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(a)Value of creation based on above information based on above information value of creation mean this means creating revenue which exceeds expenses which results in a profit, or value, to the stakeholders. A broader definition includes creating value for the customer to increase sales, and to create perceived value in the company brand. Enhancing customer value by improving the quality of products or services in a matter which induces customers to pay more than they firms costs of improvement is key to the process of value creation. Value creation is the primary aim of any business entity. Creating value for customers helps sell products and services, while creating value for shareholders, in the form of increases in stock price, insures the future availability of investment capital to fund operations. (b) ROIC , revenue growth , cash flow and cost of capital under condition will value be create High returns on invested capital come from one of two sources; 1) Large amounts of revenue generated for each dollar of invested capital, known as high “turns” of invested capital and/or 2) high levels of after-tax profits generated per dollar of revenue, known as high-profit margins. Turns x margin = ROIC (this is a rearrangement of the formula for ROIC we presented HERE). In order to generate high ROIC, a company must either have very high profit margins or need low levels of invested capital (ie. be “asset light”) or a combination of the two. Because profit margins are bounded (pre-tax profit margins can’t exceed 100% and all companies pay some tax) it is difficult for a company to generate outstanding ROIC simply through a high profit margin. The far more common path is for a company to craft a business model that does not require them to invest too much new capital in order to grow. These asset-light companies are very prevalent in Ensemble Capital’s portfolio. ROIC , revenue growth , cash flow and cost of capital under condition will value be destroyed One downside of this metric is that it tells nothing about what segment of the business is generating value. If you make your calculation based on net income (minus dividends) instead of NOPAT, the result can be even more opaque, since it is possible that the return derives from a single, non-recurring event. ROIC provides the necessary context for other metrics such as the P/E ratio. Viewed in isolation, the P/E ratio might suggest a company is oversold, but the decline could be due to the fact that the company is no longer generating value for shareholders at the same rate—or at all. On the other hand, companies that consistently generate high rates of return on invested capital probably deserve to trade at a premium to other stocks, even if their P/E ratios seem prohibitively high.
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