VBM, KPI Feb 2016

Company X
Value Based Management,
Financial KPI
February 2016Olegas Kasatkinas

2
Content
1. Value Based Management 3
2. Main Metrics and Ratio 4
3. NOPAT – Net Operation Profit After TAX 5
4. FCF – Free Cash Flow 7
5. WACC - Weighted Average Costs of Capital 9
6. Capital Structure Optimization 14
7. ROIC – Return on Invested Capital 16
8. EVA- Economic Value Added 22

3
VBM – Value Based Management
Streamline Corporate Finance based on VBM:
- Develop corporate strategy(the objective in
decision makingscenarios is to maximize
shareholder value)
- Develop management performance
measurement directlylinkedto shareholder
wealth (the basic concept is that performance
should be measured in terms of value added
during the period)
Value based management entails managing the
balance sheet as well as the income statement,and
balancing long- and short-term perspectives.

4
VBM- Main Metrics and Ratio
Main metrics and ratios:
- NOPAT – Net Operating Profit After Tax
- FCF – Free Cash Flow
- ROIC – Return On Invested Capital
- WACC - Weighted AverageCosts of Capital
- EVA – Economic Value Added
NOPAT is a very handy number in finance:
- It is the number from which you subtract investments (change in net working capital, net
capital expenditures) to derivefree cash flow (FCF) in a discounted cash flow model;
- it is the number from which you subtract a capital charge (investedcapital times the cost
of capital) to calculate economic profit (EVA);
- and it is the number that serves as the numerator of ROIC.

5
NOPAT – Net Operating Profit After Tax
NOPAT is cash earnings if company capitalization
would be unleveraged (that is, if it would not be any
debt). NOPAT is a more accurate look at operating
efficiency for leveraged companies. It does not include
the tax savings many companies get because they have
existing debt.
NOPAT = EBIT x (1- Tax Rate)
NOPAT = (Net Income + after-tax Interest Expense)

6
NOPAT - Net Operating Profit
NOPAT uses operating income before taking
interest payments into account. For this
reason, NOPAT is a crucial measure in a
variety of financial analyses because it gives a
clearer view of operating efficiency - a view
that is not clouded by how leveraged the
company is or how big of a bank loan it was
able to get. This is important, because those
interest payments on debt reduce net income
and thus reduce the company's tax expense.
Year 2015
$6,132 $2,177 $8,309
$11,316 (1 - 20%) $544 $8,309
Interest x Tax
Rate
=(1 -Tax Rate) -EBIT
Net Income
NOPAT
+
Interest*(1 - Tax
Rate)
= NOPAT
x
Year 2014
$6,036 $2,614 $8,649
$11,989 (1 - 20%) $653 $8,649
Net Income +
Interest x Tax
Rate
= NOPAT
Interest*(1 -
Tax Rate)
= NOPAT
EBIT x (1 -Tax Rate) -
Year 2016
$9,055 $1,440 $10,495
$13,557 (1 - 20%) 360 $10,495
Net Income +
Interest*(1 -
Tax Rate)
= NOPAT
= NOPATEBIT x (1 -Tax Rate) -
Interest x Tax
Rate

7
FCF – Free Cash Flow
The return that an investor in a private company should focus on is the spreadable cash that the company
generates after allowing for payment of all expenses and taxes and all reinvestment requirements for
working capital and capital expenditures. This amount, which is sometimes called Free Cash Flow
(FCF), is the net cash flow on the capital invested in the business. It is computed as:

8
FCF – Free Cash Flow
Curiously, net cash flow to invested capital appears on no financial statements, and private company
owners almost never see it. But it represents the critical cash that can be taken from the business by debt
and equity capital providers after all of the company's needs have been met. It is the capital providers'
true return

