IronBridge
Process
The CFROI Framework
The CFROI® Framework is based
on the economic truth that the value of
a company is the present value of the expected
net cash receipts over the life of the
firm. The CFROI Valuation model is a discounted
cash flow model whose innovation incorporates
economic return, reinvestment and company-specific
Life Cycle fade.
Long-term net
cash receipts are driven by five basic
economic drivers:
- Asset Base,
- IRR (CFROI) on existing assets,
- IRR (CFROI) on future capital invested,
- Reinvestment rates of cash reinvested
or return the cash, and
- Life Cycle duration.
The IRR (CFROI)
on a business is defined as the real internal
rate of return on past investments, calculated
by converting earnings to cash available
to all capital owners and comparing that
to cash invested by all capital owners.
The cash on cash ratio is converted to
an IRR by recognizing the finite life of
capital and recognizing that a portion
of the original investment is depreciating
and a portion is in non-depreciating assets.
The reinvestment
rate equals the growth in the capital invested
in the business, in excess of that required
to replace depreciated assets. The sustainable
reinvestment rate is dependent on the achieved
return on capital, historical asset growth
rate, capital structure and project life.
When a company invests at a higher rate
than its sustainable growth rate, it must
access the capital markets and borrow more
or issue more equity. When a company reinvests
capital at a lower rate than its sustainable
growth rate, it either builds cash, pays
down debt or pays out a higher dividend.
Fade rate describes
the time it takes for a company to fade
from above or below average performance
to the long term competitive average.
Relevant Links
More
information
about
the CFROI® process.
Purchase Bartley J. Madden’s book, CFROI® Cash Flow Return on Investment Valuation
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