Enterprise Value

Drivers
 CHAPTER –VI
ENTERPRISE VALUE DRIVERS

6.1 Introduction

The Enterprise value measures the "true worth" or "economic value" of a business.
More specifically, it is considered as a measure of the actual takeover price that an
investor would pay at the time of acquisition of a firm. Enterprise value is used for
assessment of aggregate value of the company as an enterprise rather than just focusing
on its current market capitalization.

The use of enterprise value instead of market capitalization for valuation is

important because it rewards the companies with good liquidity and penalizes the
companies with large size of debts. The companies with higher liquidity and lower-debt
rewards its shareholders, helps to pursue growth through new business lines or new
acquisitions and also maintains a better degree of flexibility which will ensure its easy
survival during an economic downturn. This helps in buy back of more shares and
payment of higher dividends. On the other hand, the companies with large size debts
and poor liquidity will suffer from loss of operating profits through interest payments
and are also at the risk of insolvency when the business performs poorly as they can no
longer afford to cover interest obligations. At the same time, most of the assets
depreciated or amortized lose their real value and many of these assets eventually have
to be replaced in the normal course of business.

The above facts clearly indicate that debt and cash have a tremendous impact on
a particular company's enterprise value. Hence two companies with the same market
capitalizations have very different enterprise values due to the level of debt and volume
of flow of cash which provides liquidity. In the current chapter, the enterprise value
calculation seeks to improve the accuracy and reduce the variance of traditional
financial valuation methodologies. This chapter also identifies the role of individual
drivers of enterprise value.

The present study proposes to focus on the assessment of significant difference

in the enterprise values. The results of the study would determine the significant
difference between the enterprise values from the FCFF, EVA and RV valuation

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methods, between multinational and domestic companies as well as on basis of various
industries. In addition, the chapter compares the influence of the value drivers on
enterprise value. The current study also aims to find out the significance of the value
drivers in relation to the different industries in the sample under each of the select
methods of valuation. The study also discriminates the value drivers that signify
enterprise value.

The chapter is divided into four sections. The first section applies the
independent sample t test and its significance between the enterprise values of domestic
and multinational companies and also enterprise values under each of the methods of
FCFF, EVA and RV between the domestic and multinational companies. In the second
section ANOVA has been conducted to analyse the variances of the value drivers across
the industries and also between various methods among industries. The third section
uses regression analysis to examine the influence of the value drivers on the dependent
variable i.e. enterprise value under each of the valuation methods. The fourth section
deals with comparison of the actual groupings in value drivers to the predicted
groupings generated by a discriminant analysis to identify the value drivers that
discriminate the enterprise values of domestic and multinational companies.

The value of a firm can be improved as a means of increasing the cash flow,
reducing the cost of capital, increase the growth rate and the length of the period of high
growth. The growth of all these four components depends on many value drivers. Thus
studying the impact of the firm’s value drivers on the firm’s value is inevitable by
choosing some select important value drivers chosen from the literature.

6.2 Value Drivers

This section enumerates and explains the various value drivers that are going to be
tested for its significance on enterprise value. The value drivers are those that have a
direct effect on the free cash flow generation of the company by increasing revenues,
improving the operating efficiency and also by means of optimal utilisation of the assets
of a company. These financial drivers enhance financial performance and have caused a
considerable effect on real value creation. Value companies recognize this importance
of generating future cash flows and avoid actions designed to boost short-term
performance at the expense of the long run performance. The developments of sector or

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industry-specific valuation models also have recognised these concepts in literature.
Industry-specific models helped in identifying key value drivers for the particular
industry and were of great use in guiding strategic formulation in a particular industry.
According to Rappaport (1986),within a business, there are seven drivers namely, sales,
growth rate, operating profit margin, income tax rate, working capital investment, fixed
capital investment, cost of capital -and forecast duration that can be managed to create
value. Literature suggests that effect of these value drivers lead to an increase in
shareholders’ value. The following figure shows the effect of different value drivers on
four components of value creation for an enterprise as proposed by Aswath
Damodaran(2011).

Figure 6.1 Value Drivers affecting Value of a firm

Source Valuation:Basics:Aswath Damodaran(2011)

To evaluate the past financial performance of an organisation, it is necessary to

investigate the company‘s financial statements. This way the main drivers of a
company‘s value such as the return on invested capital (ROIC), the growth rate and free
cash flowwererecognized in the earlier studies. In the current study the following drivers

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of enterprise value have been identified and studied for its significance on the value of
the enterprise of select domestic and multinational companies.

1. Beta

Beta is chosen for the study because it measures unsystematic risk which is the most
commonly used measure to assess risk. It serves as a tool to draw investors and
recognise the attractive stocks based on risk preferences. It provides a quantifiable way
of evaluating the required rate of return on a risky investment. In the current study beta
is used for the calculation of cost of capital under the CAPM approach. The beta which
is available in the Prowess database for the select companies from the year 2013 is used
in the study to identify the impact on enterprise value.

2. Standard deviation of average yield

This measure is used in the current study as a measure which depicts the riskiness of the
company on its evaluation of return to the investors. The average yield is taken as a
percentage of profit after tax divided by the book values of capital, debt and equity. The
average yield has been computed for a period of five years from 2008 to 2013 and its
standard deviation is obtained.

3. Reinvestment rate

Reinvestments are made by the company to generate future growth, precipitate an

innovation culture and processes. They are invaluable to create an ongoing competitive
advantage to the company. This rate can exceed 100% if the firm has substantial
reinvestments.

The study calculates the reinvestment rate of the company by adding the capital
expenditure with the change in non cash working capital ( add increase and deduct
decrease in working capital) and deducting the depreciation. This computed figure
represented the reinvestment of the company. When divided by the net operating profits
it is called the reinvestment rate. The reinvestment rate is calculated for the year 2013
and used as a value driver of enterprise value.

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4. Cost of capital

The cost of capital signifies the rate of financing of these assets used to discount the
cash flows of the company. The cost of capital is a composite cost of financing that
includes both the cost of debt and equity at their relative weights in the capital structure.
The study uses the computed cost of capital for 2013 previously calculated to assess its
significance on enterprise value.

5. Return on capital

The return on capital represents the company’s return on existing investments where the
book value of the capital was assumed to measure the capital invested in these
investments. In the current study, it is computed as a proportion of after tax income on
the capital invested in the business. This rate is computed for the year 2013 to study its
significance on enterprise value. The cost of capital is identical to the costs used for
calculating the value of the enterprise under the select three methods.

6. Debt Equity ratio

The leverage influences the enterprise value as a higher leverage represents more risk
and a higher return to the equity shareholders. It is pertinent to find the impact of this
ratio on the enterprise value.

7. Cash Flow per share

Free cash flow is the cash available to investors after investment in fixed assets and
working capital. The free cash flows are computed for the year 2013 and divided by the
total number of equity shares to arrive at the cash flow per share and checked for its
significance with enterprise value.