9
WACC – Weighted Average Costs of Capital
Proper investment choices must consider the risk or likelihood that the investment’s future will be
achieved. This required rate of return is also known as costs of capital, or a discount rate. The required
rate of return is the benchmark you must to achieve to create value.
Because companies employ both debt capital and equity capital the costs of each of these capital sources
must be computed. WACC is a weighted average of the after-tax costs of debt and costs of equity
Where:
Re = cost of equity
Rd = cost of debt
E = value of the firm's equity
D = value of the firm's debt
V = E + D = total value of the firm’s financing (equity and debt)
E/V = percentage of financing that is equity
D/V = percentage of financing that is debt
Tc = corporate tax rate

10
WACC – Costs of Debt
Costs of Debt is simply to obtain. This is annual
interest on bank loan. However, this is a pretax
cost of debt - companies can deduct interest
expense from their tax bill, and reap a true cash
benefit. The after-tax cost of debt is therefore
lower. To obtain this number we multiple the
pretax cost of debt by the so-called tax shield or (1-
tax rate).
Year 2014
12.0% (1 - 20%) 9.6%
Pretax Costs fo
Debt
x (1 -Tax Rate) =
After-Tax Costs
of Debt
Year 2015
12.0% (1 - 20%) 9.6%
(1 -Tax Rate)x =
After-Tax Costs
of Debt
Pretax Costs
fo Debt
Year 2016
18.0% (1 - 20%) 14.4%
Pretax Costs fo
Debt
x (1 -Tax Rate) =
After-Tax Costs
of Debt

11
WACC – Costs of Equity
We use capital asset pricing model (CAPM)to calculate costs of
equity.According to thismodel the costsofequity isdetermined by
three factors: the risk-free rate of return, the market-wide risk
premium, and a β - risk adjustment that reflectseach company’s
riskinessrelative to the average company.Ahigherbeta implies
greaterrisk which,in turn,increasesthe expected return - and the
expected return isthe same as the cost of equity.Beta,asa measure of
risk, is a measure of the stock'ssensitivityto the overall market.A
beta of 1.0 impliesthe stock will track closely with the market.A beta
greaterthan 1.0 impliesthe stock ismore volatile than the market.The
market risk premiumis the overall average excessreturn that investors
in the market expect above that ofa risk-less investment like domestic
treasury bonds,which for our calculation is 8%.There is always
vigorousdebate overwhat the correct equity premiumis.We will use
an equity premiumof32%
Cost of Equity = Risk-Free Rate + Leverage Beta x Market Risk
Premium
Year 2014
8.0% 32% x 1.00 40.0%
Risk - Free Rate +
Premium x
Beta
= Costs of Equity
Year 2015
8.0% 32% x 1.00 40.0%
Risk - Free
Rate
+ Premium x Beta = Costs of Equity
Year 2016
8.0% 32% x 1.00 40.0%
Risk - Free Rate + Premium x Beta = Costs of Equity

12
WACC –Cost of Debt vs Cost Of Equity
You may have already noticed that debt is cheaper than equity. There are two reasons for this: first, the pretax cost of
debt is lower because it has a prior claim on the company's assets. Second, it enjoys the tax shield (i.e. it is a tax-
deductible charge), which is why a balance sheet totally devoid of debt may be suboptimal. Because debt is cheaper,
by swapping some equity for debt, a company may be able to reduce its WACC.
So why not swap all equity for debt? Well, that would be too risky; a company must service its debt, and a greater
share of debt increases the risk of default and/or bankruptcy. Capital structure should be optimum.

13
WACC – Weighted Average Costs of Capital
WACC significantly higher in 2016 due to borrowing rate
increase in tenge from 12% to 18% and significant
reduction of debt share in invested capital.
Higher WACC means higher risk for investor and partly
reflect difficulties in local economy.
Weighted Average Costs of Capital 2014
Cost Share of Capital Weighted Costs
Debt 9.6% x 82% = 7.83%
Equity 40.0% x 18% = 7.36%
WACC = 15.19%
Debt 9.6% x 84% = 8.05%
Equity 40.0% x 16% = 6.47%
WACC = 14.52%
Debt 14.4% x 61% = 8.80%
Equity 40.0% x 39% = 15.54%
WACC = 24.35%

