Shareholder value analysis
It has been argued that Shareholder Value analysis is flawed in that there are too many steps in the model and too many variables attached to them. However, this essay is concerned with analyzing this statement and in doing so, evaluating the need for each step in the model. Essentially, shareholder value analysis refers to the firms’ success in enriching its shareholders. The shareholder value analysis is based on the idea that money should not be used in ventures that have a high cost of capital and low earnings. An organizations’ shareholder value analysis is derived by estimating the company’s balance sheet items i.e. assets fewer liabilities. The figure that is obtained is then divided by the share price of the company. Shareholder value analysis operates on the basic principle that a firm value is added only when the earnings exceed the total costs. After determining the value-added, a firm can then take steps so as to enhance its success.
The following are the steps that are used in determining the shareholder value analysis of a firm; the first step in determining the shareholder value analysis is to obtain the last years’ accounts i.e. the cash flow statements, profit and loss accounts and the balance sheet. The shareholder value analysis is not flawed as there are many benefits derived in this phase of getting hold of last year’s accounts. Essentially, the main aim of obtaining the previous year’s financial statements is to inform the shareholders about the performance of a firm during the last year. The users of firms’ accounts are mainly concerned with the future operations of a firm i.e. the ability of a firm to continue earning high returns and also the ability of a firm to pay dividends in the future. The cash flow analysis provides an insight on how a company obtains its financing and also on how it deploys its resources. However, historical financial documents are important as they provide the users with valuable information concerning the firm. By earning the last year’s accounts, the management is able to forecast the financial strength of a firm. The equity shareholders are mainly concerned with the relationship between the growth and the operating income and thus the last year’s accounts enable them to determine forecast the capacity of the firm to pay dividends in the future. Forecasting uses the historical date and projects it into the future to predict the occurrence of a certain event. To a great extent, the business environment has changed and therefore, every organization requires to determine its future decision variables so as to meet the customers’ needs. Forecasting thus enables a firm to research on customers’ needs and thus institutionalizes such cultures as innovation so as to survive. In general, the decision is influenced by chosen strategies with regard to organizations’ future priorities and activities. The shareholder value analysis is thus not flawed as there are many benefits that are associated with examining the previous year’s financial statements (Mekonnen, 2002, 153).
The next step of shareholder value analysis is to prepare a business plan. Essentially, a business plan is a formal statement of a set of business goals.
Normally, there is no set content for a business plan. A business plan should have sufficient information so as to enable stakeholders to make sound economic decisions i.e. whether to invest in a particular company or not. The shareholder value analysis is thus not flawed due to the many benefits that are arrived at as a result of a business plan.
The business plan should be aimed at making potential investors have confidence regarding the company i.e. it should guarantee them success in the future (Cohen & Graham, 2001, 19). A business plan plays an important role in enabling a new business to grow especially during the maturity stage of growth. A business plan usually acts as an operative tool that guides the senior leadership team on strategic objectives. The shareholders are the main stakeholders with regards to business plans as it helps them in developing and managing the business as well as helping the business to grow. The business plan is more than a document and thus, it is a management tool that is developed with an aim of securing funding. One should analyze his or her management team before submitting his or her business plan to stakeholders so as to determine whether the management team is flexible, experienced and qualified. A business plan is developed so as to accomplish specific objectives i.e. to impress the various stakeholders and hence the shareholder value analysis is not flawed (Cohen, & Graham, 2001, 18-20).
A typical business plan has the following key components i.e. executive summary, company analysis, industry analysis, analysis of customers and analysis of competition. The executive summary enables the investors to understand how the business is organized and run. This section provides details concerning the strengths and weaknesses of the business i.e. it addresses the core competencies as well as challenges of a business. The company section provides an overview of the progress that is made in creating the business i.e. it explains when the business was started, phase of growth, expansion, market share e. t. c. The industry section of a business plan provides the investors with an overview of the entire industry and it is concerned with the following aspects i.e. the competitiveness of the industry, the industry leaders, the growth and opportunities among others. Thus, it includes well-structured answers to key market research questions as follows; with what other industries do the company’s services completely e. t. c. The analysis of the customer section discusses the customer’s expectations and needs (Cohen, & Graham, 2001, 18-20).