8. Fixed Assets

A fixed asset is a key component of enterprise value as the ability of the enterprise to
generate higher returns is based on its amount of fixed assets. Hence it is imperative to
confirm the impact that these fixed assets have on enterprise value. The net fixed assets
from the financial statements for the year 2013 is taken and verified for its significance
on enterprise value.

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9. Employee cost

The value of an enterprise is also affected by its ability to hire, develop and retain
quality personnel. The enterprise value is increased if it has a leadership team to carry
out the company’s vision and mission. Hence there is a need to validate whether the
costs spent on employees signify value. The employee costs are computed for the year
2013 as a sum of compensation to employees, outsourced manufacturing jobs,
outsourced professional jobs and Non Executive Director’s fees.

10. Working capital

The changes in working capital affect the cash flow of the firm. As high growth firms
have more amount of working capital than the low growth firms it can be corroborated
for its impact on enterprise value. The gross concept of working capital which is the
sum of the total current assets of a business is computed for 2013 and used for
significance with enterprise value in the current study.

11. Sales

The recurring revenues of the company are the basis for generating profits, meeting the
expenses and for ensuring that the obligations are met. The sales for the year 2013 are
validated for its significance with enterprise value.

6.3 Comparative analysis of the methods

1. All the methods use the cash flows/profits forecasted for a restricted time period
of five years and beyond this time period, reasonable conventions and
assumptions of a stable period are incorporated. But this stable period induces
certain amount of subjectivity into the results.

2. The FCFF and EVA methods uses EBIT which is calculated with the normalization
process of the expected income without consideration of “extraordinary” income and
costs and elimination of income and expenses “not directly related to company
operation”. Extraordinary items which are excluded from consideration when
forecasting future earnings as they are items which cause earnings to deviate
significantly from operating earnings during the year. This would reduce the possibility
of gains being created in the enterprise value as financial gains and other extraordinary
income are also reported in the profit after taxes.

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3. The EVA, a simple and transparent valuation method has the advantage of identifying
the value for each year. Besides being a valuation tool, it allows measurement of the
marginal value added each year and can be used as a management tool.

4. Under the EVA method, the cost of capital is calculated on the book value of
capital and not market values of equity as it would result in lower costs. The
measuring of book value of net equity does not generally raise practical
problems, as it amounts to the sum of share capital and reserves arising in the
financial statements.

5. Most of the valuation literature pays little attention to the role of intangible assets in
enterprise valuation and the literature that exists provides mixed results on the
contribution of intangible assets to the value of an enterprise. Jenning et al., (2001)
claimed that goodwill amortization only adds noise to the stock valuation trends. Thus,
the role of intangibles in firm valuation may be an area of further investigation,
especially in the context of particular industries like Computer Software and
Pharmaceuticals.

6. Goodwill is inadequately represented in corporate Balance sheets (trademarks,

patents, know-how, image, market share and organization) and sometimes,
goodwill is understood simplistically as a substitute concept of the company’s
intangible components (e.g. trademarks and image). The value of goodwill is not
taken into account in determining the value of the company under the FCFF and
EVA methods but Relative Valuation using multiples considers the market
assessment of the company where the multiples reveal and reflect the
consideration of the goodwill of the firm.

7. Another point to be considered in the valuation of the three methods is the state
of the Indian stock market in 2013 when valuation was performed. The markets
had a bearish trend and this indicates a general trend towards undervaluation.
Most of the stocks which are not in proximity to market price show higher
intrinsic values or otherwise are undervalued.

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 8. The FCFF shows lower values for domestic companies and higher values for
multinational companies primarily because the cash flows of the MNCs are
higher. The mean cash flow per share for MNCs is Rs. 36.95 as against Rs. 26.54
for the domestic companies (Table 6.1). Also the MNCs have a lower debt/equity
ratio which means lesser interest obligations and higher EBIT.

9. Companies with large size debts and poor liquidity suffer the loss of operating
profits through interest payments. In such cases, no financial ratio that relates
price to earnings can show the company’s true worth. The Enterprise value
calculated using one of the methods more accurately reflects the true worth of a
company for investment decisions.

10. The accuracy of the valuation method has to be interpreted carefully with due
consideration to possible firm-specific characteristics which can influence the
choice of valuation method. FCFF should be employed more often to value risky
firms but there is a bigger likelihood of larger forecast errors for the FCFF
method than for Relative Valuation method.

11. Another consideration in valuation is the choice of value to use as leverage. The
debt level of a company tends to vary year after year. Therefore, complexity that
is evident regarding the representation of the financial structure for the whole life
of the company as it is assumed to be constant. The leverage assumed for the
companies as the average of the industry debt/equity ratio for the stable period
has an impact on cost of capital and also the valuation conclusions.

6.4 Value drivers’ comparison between Domestic & Multinational companies

The forthcoming section deals with the conduct of an independent sample t test to study
the difference between the domestic and multinational companies with specific
reference to the different value drivers. The current section is devoted to compare means
of Domestic and Multinational companies by applying a t test for enterprise values of
Domestic and Multinational companies computed under the three methods namely,
FCFF, EVA and RV.

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The results of independent sample t test to identify the significant difference between
the domestic and multinational companies are presented in the table below.

Table 6.1 Mean and t values of the value drivers of enterprise value

Mean
Domestic MNC t Sig (2 tailed)
Beta .766892 .703324 .524 .604
SD of yield .1500716 .084753 1.178 .248
Reinvestment rate .1796644 -.082216 .214 .832
COC .128260 .124583 .306 .762
ROC .145017 .185050 -.534 .597
Debt equity ratio .275597 .105133 1.647 .110
Cash flow/share 26.545524 36.956093 -.705 .486
Fixed Asset 45662.84 10998.89 1.008 .322
Employee Cost 31518.93 5292.69 1.536 .145
Working capital 57423.47 17932.72 1.356 .194
Sales 92439.764 69191.924 .492 .626

The above table shows that the means of all the value drivers are higher for
domestic companies. The means of standard deviation of yield, cost of capital,
debt/equity ratio, fixed assets employee costs, working capital and sales are largely
higher for the Domestic companies than the MNCs. The beta values representing the
risk of the company are higher for the domestic companies for all industries except
Food and Beverages, Information Technology and Consumer Durables. But in terms of
the reinvestment rates, return on capital and cash flow per share, the means are higher
for MNCs than Domestic companies.

Further t test for the significance of value are also given for all the value drivers
to identify the significance of difference between the domestic and multinational
companies. It is found that there is no statistical difference exists in the means of the
value drivers between domestic and multinationalcompanies. The high t values of
Standard Deviation of yield, debt/ equity ratio, fixed assets, employee costs and working
capital depict increased variability and long impact on the enterprise value.

The issue of whether the market assigns different measures of risk to MNCs than
to otherwise comparable firms has been researched by Hughes, Logue and Sweeney
(1975). Comparing various risk measures of 46 MNCs with 50 Domestic companies (for

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the period 1970-1973), they observed that multinational corporations had lower
systematic risk as well as lower unsystematic risk. Thus, the results of the current study
concluded that investors perceive multinational corporations as providing substantial
diversification benefits. The current study also shows that MNCs have lower beta than
the domestic companies.

