Terminal Value

5 Key excerpts on "Terminal Value"

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  eBook - ePub

  Corporate and Project Finance Modeling

  Theory and Practice

  • Edward Bodmer(Author)
  • 2014(Publication Date)
  • Wiley

    (Publisher)

  Chapter 25 . If the company is not sold and cash flows are always realized in the middle of the year, the value of the company should be the same as if you separately compute the present value of explicit period cash flows and the present value of terminal cash flow. This long-term theoretical exercise demonstrates that all of the business of midyear discounting ends up in a simple formula that can be implemented as follows:

  • Compute the value of explicit cash flows and the value of the Terminal Value as if you were using the end-of-year cash flows, meaning that you can use the regular old NPV function.
  • Multiply the final result by (1 + WACC)^.5 to adjust for the half-year assumption.

  To demonstrate that this formula works, you can create a proof in the same manner for proving how items associated with the bridge between enterprise value and equity value should be treated. The value of cash flows in the long-term model establishes the theoretically correct value of the company. This is the same value that should be obtained from the sum of the Terminal Value and the value of the explicit cash flow. The value of the terminal cash flow as measured by the Terminal Value is in a sense just a shortcut, as the buyer at the terminal date should pay the theoretical long-term value. When you assume that the explicit cash flows occur at the middle of the period and the Terminal Value occurs at the end of the period, but the buyer makes a valuation from receipt of cash flow in the middle of the period, the valuation is the same as the simple formula shown earlier. Figure 28.4

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  Investment Valuation

  Tools and Techniques for Determining the Value of any Asset, University Edition

  • Aswath Damodaran(Author)
  • 2012(Publication Date)
  • Wiley

    (Publisher)

  CHAPTER 12 Closure in Valuation: Estimating Terminal Value

  In the previous chapter, we examined the determinants of expected growth. Firms that reinvest substantial portions of their earnings and earn high returns on these investments should be able to grow at high rates. But for how long? And what happens after that? This chapter looks at two ways of bringing closure to a valuation: a going concern approach, where we assume that the firm continues to deliver cash flows in perpetuity and a liquidation approach, where we assume that the business is shut down and the assets are sold at some point in time.

  Consider the going concern approach first. As a firm grows, it becomes more difficult for it to maintain high growth and it eventually will grow at a rate less than or equal to the growth rate of the economy in which it operates. This growth rate, labeled stable growth, can be sustained in perpetuity, allowing us to estimate the value of all cash flows beyond that point as a Terminal Value for a going concern. The key question that we confront is the estimation of when and how this transition to stable growth will occur for the firm that we are valuing. Will the growth rate drop abruptly at a point in time to a stable growth rate or will it occur more gradually over time? To answer these questions, we will look at a firm's size (relative to the market that it serves), its current growth rate, and its competitive advantages.

  We also consider an alternate route, which is that firms do not last forever and that they will be liquidated at some point in the future. We will consider how best to estimate liquidation value and when it makes more sense to use this approach rather than the going concern approach.

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  eBook - ePub

  The Risk Premium Factor

  A New Model for Understanding the Volatile Forces that Drive Stock Prices

  • Stephen D. Hassett(Author)
  • 2011(Publication Date)
  • Wiley

    (Publisher)

  Turning our attention back to MobAppCo, if the potential market is sufficiently large, the upside case may have an NPV many times greater than the base case. For example, let's say the upside NPV is $500 million, compared to about $30 million for the base case. While no sane analyst would present the $500 million as a base case, by presenting it as the upside with a low probability, it could ignite the discussion regarding upside potential for the business.

  CHAPTER RECAP

  The key points in this chapter regard the selection of time horizon and calculation of Terminal Value. When valuing a high-growth business, extend the forecast horizon until growth stabilizes. Typically, this means that top-line growth is the same or lower than the overall economy and new investment is at a maintenance level. Terminal Value should be based on an internally consistent normalized cash flow and growth rate. Long-term real growth in the Terminal Value can be approximated by identifying mature comparable companies today that are similar to our target in the final years of our forecast horizon and calculating their RIGR. When the range of potential outcomes is large, consider developing several scenarios to illustrate the impact, both positive and negative, on valuation.

