Free Cash Flow: The Key to Shareholder Value Creation PDF download by Richard Malekian

Free Cash Flow: The Key to Shareholder Value Creation

Richard Malekian
Publication date: April 2012
Digital Book format: PDF (DRM-Free)

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About the Course

The goal of this course is to give the course participant a firm understanding of what Free Cash Flow is, and how it can be used to make better business decisions. As you go through the course, we will compare Free Cash Flow, as a metric, with other common metrics that are used in the business world today, and show why Free Cash Flow is a superior metric to use in measuring and in helping to create shareholder value.

Learning Objectives

The course is divided into eight sections. The first section of the course will begin with a general idea as to what the overarching company goal ought to be, and how Free Cash Flow can assist in the achievement of that goal. We will examine how traditional metrics have been used to achieve that goal, and why those traditional metrics are seriously flawed. We will then discuss the use of Free Cash Flow and as an economically valid tool to help us view value creation within the organization. We will see how this tool can be derived from the traditional financial statements, and how it can help us view the actual financial flows occurring within the company. In conjunction with this tool, we will also discuss the importance of return on investment and its comparison to the cost of capital in determining whether value has been created or destroyed with an organization.

In the second section of the course we will turn our attention to financial drivers, the component building blocks of Free Cash Flow, so that each person within a company can understand his or her role in helping to maximize this measure over the long term. We will also discuss the pitfalls of seeking to maximize individual Free Cash Flow components versus seeking to optimize those same components.

The third section of the course will be devoted to a discussion of the cost of capital. We will review the two major capital sources (debt and equity) and show how the costs of each should be determined. We will discuss why the cost of capital is critical in determining value creation within an organization, and the importance of viewing this cost as an “opportunity cost.” The cost of equity capital will be analyzed through the use of the CAPM (capital asset pricing model), and the theoretical underpinnings of this approach will be presented. The component parts of the CAPM will be discussed, including the calculation of beta coefficients for both private as well as public companies. Finally, the methodology for weighting the costs of debt and equity capital in order to develop a weighted average cost of capital will be presented.

The fourth section of the course will delineate how a Free Cash Flow metric can be used to evaluate capital budgeting decisions. In addition to the quantitative aspect of this discussion, the qualitative issues and pitfalls in projecting future Free Cash Flow results will also be addressed. This segment will ultimately give the participants a firm foundation for judging the value creation potential for any capital budgeting opportunity.

The fifth section of the course will present potential pitfalls in using a Free Cash Flow metric to analyze interim financial results (value creation over the short to intermediate term). We will see how an increase in Free Cash Flow does not always result in the creation of value over the short to intermediate term, and how an actual decrease in Free Cash Flow over a similar timeframe sometimes does. In addition, we will discuss the use of a “Modified Free Cash Flow” metric that will allow us to circumvent this seeming anomaly, while at the same time maintaining a strict economic underpinning. A comparison will be made between Free Cash Flow and Modified Free Cash Flow to see how each measurement quantifies business results over the short, intermediate, and long term. The advantage of using the Modified Free Cash Flow versus traditional Free Cash Flow to evaluate short and intermediate term results will be shown, and the reason why there are differences between the two metrics will be explored.

The sixth section of the course will address the use of Free Cash Flow to provide the proper quantitative analysis for acquisition opportunities. Initially, the various reasons why a company may want to engage in an acquisition will be explored and critiqued, followed by a discussion of the historical pattern of acquisitions in the U.S. from the 1960’s through the current era. This will be followed by a discussion of the importance of synergy in determining the ultimate value of an acquisition. A numeric example will be used to show how the value of an acquisition can be quantified using Free Cash Flow, and how much of that value will be reaped by the acquiring company versus the acquired company for a given purchase price.

Section seven of the course delves into the linkage of incentive compensation to Free Cash Flow. This section will address why conventional incentive compensation plans are frequently flawed, and how a plan based on Free Cash Flow will provide the proper incentive to management while delivering the expected economic return to shareholders. The various component parts of a Free Cash Flow incentive plan will be discussed with respect to their impact on the risk/reward profile of the plan.

The eighth section of the course will touch upon the variety of issues that may arise while implementing a Free Cash Flow metric within an organization, and how those issues may be overcome. These issues will include a discussion of how detailed the Free Cash Flow metric should be, how far within an organization the Free Cash Flow metric should be applied, how far within an organization should an incentive compensation plan based on Free Cash Flow be implemented, and how much training and education will be needed by a company internally implementing a Free Cash Flow metric.

Who Should Take This Tutorial

Chief Executive Officers
Presidents
Chief Financial Officers
Controllers
Financial Managers
Financial Analysts
Finance Students
Accounting Students

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