A. M. Fatemi (1988) and K. C. Lee et al., (1988) tested the means of leverage
and other variables for multinational and domestic corporations. The mean leverage
ratio for MNCs was significantly lower than Domestic companies which are
consistent with the findings of this study. In the current study the D/E ratios are
lower for MNCs than the domestic counterparts.

Several research studies yield consistent results with the present finding that
MNCs provide higher rates of return. Buckley and Casson (1976) found comparisons of
US-based MNEs (Multinational Enterprises) with other firms in the same industry in
eight countries by industries in the UK manufacturing industry. They found foreign
firms were generally more profitable than UK firms in the same industry (1965 and
1969). Another study conducted by Valsamis et al.,(2011) explored the differences
between domestic and foreign-owned firms operating in Greece for the year 2008 with a
non-linear model and found that foreign enterprises made higher use of capital,
managed more financial elements, and had more access to long-term capital and overall
presented greater profitability.The current study reveals that the return on capital and
cash flow generation are higher for MNCs than the domestic companies.

A study conducted byKimura and Kiyota (2004) for firms located in Japan
attempted to examine differences in static and dynamic corporate performance
between foreign-owned and domestically-owned firms in the 1990s. They found that
the foreign-owned firms achieved faster growth and invested in firms that may not be
immediately profitable at the time of investment but those that had profit potential.
The results of this study show similarities to the current study that MNCs had higher
reinvestment rates than the domestic counterparts. The current study shows that the
reinvestment rates of MNCs are higher than domestic companies.

Basti et al.,(2011) analyzed the performance of foreign-owned firms in contrast

to domestically-owned firms in the manufacturing sector in Turkey. The impact of

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several firm indicators like age, size, assets, firm risks on different corporate
performance measures such as ROE, ROA, Basic Earning Power and Total Factor
Productivity were investigated by a panel data regression model. The results of this
study revealed that there was no significant difference between the performances of
foreign-owned and domestically-owned firms. It is evident from the current study that in
terms of assets, employee costs, working capital, sales the domestic companies’ hold
higher levels there is no significant difference between the domestic and multinational
companies.

To sum up, from the results of the t test it can be inferred that the MNCs have a
higher rate of return and cash flow generation. They are able to operate with lower asset
bases, costs and working capital and produce superior returns to the domestic
companies. The leverage in the MNCs is also lower along with a smaller beta
coefficient representing the diversification of operating risk. The variability of their
returns is also less as indicated by the standard deviation of yield. Hence though the
means are not statistically significant they corroborate well for the MNCs who had
justified better returns, with lower risks, and costs than the domestic companies.

6.5 Comparison of Enterprise values computed under different methods between

Domestic and Multinational companies

The following analysis aims to identify whether any significant difference exists in the
enterprise values of select companies which are computed under different methods
namely FCFF, EVA and RV between domestic and multinationalcompanies. The results
of the t test are presented in the table given below.

Table 6.2 Means and t values of Enterprise value under FCFF, EVA and RV

Mean
Domestic MNC t Sign
Enterprise value FCFF 2.18000 1.49000 0.626 0.536
Enterprise value EVA 2.38000 1.42000 0.837 0.409
Enterprise value RV 2.39000 1.37000 0.937 0.356

The results of the t test show that the enterprise values of MNCs are lower than
that of Domestic companies under all the three methods. The means of the domestic
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companies are higher in the RV, followed by EVA and then FCFF. But for MNCs the
means are higher under the FCFF method followed by EVA and then RV. The above
results were also tested using the independent sample t test and the result showed no
significant difference in the enterprise values computed under the three methods. The
results which give no significant difference exist between the intrinsic values and the
market priceproved that the values were in proximity to the market price and reinforced
the strength of the valuation methods in delivering true intrinsic values.The researcher
wants the results to show insignificant difference between it shows the robustness of the
valuation methods.

The results reveal lower enterprise values under FCFF for domestic companies
and higher values using Relative Valuation. The MNCs show higher enterprise values
under FCFF because its average growth rate in annual sales is 15.41% as against
12.35% for domestic companies for the companies in the sample. When the growth rates
are higher, the sales projections of the MNCs are also more, consequently leading to
larger enterprise values under this method.

Relative valuation shows higher values for the domestic companies. This is
because the calculations for the method was performed using Profit before tax (PBT) in
the income statement instead of EBIT. The average PBT for the domestic companies in
the sample is Rs. 22,881 million as against Rs. 7,408 million for the MNCs.
Consequently the results also show higher values for domestic companies than MNCs.

Similar studies by Ronald E Shrieves et al., (2001) found that the DCF valuation
produced results which were mathematically equivalent to the discounting of
appropriately defined accounting profits under EVA. The concept of net operating profit
after tax (EBIT (1-T)) is central to both approaches and each approach according to
them require a myriad of adjustments. They showed the equivalence by deriving FCFF
from EVAs and EVAs from FCFFs. The results of the current study also show closer
values of FCFF and EVA. The difference in values is due to different assumptions
for EVA in particular when the return on capital was made equal to the cost of capital
in the terminal year for companies making EVA values higher than that of DCF
(when roc< coc).

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 Kaplan and Ruback (1995) examined the DCF approach in the context of highly
leveraged transactions such as management buyouts and recapitalizations and reported
that the CAPM-based DCF valuation approach had approximately the same valuation
accuracy as a comparable firm’s valuation approach with earnings before interest, taxes,
depreciation, and amortization as the accounting measure being capitalized. The results
of the current study also show empirical evidence that there is no significant difference
between the enterprise values obtained under the DCF and RV methods.

The proper market multiple is in essence a function of the same three

fundamental variables: the earning power, the expected growth in earnings, and the
level of risk.This is so because every investor, regardless of one’s personal preference to
the valuation approach or another, makes decisions mainly on the basis of these three
fundamentals. This indicates that the valuation of companies using P/E and P/BV
multiples is in essence a transformed version of the Discounted Cash Flows
valuation(Nenkov, 2007a). This relationship is best demonstrated through the derivation
of the theoretical model of the fundamental ratios.

All the three methods, market multiples of a peer group; the FCFF approach; and
the EVA asset-based approach depend on the circumstances surrounding the valuation.
Each of these methods has its advantages and disadvantages. The comparable firms
approach works best when a highly comparable group is available. While it can reduce
the probability of incorrect valuation of a firm relative to others, this approach provides
no safeguard against an entire sector being undervalued or overvalued. The FCFF
approach is based on a stronger theoretical footing than any other approach, but in many
situations it is difficult to estimate future cash flows and an appropriate discount rate.
The EVA, an asset-based approach looks at the underlying value of a company's assets
to indicate value. The asset-based approach is more relevant when a significant portion
of the assets can be liquidated readily at well-determined market prices if so desired.

