The Corporate Valuation Model

Corporate assets are of two types: operating and nonoperating. Operating assets, in turn, take two forms: assets-in-place and growth options. Assets-in-place include such tangible assets as land, buildings, machines, and inventory, plus intangible assets such as patents, customer lists, reputation, and general know-how. Growth options are opportunities to expand that arise from the firm's current operating knowledge, experience, and other resources. The assets-in-place provide an expected stream of cash flows, and so do the growth options. To illustrate, Wal-Mart owns stores, inventory, and other tangible assets, it has a well-known name and reputation, and it has a lot of business know-how. These assets produce current sales and cash flows, and they also provide opportunities for new investments that will produce additional cash flows in the future. Similarly, Merck owns manufacturing plants, patents, and other real assets, and it has a knowledge base that facilitates the development of new drugs and thus new cash flow streams.

Most companies also own some nonoperating assets, which come in two forms. The first is a marketable securities portfolio over and above the cash needed to operate the business. For example, Ford Motor Company's automotive operation had about $6.9 billion in marketable securities as of late 2001, and this was in addition to $6.1 billion in cash. Second, Ford also had $2.7 billion of investments in other businesses, which were reported on the asset side of the balance sheet as "Equity in Net Assets of Affiliated Companies." So, in total Ford had $6.9 + $2.7 = $9.6 billion of nonoperating assets, compared with its $87.6 billion of automotive assets, or 11 percent of the total. For most companies, the percentage is even lower. For example, Wal-Mart's percentage of nonoperating assets was only 1 percent, which is more typical.

Self-Test Questions

We see, then, that for most companies operating assets are far more important than nonoperating assets. Moreover, companies can influence the values of their operating assets, but the values of nonoperating assets are largely out of their direct control. Therefore, value-based management, hence this chapter, focuses on operating assets.

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