Simulating the contributions of cash flow components to the real value creation process

Financial managers have a need to analyze the contributions that various operating strategies and policies make in the creation of shareholder value. This paper uses a Lotus 1,2,3 program to make operational an integrated discounted cash flow (DCF) model developed by Gentry and Lee. The model integrates the cash flow contributions from short-run financial management (SRFM) variables and conceptualizes the key relationships among the SRFM variables. The program provides management a tool for analyzing the daily performance of any key variable and for determining the contribution it makes to cash inflows or outflows. The program makes it possible for management to simulate various operating strategies and policies; to analyze the performance of components that contribute to cash inflows and outflows; and to determine the operating strategy that creates the highest shareholder value. The program results highlight the need for management to use the uncertainty model for planning purposes because the certainty model may significantly overstate the value of the firm. SIMULATING THE CONTRIBUTIONS OF CASH FLOW COMPONENTS TO THE REAL VALUE CREATION PROCESS The strategic decisions of financial management are based on real economic determinants, such as market size, growth of the market size and share of the market, that create real value for shareholders. The contribution of these real economic based decisions to the long-run dividend stream is transmitted to the financial markets where it is discounted by investors, Williams [8] and Gordon and Shapiro [3]. In contrast, financial market theories such as CAPM, APT and OPT mask the fact that managers make decisions about how to operate in the factor and product markets of the real economic sectors [1]. Until recently the cash flow contributions of short-run financial management (SRFM) decisions were implicitly assumed to be imbedded in the discounted cash flow stream of the valuation models. Sartoris and Hill (S&H) [7], Gentry and Lee (G&L) [2], and Rappaport [6], have developed models that explicitly integrate the cash flow contributions from SRFM variables into a discounted cash flow (net present value) model. These models conceptualize the key relationships among the variables that contribute cash inflows and outflows. The models show that the real value of a firm can be increased or decreased by either a change in exogenous or endogenous variables, or a change in SRFM policies and decisions. The models are complex because they include a broad array of variables that contribute to daily real cash inflows and outflows. This generation of cash flows from operations is the basis for creating real shareholder value. The cash flow generating process is a dynamic nonlinear system where flows are changing