6.6 Mean comparison of value drivers with respect to industry category

The next analysis in the current study aims to find out the significant difference among
the mean values of different groups of the value drivers in relation to the industry
category. A two way ANOVA was conducted to analyse the variances of the

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value drivers across the industries. The results of ANOVA are presented in the
following table.

Table 6.3 Mean and F values of value drivers of enterprise values.

Mean

Food & Auto Consumer

Paints Pharma Bevarage mobile IT El Mach FMCG Durables F Sign
Beta 0.468258 0.580826 0.670486 0.905549 0.925129 1.071908 0.318461 0.940246 4.249 0.004

SD of yield 0.044787 0.117024 0.079083 0.269756 0.022354 0.056327 0.169672 0.182872 1.160 0.361
Reinvestment 1.028886 0.858418 -0.26484 0.161802 0.352136 1.684818 0.212131 -3.64365 0.864 0.548
rate

COC 0.101295 0.114527 0.116335 0.14852 0.140502 0.173039 0.087856 0.129298 0.562 0.001
ROC 0.179588 0.110242 0.085658 0.029145 0.207981 0.106239 0.463399 0.138017 1.938 0.107

Debt/Equity 0.093682 0.06529 0.433935 0.400963 0.042286 0.065755 0.061823 0.359188 1.479 0.222
ratio
Cash 47.486261 17.91588 50.75309 22.97179 72.87803 15.26383 16.78186 9.955733 1.244 0.318
flow/share

Fixed Asset 8882.18 8825.82 8791.32 164303.2 17723.02 5232.8 10839.92 2045.85 1.399 0.251
Employee 1794.39 4183.58 4338.34 48510.46 77455.18 2661.68 6313.08 1989.78 1.496 0.216
Cost

Working 13167.22 12587.95 9950.35 113862.6 110658.4 11522.47 21892.02 7783.72 1.313 0.287
capital
Sales 4.9200 2.5400 3.2500 2.54000 1.35000 3.5100 9.6900 1.8100 1.747 0.145

The above table shows higher betas in the Automobile, Computer, Electrical
machinery and Consumer Durable sectors. These are cyclical industries more affected
by the state of economy and generally report higher betas. The standard deviation
of average yield indicating the variability in the returns of the company is another
measure of risk. This was found high in the Automobile, FMCG and Consumer
Durable industries.

The reinvestment rates are higher in Paints, Pharmaceutical, Electrical

Machinery and Consumer Durables signifying the industry needs and that the scope of
reinvestment is greater in those sectors. The cost of capital is more for the industries in
Pharmaceutical, Electrical Machinery and Consumer Durables for which beta is higher
as there is a direct relationship between the two. The return on capital is higher for
FMCG, Computers and Paints industries. International diversification strategy tends to
lower volatility of earning as MNCs have cash flow in imperfectly correlated economies
thereby reducing the bankruptcy risk and thus enables MNCs to utilize more leverage in
their capital structure (A. C. Shapiro 1978). This reduced risk lowers the betas for

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MNCs which is not as much as the domestic companies as shown in the current study.
The beta variable shows significant difference between the domestic and multinational
companies.

The leverage is higher in Food & Beverage, Automobiles and Consumer Durable
industries. Higher cash flow generation is reported in the Paints, Food and Beverage and
Computer industries. The fixed assets, employee costs and working capitals are highest for
Automobile and Computer sectors. Sales are highest for the FMCG sector followed by Paints.

The F values between industries showed that beta coefficient and costs of capital
was found to be statistically significant. The costs of capital of MNCs are lower because
of lower debt equity ratios. Out of nine companies which are zero debt in the sample,
seven of these are MNCs.

Allen Michel and Israel Shaked of Boston University studied the financial
performance of a sample of multinational corporations (MNCs) compared with a
control group of domestic corporations (DMCs) using market-based selected financial
characteristics and performance measures. Using the asset variable to measure size
indicates that the average size of the firm in the multinational sample in 1980, 1981
and 1982 is $6.25 billion, $7.58 billion and $7.57 billion respectively. The
corresponding values for the DMCs are $578 million, $620'million, and $646 million.
The current study also shows the same trend that the domestic companies have a
greater asset size in comparison to multinational companies.

Another study by Christian Elletoft Aaen (2010) attempted to distinguish

between financial and operational value creation in the TDC buyout.She conducted an
IRR “decomposition” which would also increase enterprise value to analyse how the
direct value levers had contributed to NTCH’s overall return. First the impact from
financial leverage was calculated. It showed that leverage accounted for 41% of the
value created. The current study shows the higher leverage for domestic companies
which increases the profitability and enterprise value with the lower cost of debt.

6.7Enterprise Value comparison different industry category

The current study also attempts to investigate the significance of difference of

Enterprise values calculated under various methods among different industry categories.

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Table 6 4 Means and F values of Enterprise Value under the FCFF, EVA and
RV methods

Enterprise Value Mean

Industries FCFF EVA RV

Paints 5.8600 8.2400 1.39000

Pharmaceuticals 1.22000 7.6900 8.9700

Food & Beverages 7.2400 7.1900 7.5100

Automobiles 2.18000 3.10000 2.56000

Computer Software 4.67000 4.44000 4.51000

Electrical Mach 2.4900 2.9100 2.6200

FMCG 4.92000 4.92000 4.56000

Consumer Durables 1.3200 1.3600 1.2400

F value 1.89 1.7 1.542

Significance value 0.116 0.157 0.201

The above table shows that the highest difference in Enterprise values arises in
the Paints and Varnishes and Pharmaceutical industries. The industries where the
enterprise values calculated are closer are Food and Beverage, Computer Software,
FMCG, Electrical machinery and Consumer Durables. The RV method shows a higher
valuation of enterprise values of the companies in the Pharmaceutical sector and lower
values in the Paints sector. The EVA method shows higher values in the Paints&
Varnishes and Automobile sectors.

When the enterprise values are calculated according to the FCFF method, there
is a significant difference in the enterprise values obtained in Paints and FMCG,
Computer Software and Consumer durables., Food and Beverages and FMCG, between
Computer Software and Electrical machinery and Consumer Durables and FMCG with
Electrical machinery, Paints and Consumer Durables. The significant difference in the
Enterprise values calculated under FCFF show that some of these sectors have large
companies with higher enterprise values. The calculation of enterprise values under

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EVA shows significant difference between Electrical machinery, FMCG and Consumer
Durables. The enterprise value under the RV method shows significant difference
between the industries Computer Software, Consumer Durables and Electrical
Machinery, FMCG and Electrical machinery and Consumer Durables. More wide
variation in Enterprise values is found in the FCFF and EVA methods than the RV.

The study also uses F test for testing the significance of difference of enterprise
values between the industries. The calculated values of F were found to be not
statistically significant under any of these methods. This proves empirically that there is
no significant difference in the enterprise values computed under the three methods. In
the current study, industries where the enterprise values calculated are closer are Food
and Beverage, Computer Software, FMCG and Consumer Durables. The companies in
these industries are mostly large firms which give more accurate results.