  Passage contains an image Chapter 9 Case Study 2 Valuation of a Cyclical Business This chapter applies the principles in the previous chapters to a valuing a cyclical business. The focus is on forecasting a cycle and establishing normalized cash flow.

  Cyclical businesses are actually a bit more complicated to value from a technical standpoint than growth businesses. This is not to say that growth businesses are easy to value; they are not. Forecasting growth businesses is more difficult since assumptions regarding market development, product, and competition are much more uncertain. Cyclical businesses are more complicated in that they require understanding and adjusting for the business cycle in the forecast horizon and Terminal Value. But their identification as cyclical by virtue of their having been around for many economic cycles usually means that ample industry data is available.

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  CFA Program Curriculum 2020 Level II, Volumes 1-6 Box Set

  • (Author)
  • 2019(Publication Date)
  • Wiley

    (Publisher)

  A second method for estimating the Terminal Value involves applying a multiple at which the analyst expects the average company to sell at the end of the first stage. The analyst might use a free cash flow or other multiple that reflects the expected risk, growth, and economic conditions in the terminal year. Market multiples are rules of thumb applied by analysts, investment bankers, and venture capitalists to produce rough estimates of a company’s value. Multiples tend to vary by industry. They can be based on anything applicable to the industry and correlated with market prices. Some service industries tend to be priced as multiples of EBITDA (earnings before interest, taxes, depreciation, and amortization). In contrast, retail stores in some industries might be priced based on multiples applied to floor space. In these cases, the respective multiples can be used directly to produce a Terminal Value, or they can be incorporated into a pro forma analysis to convert the multiple into a consistent value for free cash flow.

  If the company in Exhibit 3 is in an industry where the typical company sells for about 20 times its free cash flow, then the company’s Terminal Value estimate would be:

  Terminal Value2011 = 20 × $1,799 = $35,980 = $36.0 million

  Having established an estimate for the Terminal Value, the analyst must discount it back from the end of the estimate horizon to present. The discount rate used is the same WACC estimate that was previously applied to discount the free cash flows. If we decide that the Terminal Value found using the constant growth method is more accurate than a market multiple, we would discount that value back five years (2011 back to the present):

  Adding the present value of the free cash flows ($5.802 million) to the present value of the Terminal Value ($35.670 million), we can estimate the value of the company to be $41.471 million.20

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  eBook - PDF

  Entrepreneurial Finance

  • J. Leach, Ronald Melicher(Authors)
  • 2020(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  Discounting the $10,000,000 exit value by 50 percent per year for five years gives a present value of $1,316,872 or 10,000,000/(1.5) 5 . Figure 11.1 depicts the $10,000,000 future value “exit pie” as well as the $1,316,872 present value of the exit pie. We can “work” the VC valuations using either form of the exit pie. For initial purposes, we will begin with the present value exit pie, which is consistent with applying the discounted cash flow valuation methods in Chapter 10, whereby we discount future cash flows back to the present. 2 This approach also is frequently referred to as identifying and applying a price-earnings multiple for valuation purposes. The implicit assumption is that the price per dollar of income is expected to be at the same level at the end of five years. This assumption is common when using current multiples to project future values. We are emphasizing the use of price-earnings multiples and earnings projections to estimate Terminal Value. Other comparison ratios are frequently used to estimate ter- minal value. Examples include price to cash flow, price to revenue, and price to customers. The procedure is the same: Find a recent ratio and multiply it by the venture’s projected performance on that dimension (e.g., price to revenue multiplied by projected revenue). venture capital (VC) method a valuation method that estimates a venture’s value by projecting only a terminal flow to investors at the exit event Copyright 2021 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

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