14
Capital Structure Optimization
A company’s balance sheet is the result of its financing and investment behavior. In this simplified context, the left-hand
side of the balance sheet includes the uses of funds, cash holdings kept for liquidity needs or precautionary purposes and
investments in net working capital and fixed assets made by the company (tangible and intangible). The right-hand side
of the stylized balance sheet accounts instead for the different sources of funds for the company, broken down into equity
and alternative types of financial debt – e.g. bank loans. Equity can build up from external investors who acquire a stake
in the business, as well as from a company’s internal funds such as retained earnings accumulated after dividends have
been paid to shareholders.
A company is operating efficiently if the profit on its uses of funds (i.e. on the asset side) is at least equal to the cost of its
sources of funds (i.e. the liabilities side).
On the asset side, firms need to find the right balance between the necessity to maintain an adequate cushion of liquidity,
to cover ordinary operations and to face future downturns or scarcity of funding, and the need to invest for growth. Large
cash holdings, in fact, provide protection but generate low returns which depress overall profitability, as measured in
terms of Return on Invested Capital (ROIC).
On the liabilities side, instead, firms need to find the right balance between alternative sources of funds in order to
optimize the capital structure and minimize its cost of financing, captured by the Weighted Average Cost of Capital
(WACC) that is a function of the cost of debt, the level of the tax rate, the cost of equity and the relative weights of debt
and equity.

15
Capital Structure – Debt to Equity Ratio
The finance theory is not able to determine a universal formula which would enable an indication of a target optimal
capital structure for a particular company. No formula exist to calculate optimal capital structure
In such case lets take a logical approach. First we should avoid any extreme: it should not be 100% even debt or equity
capital. Shareholder withdraw about 80% of equity capital at the beginning of each year as dividends. We can regulate
only the size of debt capital or bank loan. It depends very much on debt collection and size of Trade receivable account.
We can achieve maximum 45 days of trade receivable turnover. With assumption that company monthly turnover is
$20M the balance of trade receivable account can be minimum $30M and outstanding debt to the bank about $10M
So, the target for Company must be $10M debt capital and $10M equity capital or debt/equity ratio = 1 at the end of
each year. After dividends payment this rate will increase ($10M+$8M)/($10M x (1-80%))=$18M/$2M=9 and each year
company again should generate positive free cash flow to reduce this debt/equity ratio down to 1.
Jan-14 Jan-15 Jan-16
Debt/Equity
Raito
2.0 18.2 6.0

16
ROIC – Return on Invested Capital
ROIC shows a company’s cash rate of return on
capital (regardless of the capital structure of the
company) it has put to work
The numerator of ROIC is NOPAT, and
denominator is invested capital. You can think of
invested capital in two ways that are equal. First,
it’s the amount of net assets a company needs to
run its business. Alternatively, it’s the amount of
financing creditors and shareholders need to supply
to fund the net assets.

17

18
It is important to measure not only profit but amount
of capital employed to earn this profit. Return on
investment is limited to dividends and appreciation in
the stock value.
Return on invested capital (ROIC) is one of the most
fundamental financial metrics. When coupled with the
weighed average cost of capital (WACC), ROIC
becomes one of the most important drivers to value
creation.
The cost of capital represents the minimum rate of
return (adjusted for risk) that a company must earn to
create value for shareholders and debt holders. ROIC
is measured against the cost of capital, which is what
makes it such an important concept.
Return On Invested Capital 2014
$8,649 $42,417 20.39%
NOPAT / AVR IC - Cash = ROIC
$8,309 $32,986 25.19%
$10,495 $17,400 60.31%