In this context it is necessary to highlight the use of the FCFF, as part of DCF
method.The DCF analysis is a very powerful tool that is not only used to value
companies but also to price initial public offerings (IPOs) and other financial assets. It is
such a powerful tool in finance, that it is so widely used by professionals in investment
banks, consultancies and managers around the world for a range of tasks that it is
even referred to as “the heart of most corporate capital-budgeting systems”
(Luehrman, 1998).

The conditions for choosing the appropriate method relate to indicators such as
the current book-to-market, earnings-to-price, dividend-to-price ratios, and the present
value of the expected residual income over the forecast horizon, the growth rate in
expected earnings, and firm size. The FCFF method in combination with other methods
like the trading comparables or precedent transaction analysis is an effective approach
to obtain a realistic range of appropriate company values. This combination technique is
the method that is currently used in most companies and investment banks. When using
several valuation techniques, their individual shortfalls are eliminated and the ultimate
goal in the field of company valuation can be reached: determining a fair and valid
company value.

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6.8 Relationship between Enterprise Values calculated under FCFF method
with value drivers

In this section, the next level of analysis has been carried out to find the relationship of the
value drivers and the dependent variable the enterprise value calculated under FCFF
method. Multiple regression was used to study the impact of the independent variables on
the enterprise value calculated under the FCFF method by examining its influence on
the dependent variable the Enterprise value calculated under FCFF. The results are
presented below.

Table6.5 Model Summary of regression results of value drivers with Enterprise value-
FCFF method

Unstandardised Standardised
Coefficients Coefficients
Variables Beta Standard Error Beta t value Significance
Sales 1.478 .302 .631 4.892 .000
Cost of capital -1843857.140 771017.501 -.200 -2.391 .025
Employee Cost -3.941 2.956 -.629 -1.333 .195

Fixed Assets -3.357 .781 -1.057 -4.299 .000

ROC 394146.192 121335.267 .267 3.248 .003
Cash flow/Share -2183.823 707.425 -.293 -3.087 .005
Working Capital 6.419 2.439 1.734 2.632 .015
R2=0.87 Adjusted
F=22.908 r=.933
R2=0.832

The results of regression found that 87% of the changes in the enterprise values
are due to the independent variables namely sales, costs of capital, employee costs,
fixed assets, return on capital, cash flow per share and working capital. The correlation
coefficient is also very high which means there is greater association between the
dependent and independent variables chosen for the study. The change in R2 shows that
the introduction of the working capital as an independent variable in the model has
improved the results marginally. The adjusted R2 which is 83.2 percent better represents
the variance in the enterprise values because the independent variables are more in
number. Further an F test has been conducted to show the significance of the correlation
coefficient and the results shows that the correlation coefficient is significant between

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the dependent variable that is enterprise value under FCFF and the independent
variables namely sales, costs of capital, employee costs, fixed assets, return on capital,
cash flow per share and working capital.

The variable sales was found to have the highest influence on enterprise value
with a t value of 4.892, followed by fixed assets (-4.299), return on capital (3.248), cash
flow per share (-3.087) and working capital (2.632). The costs of capital and employee
costs were found to be insignificant in the enterprise value. The costs of capital,
employee costs, fixed assets and cash flow per share have a negative coefficient which
means for a one unit change of the independent variable there is a large negative change
or reduction in the enterprise variable to the extent of the respective coefficients. The
Sales, Return on capital and Working capital have positive beta coefficients which mean
one unit change in each variable would increase the enterprise value to the extent of the
beta coefficients.

Many scholars had studied in different countries and periods, enterprise value
along with financial value drivers to carry on empirical research on the relationship of
corporate value and the value drivers. The financial value drivers creating an impact on
the value of enterprises are profitability, cash flow, operations and capital structure. The
results of the current study are convergent with that of other studies where the financial
value drivers and corporate value are highly relevant, the debt ratio negatively
correlated with enterprises value and the operating ability is positively relevant with
enterprises value.

Table 6.6 Excluded variables in regression of value drivers with Enterprise value-
FCFF method

Partial Collinearity
Beta in t sign
correlation Statistics
Beta .083 0.478 0.637 0.099 0.185
SD of yield -.045 -0.544 0.592 -0.113 0.818
Debt/ Equity ratio -.006 -0.053 0.959 -0.011 0.481

The above table shows the excluded variables in the regression model. The
variables excluded are beta, standard deviation of yield and the debt/equity ratio. The
standard deviation of yield shows lower collinearity than debt /equity ratio and beta of

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the company. The beta values for SD of yield (operating risk) and debt /equity ratio
(financial risk) result in a negative change in the enterprise value with a unit change in
the variables. The t test result shows no significant difference in the enterprise values on
account of these value drivers. The co linearity statistics is .185 for beta which is less
than 20% which means nearly 80% of the variance of beta is due to other factors and
multicollinearity is likely to exist. All the variables show values greater than 0.1,
implying that the variables are not suspected for multicollinearity.

6.9 Relationship between Enterprise Values calculated under EVA method with
value drivers

The current study also examines the impact of value drivers which influence the
dependent variable for which enterprise value is computed under the EVA procedure.

The regression results are presented below.

Table 6.7 Model Summary of regression results of value drivers with Enterprise value-
EVA method

Unstandardised Coefficients Standardised

Coefficients
Variables Beta Standard Error Beta t value Significance
Working Capital 3.353 0.597 0.87 5.613 0
ROC 430367.417 120502.671 0.28 3.571 0.001
Sales 1.138 0.294 0.467 3.87 0.001
Fixed Assets -1.362 0.462 -0.412 -2.948 0.007
Cash flow/share -1822.397 689.241 -0.235 -2.644 0.014
Cost of capital
-1907511.026 762311.817 -0.199 -2.502 0.019
2 Adjusted
R =0.876 F=29.56 r=.936
R2=0.847

The correlation coefficient is slightly higher than that obtained with the
regression using enterprise value calculated under FCFF. The R square value is almost
the same as the one obtained in FCFF. The value signifies 87 percent of the variation in
the dependent variable “enterprise value” is caused by the independent variables
working capital, return on capital, sales, fixed assets, cash flow per share and cost of
capital. The adjusted R2 which is 84.7 percent better represents the variance in the
enterprise values because the numbers of independent variables are more in number.

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The introduction of cost of capital in the model has resulted in a small change on the
enterprise value under EVA technique.

The R2 change value shows that the model has improved with the introduction to
cost of capital. The F test was conducted to show that the correlation coefficient is
significant between the dependent variable that is enterprise value under EVA and the
independent variables working capital, return on capital, sales, fixed assets, cash flow
per share and cost of capital.

The variance caused in the dependent variable which is enterprise value by the
independent variables is 2.81 whereas the effect of the other variables is 3.96. The
computed F value to test the significance of the relationship between the enterprise
value as per EVA and the combined impact of the independent variables working
capital, return on capital, sales, fixed assets, cash flow per share and costs of capital was
found to be significant. Hence a linear combination of the independent variables has a
positive impact on enterprise value.

