EXHIBIT 17.4  Key Value Drivers by Scenario
%
Financial forecasts
2019A
2020
2021
2022
2023
2024
2025
Continuing 
value
Scenario assessment
Scenario 1: New product is a top seller
Revenue growth
5.0
12.0
15.0
14.0
12.0
10.0
5.0
3.5
New-product introduction leads to spike in revenue growth.
After-tax operating margin
7.5
9.0
11.0
14.0
14.0
12.0
10.0
8.0
Margins improve to best in class as consumers pay a price premium for product.
× Capital turnover, times
1.5
1.4
1.3
1.4
1.5
1.6
1.6
1.6
Capital turnover drops slighly during product launch as company builds inventory to meet 
expected demand.
Return on invested capital
11.3
12.6
14.3
19.6
21.0
19.2
16.0
12.8
Scenario 2: Product launch fails
Revenue growth
5.0
3.0
(1.0)
(1.0)
1.5
1.5
1.5
1.5
Revenue growth drops as competitors steal share.
After-tax operating margin
7.5
7.0
6.5
6.0
5.5
5.5
6.5
6.5
Lower prices put pressure on margins; cost reductions cannot keep pace.
× Capital turnover, times
1.5
1.4
1.4
1.4
1.3
1.3
1.3
1.3
Capital efficiency falls as price pressure reduces revenue; inventory reductions mitigate fall.
Return on invested capital
11.3
9.8
9.1
8.4
7.2
7.2
8.5
8.5
 
364

Creating Scenarios  365
(assuming interest rates have not changed, so the market value of debt equals 
the face value). The resulting equity value is $2,916 million.
If the product launch fails, the DCF value of operations is only $1,993 mil-
lion. In this scenario, the value of the subsidiaries is much lower ($276 mil-
lion), as their business outlook has deteriorated due to the failure of the new 
product. The value of the debt is no longer $2,800 million in this scenario. 
Instead, the debt holders would end up with $2,269 million by seizing control 
of the enterprise. In scenario 2, the common equity would have no value.
Given a two-thirds probability of success for the product, the probability-
weighted equity value across both scenarios amounts to $1,954 million. Since 
estimates of scenario probabilities are likely to be rough at best, determine the 
range of probabilities that point to a particular strategic action. For instance, 
if this company were an acquisition target available for $1.5 billion, any prob-
ability of a successful launch above 50 percent would lead to value creation. 
Whether the probability is 67 percent or 72 percent does not affect the decision 
outcome.
When using the scenario approach, make sure to generate a complete valu-
ation buildup from value of operations to equity value. Do not shortcut the 
process by deducting the face value of debt from the scenario-weighted value 
of operations. Doing this would seriously underestimate the equity value, be-
cause the value of debt is different in each scenario. In this case, the equity 
value would be undervalued by $175 million ($2,800 million face value minus 
$2,625 million probability-weighted value of debt).3 A similar argument holds 
for nonoperating assets.
EXHIBIT 17.5  Example of a Scenario Approach to DCF Valuation
$ million
Scenario 1: New product is a top seller
Probability- 
weighted 
equity value: 
1,954
67% probability
Value of operations
5,044 
The company’s new product launch reinvigorates 
revenue growth. Higher average selling prices lead to 
increased operating margins and consequently higher 
ROICs. ROICs decay as the new product matures, but 
future offerings keep ROIC above the cost of capital.
Nonoperating assets
672 
Enterprise value
5,716 
Interest-bearing debt
(2,800)
Equity value
2,916 
Scenario 2: Product launch fails
33% probability
Value of operations
1,993 
The company launches a new product, but the product 
is seen as inferior to other offerings. Revenue growth 
remains stagnant and even declines as prices erode and 
the company loses share. Returns on capital eventually 
rise to the cost of capital as management refocuses on 
cost reduction.
Nonoperating assets
276 
Enterprise value
2,269 
Interest-bearing debt
(2,269)
Equity value
– 
3 Although this approach is typically recommended, deducting the market value of debt from enterprise 
value will lead to an inconsistent estimate of equity value if your estimate of default does not match 
market expectations. For more on how to correctly incorporate debt into the valuation, see Chapter 16.