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Using CFROI
One of the advantages of CFROI is that it can be used to
track long-term trends. CFROI is often plotted within the economic life cycle of
a business. Over time, many companies experience maturity and slower growth. If
the company fails to recognize declining values, the market value of the firm
will fall below the firm's cost. On the other hand, if the company has strong
growth and high returns, competition will move-in and put pressure on the
company's ability to sustain high values. When a company has high CFROI in
relation to what investors require, the company sells at a premium and when
CFROI is below the rate of return required by investors, the company will sell
at a discount.
CFROI is quite popular for determining the value of a target
company that is a possible takeover candidate. CFROI looks at the economic cash
flows over the life of the entity. Net Present Values are calculated for the
target investment as well as for future investments required. The combination of
the two represents the market value of the target company. Debt and debt
equivalents are subtracted from the market value, then divided by the total
shares outstanding to arrive at the target price per share. Investment and
Portfolio Managers also use CFROI to ascertain company values in an effort to
predict future economic performance and stock prices.