The variable which has the highest effect on enterprise value is working capital
with a t value of 5.613 unlike the previous model where sales created the greatest
impact. This is followed by sales (3.87) and the return on capital (3.571). The other
variables that influence the dependent variable are fixed assets (-2.948), cash flow per
share (-2.644) and cost of capital (-2.502). The independent sample t test was conducted
to test whether there is a significant difference in the enterprise value under EVA due to
the variables working capital, sales, return on capital fixed assets, cash flow per share
and cost of capital. The results show significant effect of the independent variables on
enterprise value under EVA.

Table 6.8 Excluded variables in regression of value drivers with Enterprise value-EVA
method

Partial Collinearity
Beta in t sign correlation Statistics
BETA .125 0.761 0.454 0.153 0.185
SD OF AV YIELD -.014 -0.176 0.861 -0.036 0.818
DEBT EQ RATIO .018 0.179 0.86 0.036 0.481
EMPLOYEE COST -.541 -1.212 0.237 -0.24 0.024

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 The above table shows the variables excluded under the regression model of
enterprise value under EVA. In addition to the same variables which are excluded under
FCFF, employee costs are also significant with the enterprise value. The standard
deviation of yield and employee costs shows negative coefficients whereas beta and
debt equity ratios have positive coefficients. The collinearity statistics is 0.185 for beta
and 0.024 for employee costs which is less than 0.1 and indicates the variables are
suspected for multi collinearity.

6.10 Relationship between Enterprise Values calculated under RV method with

value drivers

The current study proposes to study the influence of the independent variables on the
enterprise values calculated under RV method. The result of the study using multiple
regression is presented below.

Table 6.9 Model Summary of regression results of value drivers with Enterprise
value-RV method

Standardised
Unstandardised Coefficients
Coefficients
Standard
Variables Beta Beta t value Significance
Error
EMPLOYEE
COST 3.442 0.648 0.552 5.315 0
ROC 361927.008 113781.236 0.247 3.181 0.004
SALES 0.871 0.246 0.374 3.545 0.001
COST
OFCAPITAL -2429602.531 718592.037 -0.265 -3.381 0.002
2
R =0.926 Adjusted
F=40.414 r=.926
R2=0.836

The above table shows the results of regression. The correlation coefficient is
found to be lower than the other regression models. The variation of the dependent
variable which is enterprise value computed under the relative valuation method is 85%
with the independent variables employee costs, return on capital, sales and cost of
capital. The value of R2 change has improved with the introduction of cost of capital.
The F test shows that the correlation coefficient is found to be significant for the model

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between enterprise value and the independent variables employee costs, return on
capital, sales and cost of capital and enterprise value under relative valuation.

The table depicts the variables which have a significant effect on enterprise
value computed under the RV technique. Unlike the previous model, the employee costs
exercise the highest influence on the dependent variable with a t value of 5.315. This is
followed by return on capital (3.181), sales (3.545) and costs of capital (-3.381). The t
test conducted shows significant difference in the dependent variable which is enterprise
value by the independent variables and employee costs exercises the highest influence
on the dependent variable.

Table 6.10 Excluded variables in regression of value drivers with Enterprise value-
RV method

Partial Collinearity
Beta in t sign correlation Statistics

BETA -.004 -0.021 0.983 -0.004 0.193

SD OF AV YIELD .040 0.544 0.591 0.106 0.987

DEBT EQ RATIO -.053 -0.567 0.576 -0.111 0.619

CASH FLOW PER -.066 -0.752 0.459 -0.146 0.701

SHARE

FIXED ASSETS -.186 -1.668 0.107 -0.311 0.401

WORKING CAPITAL -.159 -0.495 0.625 -0.097 0.053

The above table shows the excluded variables which are much higher than the
other models. In the model, beta, standard deviation of yield, debt/equity ratio, and cash
flow per share, fixed assets and working capital are excluded variables. The t test shows
no significant difference in the enterprise values calculated under RV for these
independent variables. The collinearity statistics show that the variable beta and
working capital have less than 20% tolerance which means the remaining 80% of the
variation in this variable is due to other factors. The collinearity for working capital is
less than 0.1 which means the variable is suspected for multicollinearity.

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6.11 Overall regression results

A multiple regression analysis was conducted using SPSS to study the significance of
the selected value drivers under each of the methods of FCFF, EVA and RV. The F test
results showed that there is a significant difference on the enterprise value calculated
under FCFF with the variables of sales, costs of capital, fixed assets, return on capital,
cash flow per share and working capital. The results of regression found that 87% of the
changes in the enterprise values are due to the independent variables- sales, cost of
capital, employee costs, fixed assets, return on capital, cash flow per share and working
capital. The variable with the highest influence on enterprise value was found
to be sales, followed by fixed assets, return on capital, cash flow per share and
working capital.

Regression was conducted to find the significance of the correlation coefficient

showed that the correlation coefficient is significant between the dependent variable that
is enterprise value under EVA and the independent variables working capital, return on
capital, sales, fixed assets, cash flow per share and cost of capital. The value of R2shows
that 87 percent of the variation in the dependent variable which is enterprise value is
caused by the independent variables working capital, return on capital, sales, fixed
assets, cash flow per share and cost of capital. The variable which has the highest effect
on enterprise value is working capital unlike the previous model where sales created the
greatest impact. This is followed by sales and the return on capital. The other variable
that influence the dependent variable are fixed assets, cash flow per share and cost of
capital.

The F test shows that the correlation coefficient is found to be significant for the
model with the independent variables employee costs, return on capital, sales and cost
of capital and enterprise value under relative valuation. The variation of the dependent
variable which is enterprise value computed under the relative valuation method is 85%
with the independent variables employee costs, return on capital, sales and cost of
capital. Unlike the previous model the employee costs exercise the highest influence on
the dependent variable. This is followed by return on capital, sales and costs of capital.
The t test conducted shows significant difference in the dependent variable which is
enterprise value by the independent variables.Employee costs exercise the highest

177
influence on the dependent variable. Hence from the study it can be inferred that the
sales of the company, working capital and employee costs are the most important
variables that create an impact on the value of a firm.

A study which gives similar results to the current study is that of Srishty Sarawgi Jain et
al., (2012) who compared the impact of different value drivers on enterprise value for
the Indian ITeS sector with multiple linear regression. The independent variables (value
drivers)included were: fixed assets working capital earnings before interest, tax,
depreciation, and amortization and employee cost. Dependent variable was the
enterprise value. The sample companies selected for the study were thirty-seven
companies listed in the Indian ITeS sector. The model was found to be significant,
explaining 53.8% of the variation in enterprise value. The variable with highest effect
on enterprise value was working capital, followed by employee cost, and EBITDA.
Fixed assets were found not to have a significant effect on enterprise value, though it
was significant in conjunction with working capital and costs spent on employees.

The working capital multiple represents the long-term value creation of

operating finance. Though working capital is basically short-term funding of operations,
efficient utilization of working capital in balancing liquidity and profitability is a key
element in growth and value. In the context of the Indian industry, the major
components of working capital are loans & advances, cash and bank balances, and
receivables and payables. In particular, loans and advances represent investment of
excess cash generated by the firm in its subsidiaries, usually to finance new projects
and/or for research and development, which further enhances value.

