Extracts from S. Handler – Value-based strategic management: a survey of UK companies: Economic value - Strategic Management

There are a number of variations on the theme of value assessment, but all arebased on an analysis of the future cash flows which will be generated. This analysis involves the discounting of future cash flow values by an appropriate cost of capital. Economic value appraises future expectations rather than current and past performance. The limitations seen by the companies in the survey relate mainly to its practical application, for its usefulness relies heavily on making the correct assumptions and preparing the cash projections.

The advantages, it is argued, outweigh the limitations, making it the clearly favoured approach, because:

  1. It measures cash, not accounting profit, which can be distorted by accounting conventions such as those for depreciation, stock valuation and provisions.
  2. Accounting measures concentrate on the past and the present profits, not on the future. Investors focus on future cash generation, looking for dividends and capital gains.
  3. It considers the time value of money, unlike the other methods. It is concerned with the timing of all cash flows.
  4. Empirical studies show that future cash flow is a better indicator for potential value creation.

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