Question

Fact 1: The faster companies can grow their revenues and deploy more capital at attractive rates of return, the more value they create. The combination of growth and return on invested capital (ROIC) drives value and value creation.

Question 1: Comprehensively explain, using numerical examples, why companies create value by investing capital, from investors, to generate future cash flow at rate of return exceeding the cost of capital.

Answer 1

Companies are creating value by investing capital from investors to generate future cash flows at the rate of return which is exceeding the cost of capital because it is helping the company in order to expand its market capitalisation and it is helping them in order to create their value because when the company is able to borrow the money either in equity capital form or in debt capital form and they are going to invest that money in the the business itself and they are able to generate a rate of return which is higher than the cost of capital that it was leading to growth of the company because when the rate of return of capital is higher than the cost of capital then the differential between the rate of return and the cost of capital will be the growth of the company and it is also helpful in providing the investor with the higher rate of return because the market will be rewarding those company who are having a higher profits in the respective segments.

For example, the cost of capital of the company is 8% and the company is able to invest the capital in its own project and generate almost 15% return, then the differential 7% of Return is the net profit for the company and net profit for the company can be paid back to the shareholders in form of dividend or it can also used by the company in order to buy back the share or we invest that money back into the company and compound the rate of return of the investors so it can be helpful for investor and the company in order to maximize the value of the shareholders and value of the company as well so it is in line with the synchronisation of goals of various stakeholders in the organisation and it will be helpful for maximization of the overall value of the organisation which will helping satisfaction of the goals of various stakeholders.