Session 12: Measuring Investment Returns
In this session, we started on measuring investment returns, drawing on the theme from Jerry Macguire (Show me the money). After making an argument for the primacy of cash flows, we looked at how a good measure of return is time weighted and incremental and how every investment is a project (small or large). We spent the bulk of the class describing the Rio Disney investment, and then computing the return on capital on that investment, based upon expected revenues and operating income. We also looked at what the hurdle rate for the investment should be, drawing on the notion that the discount rate for a project should reflect the risk of that project (business, geography etc.). We also extended the return on capital concept to entire companies to judge the quality of existing investments. In the last part of the class, we talked about the process of getting from earnings to cash flows, by adding back depreciation and amortization, subtracting capital expenditures and change in working capital. Depreciation leaves an imprint because it saves taxes, capital expenditure drain cash flows and investments in inventory tie up cash.
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