UNLOCKING THE MAGIC OF NUMBERS UNLOCKING THE MAGIC OF NUMBERS 2 = DR. GEORGE WEBSTER EXECUTIVE EDUCATION PHARMACEUTICAL MARKETING ST. JOSEPH’S UNIVERSITY

2 VALUE CREATION IN THE PHARMACEUTICAL INDUSTRY What is value creation? What are the drivers of value creation ? How do we measure value creation?

3 WHAT IS VALUE CREATION? Process Involves decision making –Financing –Investing –Operating Includes all stakeholders

4 THE F-I-O MODEL FINANCING - the process of obtaining capital for the business INVESTING - the process of asset acquisition to operate the business OPERATING - using resources to maximize shareholder wealth

5 “THE SCORECARDS” BALANCE SHEET - a statement of position at a point in time –Shows what we own and what we owe –Of particular interest to the CFO INCOME STATEMENT - a statement of value creation over time –Measures how well we operated –Of particular interest to the CEO CASH FLOW STATEMENT - puts operations on a cash basis –Gives sources and uses of cash –Of particular interest to the COO

6 BALANCE SHEET- FACSIMILE COMPANY DECEMBER 31, 19XX ASSETS LIABILITIES & O.E. CURRENT ASSETS CURRENT LIABILITIES Cash 3000 Accts. Payable 2000 Accts. Rec Wages Payable 1000 Inventory Rent LONG TERM P & E Long Term Debt 7000 Other 4000 OWNER’S EQUITY TOTAL Common Stock 5000 Ret. Earnings TOTAL TOTAL ASSETS TOTAL LIAB. & OE 42000

INCOME STATEMENT- FASCIMILE CO. FOR THE YEAR ENDED 12/31/XX NET SALES LESS: COST OF GOODS GROSS MARGIN LESS: OPERATING EXPENSES Salaries 5000 Rent Expense 1000 S.,G., & A OPERATING PROFIT LESS: INCOME TAX (.40) 4000 NET INCOME AFTER TAX 6000

STATEMENT OF CASH FLOWS-FASCIMILE CO. FOR THE YEAR ENDED 12/31/XX CASH FROM OPERATIONS Net Income 2000 Depreciation CASH FROM INVESTING ACTIVITIES Capital Expenditures 5000 Acquisitions CASH FROM FINANCING ACTIVITIES Issuance of Long Term Debt 700 Sale of Common Stock Cash Dividends NET CHANGE IN CASH -5700

9 WHAT ARE THE DRIVERS OF VALUE? EFFECTIVENESS - How much revenue do we generate from the assets we have? EFFICIENCY - How well do we use the assets we own? LEVERAGE - How much debt do we have in the capital structure?

10 EFFECTIVENESS EFFECTIVENESS = Total Sales Total Assets BMS = $18,284,000,000 $16,272,000,000 BMS Effectiveness is 1.12 BMS Effectiveness is 1.03

11 EFFICIENCY EFFICIENCY = Net Income Total Sales BMS = $3,052,000,000 $18,284,000,000 BMS Efficiency is.167 BMS Efficiency is.187

12 LEVERAGE LEVERAGE = Total Assets Owner’s Equity BMS = $16,272,000,000 $7,576,000,000 BMS Leverage is 2.15 BMS Leverage is 2.24

13 HOW WE MEASURE VALUE CREATION ROI - Return on investment ROE - Return on equity EPS - Earnings per share EVA - Economic value added

14 RETURN ON INVESTMENT RETURN ON INVESTMENT = Net Income Total Assets ROI = Net Income Sales X Total Assets ROI = Net Margin X Asset Turnover BMS 1998 ROI =.167 X 1.12 =.187 BMS 1996 ROI =.187 X 1.03 =.193

15 RETURN ON EQUITY RETURN ON EQUITY = Net Income Owner’s Equity (Effectiveness) X (Efficiency) X (Leverage) Total Assets Owner’s Equity Sales Total Assets X Net Income Sales X BMS 1998 ROE = $3,052,000,000 / $7,576,000,000 =.40 = 1.12 X.167 X 2.15 =.40

16 THE F-I-O MODEL FINANCING - the process of obtaining capital for the business INVESTING - the process of asset acquisition to operate the business OPERATING - using resources to maximize shareholder wealth

17 (Effectiveness) X (Efficiency) X (Leverage) HOW WE MEASURE VALUE CREATION Total Assets Owner’s Equity Sales Total Assets X Net Income Sales X Investing OperatingFinancing FIO MODEL (Asset Turnover) X (Net Margin) X (Degree Financial Leverage)

18 EARNINGS PER SHARE EARNINGS PER SHARE = Earnings Shares of Common Stock Outstanding BMS 1998 EPS = $1.54 BMS 1996 EPS = $2.81 Market Measure External to the Firm Unambiguous Represents per Share Value Creation

19 ACTIVITY/PERFORMANCE/ LEVERAGE MEASURES BMS SCHERING P&G ACTIVITY Total Asset Turnover PERFORMANCE Net Margin (%) Return on Equity (%) LEVERAGE Total Assets/ Equity

20 ECONOMIC VALUE ADDED Measures real profitably- on a cash basis Measures the cost of equity- not shown on balance sheets Cost of equity is its opportunity cost- what the investors could do in their next best alternative Capital includes long term debt, preferred stock, and common stock Cost of capital is its weighted average

21 ECONOMIC VALUE ADDED ECONOMIC VALUE ADDED = [Net Operating Profit After Tax - After Tax Dollar Cost of Capital] Net Operating Profit After Tax = Operating Profit - Income Tax Cost of Capital = Weighted After Tax Cost of Capital Capital = Total Capital Employed = Common and Preferred Stock + Long Term Debt After Tax Dollar Cost of Capital= Cost of Capital (%) X Capital

22 Economic Value Added Example BMS, 1998 NOPAT Operating Profit Less: Income Tax Equals: NOPAT =12889 EVA EVA = NOPAT - $ CC = =11495 WACC Debt Equity WACC =.148 $ CC = 9422(.148) = 1394