How the Corporate Money Machine Works?

Corporate money machine is build using invested capital raise from shareholders, insiders and lender.

Each "captain of industry" has their own idea of how to build a money machine. But all the machines have the same basic mechanism. The machine is builted using invested capital. Money is raised from shareholders, financial institution and goes to build the products and services. The best machines are the ones which generate a lot of efficient force with a little invested capital.

How is Shareholder Value Created to maximize Company Intrinsic value?

Earning an attractive rate of return (ROIC), one in excess of the cost of capital (WACC), is a prerequisite for enhancing shareholder wealth.

 

 

Four Ways of Building Shareholder Wealth

 1. Improve operating efficiency (increase ROIC)

 2. Reduce Cost of Capital (WACC)

 3. Undertake real value-added new investment/projects

 4. Change perceptions of future growth.

 

ROIC > WACC. Projects return more than the cost of capital. Because management can earn a greater return by investing capital inside the company than investors could by investing in the market, value is created. The common share of this group of company sell at high P/E ratios and at premiums to their economic book values.

ROIC = WACC. Projects break even in economic terms. The return earned just covers the cost of capital, so that no value is created over and above the capital invested. The common share of this group of company sell at modest P/Es and at their economic book values. Theoretically, competitive forces drive tend to drive ROIC decrease and approaching WACC.

ROIC < WACC. Projects, a favorite of many large, mature companies with cash to burn, return less than their cost of capital. Because the return earned on the capital invested within the company is less than investors could earn elsewhere, an economic, or opportunity, loss is suffered and value is destroyed. The common shares of this group of companies sell at low P/Es and beneath their economic book value.

There is no guarantee that companies with ROIC < WACC will go bankrupt. A company could in theory go on forever earning a rate of return that, though short of recovering the full cost of capital, is sufficient to cover the after-tax cost of whatever money is borrows. With positive accounting earnings, this unfortunate company could continue to invest, grow earnings per share, and seemingly prosper all the while, when in reality it destroys value with each additional breath that it take.

Growth is only valuable if: Return on invested capital (ROIC) > WACC, NPV > 0. If ROIC = WACC, Growth neither creates nor destroys value NPV = 0. If ROIC < WACC, Growth destroys value, NPV < 0.