Determining the cost of capital of a firm and disaggregating it to the various product sectors and business unit is the next phase of shareholder value analysis. When a company offers long term funds through the issue of corporate bonds or the issue of shares, they incur finance costs and these costs are the costs of obtaining capital. This cost of capital from the investor’s point of view is the minimum required rate of return which is at times known as the discount rate or the opportunity cost of capital. The various investors include preference shareholders, debenture shareholders and ordinary/equity shareholders. The cost of capital of a firm is not necessarily a cost, but rather the required rate of return for a project. Ordinary shares are valued by using different models which includes the following; price earning ratio basis, net asset basis, capitalization of earnings model, dividend growth model, finite earnings model and super-profits model. The capitalization of the earnings valuation model is used to determine the value of ordinary shares where firms’ future earnings or dividends are not expected to grow or increase. This model is also referred to as a zero-growth/no growth valuation model. The capitalization of the earnings valuation model is recommended to companies whose earnings are relatively uniform or those companies that adopt a 100% pay-out ratio dividend policy. The dividend growth model is also known as Gordon’s model is used to estimate the value of ordinary shares where it is expected that a firm’s future dividend shall increase at a constant rate each year in perpetuity. This policy is adopted by companies that have the capacity to generate higher earnings out of which additional dividends can be financed (Ogilvie, 2007, 233).
The shareholder value analysis is not flawed as there are many benefits that are associated with the cost of capital. Cost of capital is also used in investment appraisal i.e. when a firm is making capital budgeting decisions; the cost of capital is used as a discounting rate. The cost of capital is also playing an important role in making capital structure decisions i.e. when determining the optimal capital structure. e. t. c. Firms usually reflect on the following factors when making the capital structure decisions; sales stability i.e. those companies that have stable sales are able to use debt financing as opposed to companies that have unstable sales. Other factors that are taken into account when making capital structure decisions include the asset structure, operating leverage, growth rate, profitability, market conditions, industrial norms, cost of capital, and nature of assets among others. The cost of capital is also used in making financial decisions i.e. when deciding how to raise finances, one of the factors that are considered is the cost of raising such funds and thus, the cost of capital is used as a basis of determining how to raise the finances. Also, the cost of capital is used to evaluate the performance of top management i.e. the actual rate of return of projects undertaken is compared with the minimum required rates of return. If the management has undertaken a project where the actual rates of return are equal to the minimum required rate of return, then they can be said to be doing a good job and vice versa. It is important to determine the cost of capital with care because if not, the management may end up making an incorrect investment decision, incorrect financing decisions, incorrect capital structure decisions an incorrect evaluation of top management performance (Bragg,2010,148).
The next phase of shareholder value analysis is to calculate the value of the shareholder. The shareholders are mainly concerned with the forms earnings. In the case of publicly held corporations, the profits are not shared with the owners directly but rather, the profits are paid out in form of dividends. The owners are concerned with the total returns which are comprised of the shares plus dividends. The appreciation of shares plays an important role in maximizing the shareholder return and therefore, the shareholder’s main aim is to maximize the share value of their firm. Essentially, the firm’s value is determined the same way just like any other asset i.e. determining the net present value of cash flows. Thus, the discounted cash flow techniques are used in determining shareholder value maximization. In maximizing its value, a company usually maximizes its free cash flow to minimize the cost of capital. The shareholder value analysis is thus not flawed because it helps in determining the value of shareholders (Grant, 2005, 45).
Decomposing the business strategies into the main drivers is the next phase of shareholder value analysis. This is important because the results are used in gaining an insight into the likely behaviors of unpredictable variables. Firms usually monitor the main drivers that can influence their share prices such as political instability, legislation e. t. c. Most companies that have diverse units are associated with significant synergies between the business units. Thus synergy between the various business units is essential in realizing the synergies. The shareholder value analysis is not flawed as it helps in enhancing superior shareholder value. Firms usually create shareholders by ensuring that their cash flows are at a higher level as compared to other firms in the industry. Once the top management identifies the strategies for maximizing value drivers, then the drivers are decomposed into strategic drivers (Dauber, N. et.al.2008, 1417).