The employee cost multiple represents the long-term value creation of the
company. The employees are the vital ingredient for growth and value creation in an
enterprise. Effective utilization of productive capacity and working capital is possible
only in the hands of committed, motivated employees

6.12 Discriminant analysis of value drivers between Domestic and MNCs

The discriminant analysis was carried out to perform a canonical linear discriminant
function which is the classic form of discrimination. The specified groups are the
domestic and multinational companies which are considered as the dependent variable

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for the study. The independent variables are the value drivers which are used to
discriminate the specified groups. The value drivers of enterprise value comprises
eleven predictors which was selected for the study namely beta, standard deviation of
yield, cost of capital, return on capital, debt equity ratio, cash flow per share, fixed
assets, and employee costs, working capital, sales and reinvestment rate. The current
study focuses on comparing the actual groupings of the value drivers with the predicted
groupings generated by the discriminant analysis to identify and analyse the value
drivers that discriminate much between domestic and multinational companies.

Group Statistics’ is examined to check whether there is any variation between

the two groups of the dependent variable considering each of the independent variables.
Table 6.11 displays the mean values for each of the variables chosen for the study based
on the two categories of the companies.

Table 6.11 Discriminant analysis - Mean values

Domestic MNC
Beta 0.766892 0.703324
SD of avg yield 0.150716 0.084753
Cost of capital 0.12826 0.124583
ROC 0.145017 0.18505
Debt equity ratio 0.275597 0.105133
Cash flow /share 26.545524 36.956093
Fixed asset 4.5700 1.1000
Employee cost 3.1500 5292.685396
Working capital 5.7400 1.7900
Sales 9.2400 6.9200
Reinvestment rate 0.179644 -0.082216

From the Table 6.11 it is observed that the mean values of a majority of the
variables reveal the existence of difference among the domestic and multinational
companies. This implies that the mean differences between the various value drivers
of the two groups are showing some difference. The variables that are identified to
show a larger difference in mean values are standard deviation of average yield,
return on capital, debt equity ratio, and cash flow per share, fixed assets, employee

179
costs, working capital, sales and the reinvestment rate. The results prove that other
than the exceptions variables of beta and costs of capital, the statistics reinforces the
existence of inequity between the variables for domestic and multinational companies.

This suggests that multiple discriminant analysis can be used to explore the
degree to which the value drivers discriminating the domestic and multinational
companies. Table6.12 displays information on each of the discriminate functions
produced. An Eigen value represents the proportion of variance explained and Wilks’
Lambda test shows the significance of the discriminant function.

Table 6.12 Eigen values & Wilks' Lambda values

% of Cumulative Canonical Wilks' Chi-

Function Eigen value
Variance % Correlation Lambda square
1 .368a 100 100 0.519 .731 7.682

The Eigen value shown in the above table is associated with a very strong
function. The canonical correlation is the multiple correlations between the predictors and the
discriminant function. Since the study involves only two groups, dicriminant analysis will
show (n-1) function, i.e. only one function. With only one function it provides an index of
overall model fit which is interpreted as being the proportion of variance explained (r2). The
canonical correlation of 0.519 suggests that the model explains only 51.9% of the correlation
between the discriminant scores and the dependent variable. It reveals the extent to which the
value drivers discriminate between the domestic and multinational companies.

A high Wilk’s lambda indicates that group means appear to differ. The high
Wilks’ Lambda statistic (Wilks' = 0.731; 2=7.682) suggests that the group means
do appear to differ. The function explains 100% of the variance in the enterprise
values of domestic and multinational companies.

When tested, Box M shows that a significant M (Box M is 320.534; F=2.897

and p=0.00) confirms that both groups have differing variance-covariance matrices.
This is a necessary condition to proceed with the tests further. The value drivers selected
for signifying an impact on enterprise values of domestic and multinational companies
are considered reliable for subsequent analysis.

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 Table 6.13Classification Results is a simple summary of number and percent of
subjects classified correctly and incorrectly. The cross validated set of data is a more
honest presentation of the power of the discriminant function.

Table 6.13 Classification results of Discriminant analysis

INDUSTRY Predicted Group Membership

DOSMESTIC MNC Total
DOSMESTIC 10 (62.5%) 6 (37.5%) 16
MNC 3 (18.8%) 13 (81.2%) 16
DOSMESTIC 7 (43.8%) 9 (56.2%) 16
MNC 8 (50.0%) 8 (50.0%) 16

Table 6.13 reveals that the discrimination was successful in classifying 71.9% of
original grouped respondents. Hair et al., (1987) provide a rough estimate by suggesting
an improvement of at least 25% on that which could be achieved by chance. Thus,
research findings has obtained classification accuracy greater than 25% achieved by
chance and has cross validated the above discriminating results. Discriminant analysis
has worked well with a value of 71.9% to differentiate the value drivers that signify the
enterprise values between the domestic and multinational companies.

The standardised coefficient of each of the value drivers are provided in Table
(6.14). The Standardized Canonical Discriminant Function coefficients are analogous to
the coefficients in multiple regressions

Table 6.14 Standardized Canonical Discriminant Function Coefficients

Standardized Canonical Discriminant Function Coefficients

Function
1
BETA -0.505
SD OF AV YIELD 0.455
COST OFCAPITAL 0.6
ROC 0.336
DEBT EQ RATIO 1.073
CASH FLOW PER SHARE -0.177
FIXED ASSETS -0.203
EMPLOYEE COST 1.638
WORKING CAPITAL -0.79
SALES -0.342
REINVESTMENT RATE 0.395

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 The standardized coefficients denote the partial contribution of each of the value
drivers to the discriminant function. The larger the standardised coefficient, the greater
is the contribution of the value driver in discriminating between the two categories of
domestic and multinational companies. The higher values of coefficients indicate an
increasing importance of these variables in predicting the differences between the
groups. The signs indicate direction of the relationship. Employee cost is the strongest
predictor while debt/equity ratio was next in importance as a predictor. These two
variables with large coefficients are found to strongly discriminate the domestic and
multinational companies. The other variables are less successful as predictors.

However, several authors (e.g., Hair et al.,.(1998) warn that the interpretation of
the standardized coefficient may lead to misinterpretations. As in regression analysis, a
small weight may either indicate that the discriminating power of a construct is low or
that it has been partialed out of the relationship because of high degree of
multicollinearity (Hair et al., 1998). Discriminant loadings are used as a means of
interpreting the discriminating power of the independent constructs because of their
correlational nature (Hair et al., 1998), which are considered relatively more valid than
standardized coefficients.

Table 6.15 gives the structure matrix table which is another widely employed
method for testing the relative importance of predictors. It gives the discriminant
loadings which denote the correlation between the value drivers and the discriminant
function which are considered more accurate than the Standardized Canonical
Discriminant Function coefficients.

