Merck 2014 Annual Report Download - page 62

57GROUP MANAGEMENT REPORT → FUNDAMENTAL INFORMATION ABOUT THE GROUP → Internal management system of the Group
Business free cash flow (BFCF)
Business free cash flow comprises the major cash-relevant items
that the individual businesses can influence and are under their
full control. It sums up EBITDA pre one-time items less invest-
ments in property, plant and equipment, software, advance pay-
ments for intangible assets, as well as changes in inventories
and trade accounts receivable. To manage working capital on
a regional and local level, the businesses use the two indicators
days sales outstanding and days in inventory.
GROUP →
BUSINESS FREE CASH FLOW
€ million / change in % 2014 2013 Change
EBITDA pre one-time items 3,387.7 3,253.3 4.1
Investments in property plant and equipment and software as well as advance payments
for intangible assets – 527.5 – 446.2 18.2
Changes in inventories as reported in the balance sheet –185.5 59.7 –
Changes in trade accounts receivable as reported in the balance sheet – 214.2 93.2 –
Adjustment first-time consolidation of AZ Electronic Materials S.A. 144.6 – –
Business free cash flow 2,605.1 2,960.0 –12.0
INVESTMENTS AND VALUE MANAGEMENT
Sustainable value creation is essential to secure the long-term
success of the company. To optimize the allocation of financial
resources, the Group uses a defined set of parameters as criteria
for the prioritization of investment opportunities and portfolio
decisions.
Net present value
The main criterion for the prioritization of investment opportu-
nities is net present value. It is based on the discounted cash flow
method and is calculated as the sum of the discounted free cash
flows over the projection period of a project. Consistent with the
definition of free cash flow, the weighted average cost of capital
(WACC), representing the weighted average of the cost of equity
and cost of debt, is used as the discount rate. Depending on the
type and location of a project different mark-ups are applied to
the WACC.
Internal rate of return (IRR)
The internal rate of return is a further important criterion for the
assessment of acquisition projects and investments in property,
plant and equipment. It is the discount rate that makes the present
value of all future free cash flows equal to the initial investment
or the purchase price of an acquisition. A project adds value if the
internal rate of return is higher than the weighted cost of capital
including mark-ups.
Return on capital employed (ROCE)
In addition to NPV and IRR, ROCE is an important metric for the
assessment of investment projects. It is calculated as the operating
result (EBIT) pre one-time items divided by the sum of property,
plant and equipment, intangible assets, trade accounts receivable
and trade accounts payable, as well as inventories.
Payback period
An additional parameter to prioritize investments into property,
plant and equipment is the payback period, which indicates the
time in years after which an investment will generate positive net
cash flow.
Value added of Merck KGaA, Darmstadt, Germany (ME VA)
MEVA gives information about the financial value created in a
period. Value is created when the return on capital employed
(ROCE)
of the company or the business is higher than the weighted
average cost of capital (WACC). MEVA metrics provide the Group
with a powerful tool to weigh investment and spending decisions
against capital requirements and investors’ expectations.