19
ROIC can be decomposed into two parts
(this is a modified version of what is
known as a DuPont Analysis):
The ratio of NOPAT/Sales, or NOPAT
margin, is a measure of profit per unit.
Sales/Invested Capital, or invested capital
turnover, is a measure of capital efficiency.
When you multiply the terms, sales cancel out
and you are left with NOPAT/Invested
Capital, or ROIC.
ROIC DuPONT Analysis 2015
xROIC =
NOPAT
Invested
Capital
=
NOPAT
Revenue
Revenue
Invested
Capital
$8,309 $8,309 $260,440
ROIC = = x
$32,986 $260,440 $32,986
ROIC = = x25.2% 3.2% 7.9 times

20
Spread ROIC – WACC
When compared to WACC, ROIC can help
determine whether or not a company creates
value for its shareholders. If the ROIC of a
company is higher than its WACC, it means that
the company is a value creator.
The ROIC-WACC spread is one of the most
important metrics to assess the quality of a
company. In today’s market, everybody talks
about growth, but the fact is that growth is good
only if a company is a value creator. Because if a
company destroys value, growing will only
make things worse. When ROIC is high, faster
growth increases value, but when ROIC is lower
than the company costs of capital, faster growth
necessarily destroys value.
High-ROIC companies should focus on growth,
while low-ROIC companies should focus on
improving returns before growing.
ROIC - WACC spread 2014
20.39% 15.19% 5.20%
ROIC - WACC = Spread
25.19% 14.52% 10.67%
= SpreadROIC - WACC
60.31% 24.35% 35.97%
ROIC - WACC = Spread

21

22
ROIC, Growth, Investment and dividends
Company growth must be supported by additional investment. It can be equity investment or debt investment.
Equity reinvestment, seems to be, is not preferable. Debt investment should be minimized to minimize
interest costs. So, we have only one option: support company growth by working capital optimization, means
increase working capital turnover.
Formula below represents calculation of optimal size of dividends to support further business growth or % of
total net profit for distribution and reinvestment. Based on 2015 result and according to this calculation 75%
of net profit could be distributed and 25% reinvested, accordingly in 2016 81% and 19%.
Dividends distribution
Growth
D = x (1- )
ROIC
Net Profit
Dividends distribution 2015
6.64%
D = $6.132 x (1- ) =
26.68%
$4,605
Dividends distribution 2016
11.50%
D = $9,055 x (1- ) = $7,328
60.31%

23
EVA – Economic Value Added
There is a new and significantly better way to
measure and maximize shareholder value that
involves replacing traditional financial metrics
and valuation tools with new ones. Economic
Value Added (EVA) measures profit according
to economic principles and for the purpose of
managing a business, and not by following
accounting conventions. It is computed as net
operating profit after tax less a charge for typing
up balance sheet capital. It consolidates income
efficiency and assets management into one net
profit score.

24
Economic Profit 2014
$8,649 15.19% $42,417 $2,204
=
Economic
Profit
NOPAT - WACC x AVR IC - Cash
$8,309 14.52% $32,986 $3,520
=
Economic
Profit
$10,495 24.35% $17,400 $6,258
=
Economic
Profit
Economic profit is NOPAT minus a capital charge, which
represents a sort of rental fee charged to the company for
its use of capital. In other words, economic profit is the
profits (or returns) our company must generate in order to
satisfy the lenders and shareholders who have "rented"
capital to the company.
EVA is equal to NOPAT less a charge for capital or EVA =
NOPAT – WACC x IC
To create economic profit NOPAT should exceed a charge
of capital.

25
EVA = NOPAT – WACC x IC
Lets little change presentation of this equation and replace
NOPAT by ROIC
ROIC = NOPAT/IC or NOPAT = ROIC x IC
than EVA = ROIC x IC – WACC x IC = (ROIC-WACC) x IC
The ROIC-WACC spread is one of the most important metrics
to assess the quality of a company. if a company has a positive
ROIC-WACC spread or alternatively has a positive EVA; it is a
value creator. If the ROIC-WACC spread is negative or that the
firm has a negative EVA, it is a value destroyer.
Economic Spreadt 2014
5.2% $42,417 $2,204
ROIC - WACC + AVR IC - Cash = Economic profit
10.7% $32,986 $3,520
ROIC - WACC x AVR IC - Cash = Economic profit
36.0% $17,400 $6,258
ROIC - WACC + AVR IC - Cash = Economic profit

