The Profitability, Financing, and Growth of the Firm

Preface 7

 1 Conceptual Framework 9

 2 Profit, rate of return, and growth as conditions for …|the survival of the firm 11

2.1 Profit is no measure of profitability 11

2.2 The market price for capital 12

2.3 
 Relationships between the market value of equity and the return on equity 13

2.4 Relationships between growth, return, and equity ratio 22

2.5 Illustrations 24

 3 Leverage relationship: the link between return and …|the liabilities-to-equity ratio 29

3.1 Measures of return on capital 29

3.2 Relationships between different return measures 31

3.3 Relationships when the values of variables change 35

3.4 Illustrations and exercises 40

 4 The rate of return, the liabilities-to-equity ratio, and risk 43

4.1 Financial policy considerations and risk 43

4.2 Financial policy as a problem of risk 47

4.3 
 Valuation of risk and selection of liabilities-to-equity ratio 49

4.4 The interest coverage ratio 53

 5 Calculation of the rate of return and taxation 57

5.1 Introduction 57

5.2 No temporary or permanent differences 59

5.3 Only temporary differences 60

5.4 Only permanent differences 62

5.5 Illustrations and exercises 66

 6 The DuPont relationship and alternative ways to analyze …|operating performance 69

6.1 
 The split of ||ROA|| into a margin and a capital turnover component 69

6.2 
 Capital employed or invested capital instead of total assets 77

6.3 Exercises 90

 7 The relation­­ship between growth, rate of return …|and the liabilities-to-equity ratio 93

7.1 Targets concerning growth 93

7.2 Balanced financial growth 94

7.3 Growth of equity 97

7.4 A few measurement issues 104

7.5 Opening or average capital: How do you choose? 106

7.6 Illustrations and exercises 107

 8 Summary of financial relationships 109

8.1 
 Summary of relationships with total assets as a capital basis 109

8.2 Capital employed and invested capital as capital basis 113

8.3 Confusing terminology 114

8.4 Illustrations and exercises 117

 9 Cash flow and growth in financial balance 129

9.1 Cash flow statement 129

9.2 Cash flow and targets for return, growth, and leverage 131

9.3 Investment capacity at set financial targets 135

9.4 Loan repayment required by a ||ND/EBITDA|| covenant  138

9.5 Illustrations and exercises 146

 10 Growth – allowing a changed debt-equity ratio 149

10.1 Planned continuous changes 149

10.2 Unplanned continuous changes 152

10.3 Planned changes of a non-recurring nature  154

 11 Management control, return, and growth for a group and its parts 157

11.1 
 Control via targets for ||ROCE|| and financially stable growth 158

11.2 The relationship between ||ROCE|| and capacity for growth 161

11.3 Control of ||ROIC|| and free cash flow 166

11.4 
 Control with the focus on economic profit as an alternative to ROIC|| 167

11.5 Illustrations and exercises 172

 12 Returns, growth, and equity valuation 175

12.1 Valuation of Multibrands 175

12.2 Future dividends  179

12.3 Equity and economic profit 184

12.4 Future free cash flow 186

12.5 Invested capital and future economic profit 190

12.6 A simple benchmark model 192

12.7 Summary 199

 13 Pitfalls of using financial key ratios 201

13.1 Origin of problems 201

13.2 Unrealized appreciation of value in fixed assets 203

13.3 Expensed intangible investments 205

13.4 Growth by acquisition 210

13.5 Stakeholders with multiple roles 210

13.6 Deliberate improvements 213

13.7 Illustrations and exercises 215

Symbols/Definitions 219

References 223

Index 225