MfVA CASE STUDY
The first use of the MfVA model was for a Fortune 500 firm. The model was created using very simple Excel tools. As a first effort, rules had to be established to ensure consistency of data development and to make sure the process could be repeated. The following rules, concepts, and assumptions were developed: Rules
1. "Actuals" will be used in all cases when available.
2. Certain values will have to be derived or agreed upon by the pro
cess owners and the analyst.
1. As long as the approach used for calculations is applied across the
areas to be evaluated, the results will be representative of each area.
2. The absolute numbers are not that important; it is the MfVA index
that is important.
3. The index does not measure how well the process is performing. It
compares each process's performance index with that of other pro
cesses to provided a baseline comparison.
4. The index number can be used, relative to other process indices, to
make strategic and tactical business decisions.
5. Goodwill, loaner instruments, PP&E, and inventory are valued at
gross (reserves, depreciation, and amortization are reversed).
1. The "planned life" for strategic investments will be used (whichever is shorter) when calculating the cost application of OCFD. It will be based on a combination of "useful
life" or "technological life" and any other appropriate factor.
2. The numbers used will never be perfect but will be applied consistently across all measured processes. 3. Certain income statement items are reversed (e.g., A/R reserves, obso
lescence), and it is assumed that there is no relationship with these reversals and specific processes being measured.
4. OCF will be adjusted down for royalties. This is a cost to be in the business.
The first step was to calculate the WACC. Using the definitions for each category discussed earlier, figure 3 lists each of the values that were identified. The WACC was then calculated as their blended value using the relative weight of the cost of debt and the cost of equity. In this case, the WACC was determined to be 13.4 percent. It is recognized that some of the numbers, such as inflation and risk beta, are very subjective. As long as they are used uniformly across all the calculations, the indexes will be usable.
Once the WACC is calculated, identifying the strategic investments was the next task. This is necessary as these are the items that are used to determine the Operating Cash Flow Demand (OCFD). To do this, a strategic investment ledger was created in the Excel model. A sheet was created for each manufacturing cell. For this MfVA model, each manufacturing cell produced a different item. The result was 15 sheets linked together. For the strategic investments within each cell, a breakdown was required. This breakdown included strategic investments, strategic marginal investments, infrastructure investments, R&D investments, and strategic inventory investments. The last three items were included because of the company's operating plan for each manufacturing unit. The final definition of which investments are used is up to each company, and as long as the rules are applied uniformly, the indexes will be usable.
To simplify the model, the spreadsheets were set up so that the specific information required for each item only had to be entered once and the formulas and relationships were set up as scalable (see figure 4).
Once all the strategic investment data was entered, each investment type was summed and linked to the Operating Cash Flow Demand (OCFD) table (see figure 5). This table summarizes, by line item, the period OCFD required. If desired, this table could be broken down into quarters, months or whatever time increment desired. The total of this table is the amount of cash flow that must be created by the business unit to meet minimum value requirements. For each unit, line, cell, or operation being measured, there will be an individual OCFD summary table. Just as multiple tables were used for the different types of investments with them summing into the OCFD table, the OCFD tables will sum into the Summary Valuation Report, which combines the unit valuations
into a summary valuation.
Once each of the OCFD tables is completed, the data is fed into the Summary Valuation Report (see figure 6). This report combines all the unit numbers into a summary. This provides management with information that allows for unit performance evaluation in comparison to the company as well as to each other using the index. There is also a summary index number, although there is little to compare it to.
To Be Continued