The last step of shareholder value analysis is to allocate the resources of the firm to business units. Allocating the resources of the firm to business units is a strategy that enables the firm to compete successfully in the market. A strategic business unit is usually part of an organization for which there is a separate external marker that is completely different from another strategic business unit. This phase is important as it enables the management to focus on gaining a competitive advantage over the rival firms. Thus the shareholder value analysis does not flow as it enables the management to determine how the various business units of the organization deliver effectively the corporate and business strategies in terms of resources, processes and people (Morin, & Jarrel,2001,449-150).
Despite the many steps in the model, shareholder value analysis is not flawed as it has been proved above.
Genetic Algorithms in managerial decision-making
Genetic algorithms abbreviated as GA refer to a system of programming that uses biological evolution in decision making. The lives of human beings are associated with genes. Genes thus govern the physical features, personalities, behaviors, longevity and health of human beings. It is easy to control and manipulate genes and also is easier to turn them on and off so as to attain the desirable results. The significant discovery of genes has thus led to the increased usage of GA in computational engineering. Genetic Algorithms has over the years emerged an s unique technique for solving a range of mathematical problems (Sage, & Rouse, 2009, 743).
Benefits of using genetic algorithms in decision making
The following are the main benefits of using genetic algorithms in decision making; a genetic algorithm enhances continuous learning. Genetic algorithms are mainly applied in financial markets. Financial markets are usually characterized by continuous revolution and thus the traders are always aware that the financial markets can change at any particular time. As a result of the changes in financial systems, genetic algorithms are used so as to provide the investors in making trading decisions. Genetic algorithms are able to learn intermittently from the financial market and thus they help in inducing new relationships, testing them and presenting them to the various users for decision making (Hillebrand, Stender, & Kingdon, 1994, 185-188).
Genetic algorithms have the capacity of coping with brittleness. Genetic algorithms usually maintain a series of solutions and this, in turn, makes the genetic algorithms to be non-brittle. For instance, each rule in a population has a relationship that describes the system that should be modeled. The systems of genetic algorithms are flexible implying that they are able to represent many hypotheses. Just like neural networks, genetic algorithms have statistical reasoning power and this enables them to deal with brittleness (Zhang, & Zang, 2004, 22).
A genetic algorithm enhances the transparency of the decision-making model. Genetic algorithms have the capacity of determining the exact conditions and thus it enables the top management in an organization to make decisions. Genetic algorithms also have reasoning capability and this is important as it ensures that correct decisions are made (Hillebrand, Stender, & Kingdon, 1994 185-188).
Weaknesses of genetic algorithms in decision making
The following are the main weaknesses of genetic algorithms in decision making; the convergence time is usually slow. In a genetic algorithm, the quality of the solution is dependent on the initial population implying that, the solution obtained may be inaccurate if the initial population is incorrect. In a genetic algorithm, the initial population is randomly created and also the exploration is randomly done and this implies that the initial population may not be correct and hence an incorrect solution (Kale, 2008, 288)
Reference List
Bragg, S. M., 2010.The New CFO Financial Leadership Manual. London: John Wiley and Sons.
Cohen & Graham, R.2001.The project manager’s MBA: how to translate project Decisions into business success. Hoboken: John Wiley and Sons.
Dauber, N. et al., 2008. Corporate controller’s handbook of financial management 2008-2009. Christchurch: CCH.
Grant, R. M., 2005. Contemporary strategy analysis. Hoboken: Wiley-Blackwell.
Hillebrand, E, Stender, J & Kingdon, J., 1994. Genetic algorithms in optimisation, Simulation and modeling. Amsterdam: IOS Press.
Kale, K.V., 2008. Advances in Computer Vision and Information Technology. New Delhi: I. K. International Pvt Ltd.
Mekonnen, M., 2002. Projects for Shareholder Value: a capital budgeting Perspective. Amsterdam: Rozenberg Publishers.
Morin, R.A. & Jarrel, S.L., 2001. Driving shareholder value: value-building Techniques for creating shareholder wealth. New York: McGraw-Hill Professional.
Ogilvie, J., 2007. CIMA Official Learning System Management Accounting Financial Strategy. London: Butterworth-Heinemann.
Sage, A.P. & Rouse, W.B., 2009. Handbook of Systems Engineering and Management. Hoboken: John Wiley and Sons.
Zhang, Z & Zang, C., 2004. Agent-based hybrid intelligent systems: an Agent-Based framework for complex problem solving. Berlin: Springer.