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Table 6.15 Structure matrix

Structure Matrix
Function
1
DEBT/ EQUITY RATIO 0.496*
EMPLOYEE COST 0.462*
WORKING CAPITAL 0.408*
SD OF AV YIELD 0.354*
FIXED ASSETS 0.303*
CASH FLOW PER SHARE -0.212
ROC -0.161
BETA 0.158
SALES 0.148
COST OFCAPITAL 0.092
REINVESTMENT RATE 0.064
* Largest absolute correlation between each variable and any discriminant function

The structure matrix provides another way of indicating the relative importance
of the predictors and it is observed above that the same pattern holds.

The structure matrix table given shows the correlations of each variable with
each discriminate function. These Pearson coefficients are structure coefficients or
discriminant loadings. They serve like factor loadings in factor analysis. By identifying
the largest loadings for each discriminate function. The debt/equity ratio (0.496),
employee costs (0.462), working capital (0.408), standard deviation of yield (0.354) and
fixed assets (0.303) are the foremost value drivers that discriminate to a large extent the
enterprise values of domestic and multinational companies. This is consistent with
results from the other tests conducted previously. Generally, just like factor loadings,
0.30 is taken as the cut-off between important and less important variables. A minor
loading obtained is the reinvestment rate which is the weakest predictor suggests that
capital expenditures made by the company is not associated with the enterprise value
but a function of other unassessed factors.

Table 6.16 provides another way of interpreting discriminant analysis results

by describing each group in terms of its profile, using the group means of the
predictor variables.
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Table 6.16 Functions at Group centroid

Functions at Group Centroid

Function
INDUSTRY 1
DOSMESTIC 0.588
MNC -0.588

An examination of group centroid in Table 6.16 clearly suggests that function 1

discriminates between the enterprise values of domestic and multinational companies. The
study finds that the domestic group deviates positively and has a higher centroid of 0.588
than the multinational group deviates negatively and has a lower centroid of-0.588. These
values portrays that the enterprise values of the domestic and multinational companies
discriminate enormously and the two are distinct groups as indicated by the group
centroid values.

Table 6.17 Classification Function Coefficients

Classification Function Coefficients

INDUSTRY
DOSMESTIC MNC
BETA -34.287 -32.559
SD OF AV YIELD 15.744 12.366
COST OFCAPITAL 507.895 487.148
ROC 19.987 18.127
DEBT EQ RATIO 30.994 26.686
CASH FLOW PER SHARE 0.087 0.091
FIXED ASSETS .0000605 .0000581
EMPLOYEE COST .0000430 .0000829
WORKING CAPITAL .0000697 .0000810
SALES .0000168 .0000138
REINVESTMENT RATE -0.124 -0.258
(Constant) -27.326 -24.604

The domestic companies have a large debt/equity ratio which is the primary
discriminating factor. This factor discriminates the companies, as domestic companies
use both equity and debt funds for financing. The Multinational companies on the other
hand are financially stable with funding from the parent company. Six of the sixteen in
the multinational group are companies with no debt funding. The multinationals on the

184
other hand show employee cost as the highly contributing variable in discriminating
with the domestic counterparts. The study provides empirical evidence of higher
compensation being paid to employees in multinational companies.

6.13 Overall Discriminant Analysis Results: A discriminant analysis was conducted

to predict whether the value drivers signify the enterprise values of domestic and
multinational companies. Predictor variables were beta, standard deviation of yield, cost
of capital, return on capital, debt equity ratio, cash flow per share, fixed assets,
employee costs working capital; sales and reinvestment rate. Large mean differences
were observed for all the predictors except the variables of beta and costs of capital on
the DV. The discriminate function revealed a significant association between groups
and all predictors.The value drivers discriminates the domestic and multinational
companies accounting for 51.9% of between group variability, although closer analysis
of the structure matrix revealed only three significant predictors, namely debt equity
ratio (0.496), employee costs (0.462), working capital (0.408), standard deviation of
yield (0.354) and fixed assets (0.303) with the reinvestment rate as a poor predictor. The
classification results showed that the discrimination was successful in classifying 71.9%
of original grouped respondents for domestic and multinational companies.

There are several researches that provide results similar to the current study. Pai
V. S.et al., (2013) in their study, analyzed the performance of 45 companies drawn
equally from domestic public sector, domestic private sector and foreign companies in
India. They tested the hypothesis that foreign firms operating in India are superior in
performance vis-à-vis domestic firms and concluded that all three group firms showed
similar performance. The study found that domestic Indian firms have withstood the
forces of competition almost two decades after the liberalization of the Indian economy
in the early 90s. This bodes well for Indian industry. Operating performance is a key
value driver in determining enterprise values. Hence the study endorsed the current
research that there is no significant difference in the enterprise values of domestic
companies and MNCs.

Another study conducted by Kaushik Chakraborty et al., (2014) examines the

relationship between financial leverage and profitability of the Indian pharmaceutical
industry during the period of March 2002 to December 2011 with a sample of twenty

185
companies. The study compared the relationship between financial leverage and
profitability of multinational companies with that of the domestic companies in the
Indian pharmaceutical industry. The research found strong evidence of the negative
contribution of financial leverage towards improving profitability for multinational and
domestic firms. The results of the discriminant analysis show debt /equity ratio as the
signifying variable influencing the enterprise value of domestic and multinational firms.

Keshari(2010) empirically examined the differences in the relative

characteristics, conduct and performance of two different ownership groups of firms,
namely, foreign affiliates of multinational enterprises and domestic firms. The study
was restricted to non-electrical machinery industry in India for the period 2001 to 2007.
Three alternative techniques were employed, univariate statistical method based on
Welch’s t-test, the multivariate linear discriminant analysis and the dichotomous logit
and probit models. The findings suggest that foreign affiliates had lower financial
leverage. The results of the current study confirm that the MNCs employ lower level of
financial leverage as the financial support from the parent company is sufficient for
them that they engage low or no debt.

According to A. M. Fatemi (1988) diversifying across geographies reduces the

operating risk, thereby increases the debt capacity of the firm, indicating a positive
relationship between geographic diversification and leverage ratio. The former studies
in Turkey, revealed that there was no significant difference between the performances of
foreign-owned and domestically-owned firms.

The OECD Employment Outlook(2008) shows large wage gains for newly hired
workers, with a rise of 6% in wages in the UK, 8% in Germany, 14% in Portugal and up
to 21% in Brazil. In contrast, there were small losses or no effect on wages for those
moving from foreign to domestic firm. The wage premia of working in foreign
multinationals apply to workers who move to those firms. The discriminant analysis
found employee costs as the significant variable discriminating the domestic and
multinational companies.

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6.14 Chapter Summary

An investment is made with the primary purpose to generate higher returns. The
forthcoming chapter aims to study long terms abnormal returns of performance and its
relationship with the Value/Price ratio signifying the impact of intrinsic values under
each of the methods with the abnormal returns. The chapter also brings into the picture
the size of the company represented by market capitalisation and Market/Book Value
ratio indicating the attractiveness of the investment.

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