Why are you destroying the FCF

Shareholder value


The shareholder value concept was first defined in 1986 by the American economist Alfred Rappaport. Thereafter, the value of a company is measured by the market value of its shares.

1 This is the purpose of shareholder value

The shareholder value is part of the strategic target planning. With its help, the value of strategies can be determined. Equity represents the most important variable. Its increase means an increase in value for the owners. The shareholder value approach says that this should be the top priority of management, as the owners also bear the risk.

2 These data are important for the concept

The following values ​​are considered to be the basic evaluation factors for a successful strategy:

These values ​​must always be included in strategic considerations.

3 Calculation of shareholder value

The following formula is used to calculate the shareholder value as the present value of future cash inflows:

The following apply:

K= Cost of capital rate, discount factor
t = 1, ..., T= Planning periods

For the calculation, the free cash flow must first be determined:

Free cash flow= Operating profit
- paid taxes
+ Depreciation (does not affect expenditure)
- Investments in fixed assets (net)
- Investments in current assets (net)

The cost of capital is in turn calculated using the following formula:

For the determination of the shareholder value a Planning period from five to 10 years. Ultimately, the period chosen depends on the lifespan of the strategy. When determining the shareholder value, the cash flows of a period of z. If, for example, five years are used, the present value of the cash flows for these five years is the so-called Final value to complete. Based on the consideration that even after the five-year period under consideration there is still an enterprise value that will also lead to a cash flow contribution beyond the five years, this final value must be taken into account.

The final value summarizes the present value of the net cash flow inflows after the planning period. For the sake of simplicity, it is usually assumed that these net cash flow inflows will be achieved continuously at a constant level. For the calculation, this means that the net cash flows beyond the planning period are to be calculated as a "perpetual" annuity.

Practical example

Determination of the shareholder value

As a result of its strategic considerations, a company decides to add a new product to its product range. Development costs for this product have so far been EUR 3.7 million. Production and sales are to be started from 2 year 1.

The following investments are required in year 0:


Construction of production

Development of sales organization

7,500 amortization 5 years

1,200 amortization 5 years

The following sales are to be achieved with the new product:

Year 1Year 2Year 3Year 4Year 5Year 6ff
Turnover kEUR5.50011.00016.50019.50021.00021.000

The product achieves a coverage ratio of 25% in year 1. This is reduced by 1% per year as a result of the cost increases. From 2008, a constant coverage ratio of 20% is assumed.

10% of the increase in sales in each year is assumed to be an investment in current assets.

15% of the increase in sales in each year is invested as a net investment in the fixed assets of the following year. For 2003, 10% of the initial investment is calculated.

From year 6ff, the depreciation corresponds to the investment in fixed assets, so that the net investment is zero.

A profit tax rate of 50% is used.

periodYear 0Year 1Year 2Year 3Year 4Year 5Year 6ff
Increase in sales5.5005.5005.5003.0001.5000
Coverage ratio25%24%23%22%21%20%
contribution margin1.3752.6403.7954.2904.4104.200
from initial investment1.7401.7401.7401.7401.740
Initial investment8.700
Net investment AV8708258258254500
Net investment UV5505505503001500
contribution margin1.3752.6403.7954.2904.4104.200
profit after taxes–182,54501.027,51.2751.3352.100
Cash flow I1.557,52.1902.767,53.0153.0752.100
Net investment8.701.4201.3751.3751.1256000
Cashflow II (free CF)–8.700137,58151.392,51.8902.4752.100
Present value factors 15%0,8695650,7561430,6575160,5717530,4971760,432327
Present value CF II–7.5651045367969401.070
Cumulative present value CF II–4.120
Residual valueCash flow in year 0: cost of capital =14.000
Present value of the residual value14.000 × 0,432327 =6.053
Shareholder value1.933