Financial KPIS - Financial Metrics

By: EconomyWatch   Date: 30 June 2010

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Metric: Net Present Value (NPV)

The Question:

What is the value today of the cash flows I will generate in the future?

Approach:

The value of future money is discounted to achieve present value

Commentary:

Used for budgeting purposes. The Discount Rate may be equivalent to interest earned on investments, WCC, or inflation plus risk.

Key to a convincing NPV calculation is picking the right Discount Rate.

Very similar to Discounted Cash Flow (DCF) analysis.

The Formula:

Net Present Value (NPV) = Rt/ (1+i)^t Or, NPV ($)= (Total cash in – cash out, $) / (1 + Discount %) ^ total yearsIf the Discount Rate is 3%, then in year 1 we discount by 3%, in year 2 by 3% + 3%, and so on

Cost of Capital, Weighted Cost of Capital (WCC)

  • How much does it cost to get the investment required to fund the marketing activities?
  • If you work only with budgets funded out of operating profit, then you may not have to worry about Cost of Capital or WCC
  • Cost of Debt: The interest rate paid on a loan
  • Cost of Equity: Harder to calculate. May need to look at comparible Price-Earnings Ratios
  • Weighted Cost of Capital (WCC): Total effective cost of all debt and equity funding for that company
  • Your projected Return on Capital must be more than the Cost of Capital for the CFO to bite

Metric: Economic Value Added (EVA)

The Question:

How much profit in dollar terms have I generated, factoring in borrowing costs for the investment?

Approach:

Net profit after tax (NOPAT) less the cost of capital

Commentary:

Gives an actual dollar figure for revenue generated rather than the percentage shown by ROI. CFO likes the fact that cost of capital is included. Pain the a** to calculate!

The Formula:

Economic Value Added (EVA) = Net Operating Profit After Tax (NOPAT, $) – Cost of Capital ($)
Cost of Capital ($) = Capital Employed ($) * Weighted Average Cost of Capital (WACC, $)

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