
TABLE 12-9 Bell Electronics’ Forecasted Value Drivers for 2007
Division 1: Division 2:
Bell Memory Bell Instruments
Growth, g 5.0% 5.0%
Profitability
(NOPAT 2007 /Sales 2007 ) 7.9 7.2
Capital requirement
(Capital 2007 /Sales 2007 ) 87.0 40.0
WACC 10.5 10.5
Expected return on invested capital, EROIC
(NOPAT 2007 (1g)/Capital 2007 ) 9.5 18.9
TABLE 12-10 Comparison of the Preliminary and Final Plans
(Millions of Dollars)
Bell Memory Bell Instruments
Preliminary Final Preliminary Final
Inputs
Sales growth rate, g 5% 5% 5% 6%
Inventories/sales 30 20 15 16
Net plant/sales 59 50 30 30
Results
EROIC (2007)a 9.5% 13.0% 18.9% 18.6%
Invested (operating) capital (2007)a $1,110.4 $867.9 $255.3 $274.3
Current value of operations (2002)b $709.6 $1,157.4 $505.5 $570.1
Current MVA (2002)b ($160.4) $287.4 $305.5 $370.1
Notes:
aWe report EROIC and capital for the end of the forecast period because ratios can change during the forecast
period if inputs change during the forecast period. By the end of the forecast period, however, all inputs and ratios
should be stable.
bWe report the value of operations and the MVA as of the current date, 2002, because we want to see the effect
that the proposed plans have on the current value of the divisions.