26
Bigger isn't always better. The assumption that a
company growing revenue, assets, employees, and profits
becomes more valuable to its shareholders requires closer
examination. Growth creates value only if adequate
compensation exists for the incremental capital required
to generate that growth. Focusing on where and how a
business earns an adequate return on the capital
employed, even if that means shrinking the business from
a revenue or asset perspective, can create more value.
Managers commonly focus on EBITDA growth, giving
little consideration to the amount of capital required to
achieve that growth. Ensuring that growth-oriented
projects achieve acceptable returns should trump other
decision criteria.

27
Companies thrive when they create real economic
value for their shareholders. Companies create
value by investing capital at rates of return that
exceed their costs of capital.
The capital charge is computed by multiplying the
costs of capital rate times the capital – that is, times
the amount invested in the firm’s net business
assets, which is all the assets used in the business,
net of, or less, the money advanced by trade
suppliers.
That being the case, the more a company is able to
finance its working capital with interest-free credit
from its suppliers, the less capital it will need to
obtain from lenders and shareholders, and the
higher it’s EVA will be.

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It is real value in teaching team members about what
goes into EVA and provide company-specific
examples of how they can win. It’s the simplest way
to spread financial literacy company-wide and
stimulate a lot of good thinking around how to
improve performance in ways that may not have
occurred to anyone before that thinking in terms of
EVA. On they understand that trade credit reduces
the capital charge, for instance, employees will
naturally lean on suppliers for better term without
need for constant prodding from the CFO.
A fundamental reason accounting is so flawed as a
management and shareholder valuation tool is that
accounting statement cater to lender rather than to
owners. All else being equal, fewer assets mean
more EVA, more real franchise value, and more
wealth to the owners. The only true assets any
company has is its ability to earn and increase EVA,
which never appears on balance sheet.
2014 2015 2016
ROIC 20.4% 25.2% 60.3%
Economic Spread 5.2% 10.7% 36.0%
Economic Profit $2,204 $3,520 $6,258
$9,055
$1,440
$10,495
After-Tax Costs of
Debt
Costs of Equity
9.6%
40.0%
9.6% 14.4%
40.0% 40.0%
Net Income
Interest Tax Free
NOPAT
$6,132
$2,177
$8,309
$6,036
$2,614
$8,649
WACC 15.2% 14.5% 24.3%
Debt Share Of Capital
Equity Share of
Capital
82%
18%
84%
16%
61%
39%

29
Company Financial KPI 2016
Financial KPI Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16
Forecast Forecast Forecast Forecast Forecast Forecast Forecast Forecast Forecast Forecast Forecast Forecast
Moving Average DSO 62 62 58 58 58 58 58 58 58 58 58 58
NOPAT 8,318 8,364 8,293 8,397 8,572 8,778 9,126 9,775 10,524 10,795 10,519 10,495
Debt Investment 17,900 14,778 10,676 10,351 11,475 10,992 10,799 10,287 9,701 9,165 8,146 7,800
Equity Investment 2,959 3,611 4,206 4,971 5,668 6,443 7,260 8,072 8,875 9,804 10,654 11,410
ROIC 26.97% 29.47% 31.80% 34.49% 37.87% 39.86% 42.11% 46.55% 51.26% 53.98% 56.16% 60.31%
WACC 14.90% 15.41% 15.98% 16.55% 17.19% 17.56% 17.88% 18.38% 18.86% 19.45% 20.37% 21.41%
Economic Spread 12.07% 14.06% 15.82% 17.94% 20.68% 22.31% 24.23% 28.17% 32.40% 34.54% 35.79% 38.90%
Accumulated AV 203 471 606 849 1,161 1,392 1,731 2,396 3,131 3,386 3,184 3,249

Company X
Thank you very much for
your attention!
Feb 2016Olegas Kasatkinas

VBM, KPI Feb 2016

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