Cash-flow return on investment

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Cash-flow return on investment (CFROI) is a valuation model that assumes the stock market sets prices based on cash flow, not on corporate performance and earnings.[1]

For the corporation, it is essentially internal rate of return (IRR).[2] CFROI is compared to a hurdle rate to determine if investment/product is performing adequately. The hurdle rate is the total cost of capital for the corporation calculated by a mix of cost of debt financing plus investors `expected return on equity investments. The CFROI must exceed the hurdle rate to satisfy both the debt financing and the investors expected return.

Michael J. Mauboussin in his 2006 book More Than You Know: Finding Financial Wisdom in Unconventional Places, quoted an analysis by Credit Suisse First Boston, that, measured by CFROI, performance of companies tend to converge after five years in terms of their survival rates.[3]

The CFROI for a firm or a division can then be written as follows:[4]

This annuity is called the economic depreciation:

where n is the expected life of the asset and Kc is the replacement cost in current dollars.[5]

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References[edit]

  1. ^ Dr. Eric Yocam (22 February 2010). Corporate Governance: a Board Director’S Pocket Guide: Leadership, Diligence, and Wisdom. iUniverse. pp. 84–. ISBN 978-1-4502-0484-2. 
  2. ^ James L. Grant (5 May 2003). Foundations of Economic Value Added. John Wiley & Sons. pp. 33–. ISBN 978-0-471-23483-8. Although accounting differences exist, cash flow return on investment is analogous to the internal rate of return (IRR) concept that is widely used in capital budgeting analysis. Specifically, CFROI is the after-tax rate of return (IRR) on a company's existing assets. In principle, CFROI is that rate that sets the present value of the after-tax operating cash flows equal to their investment cost. l.ike any IRR, CFROI is that rate which sets a company's net present value equal to ... 
  3. ^ Michael J. Mauboussin (11 June 2013). More Than You Know: Finding Financial Wisdom in Unconventional Places (Updated and Expanded). Columbia University Press. pp. 166–. ISBN 978-0-231-14373-8. 
  4. ^ Aswath Damodaran (2001). The Dark Side of Valuation: Valuing Old Tech, New Tech, and New Economy Companies. FT Press. pp. 462–. ISBN 978-0-13-040652-1. 
  5. ^ Aswath Damodaran (17 April 2012). Investment Valuation: Tools and Techniques for Determining the Value of Any Asset, University Edition. John Wiley & Sons. pp. 885–. ISBN 978-1-118-13073-5. 

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