Valuation of Public Companies: Estimating Terminal Value, Slides of Marketing Management

Download Valuation of Public Companies: Estimating Terminal Value and more Slides Marketing Management in PDF only on Docsity! Aswath Damodaran 166 IV. Closure in Valuation Discounted Cashflow Valuation Aswath Damodaran 167 Getting Closure in Valuation   A publicly traded firm potentially has an infinite life. The value is therefore the present value of cash flows forever.   Since we cannot estimate cash flows forever, we estimate cash flows for a “growth period” and then estimate a terminal value, to capture the value at the end of the period: Value = CFt (1+ r)tt = 1 t = ∞ ∑ Value = CFt (1 + r)t + Terminal Value (1 + r)Nt = 1 t = N ∑ Aswath Damodaran 170 Getting Terminal Value Right 2. Don’t wait too long… Assume that you are valuing a young, high growth firm with great potential, just after its initial public offering. How long would you set your high growth period?   < 5 years   5 years   10 years   >10 years What high growth period would you use for a larger firm with a proven track record of delivering growth in the past?   5 years   10 years   15 years   Longer Aswath Damodaran 171 Some evidence on growth at small firms…   While analysts routinely assume very long high growth periods (with substantial excess returns during the periods), the evidence suggests that they are much too optimistic. A study of revenue growth at firms that make IPOs in the years after the IPO shows the following: Aswath Damodaran 172 Don’t forget that growth has to be earned.. 3. Think about what your firm will earn as returns forever..   In the section on expected growth, we laid out the fundamental equation for growth: Growth rate = Reinvestment Rate * Return on invested capital + Growth rate from improved efficiency   In stable growth, you cannot count on efficiency delivering growth (why?) and you have to reinvest to deliver the growth rate that you have forecast. Consequently, your reinvestment rate in stable growth will be a function of your stable growth rate and what you believe the firm will earn as a return on capital in perpetuity: •  Reinvestment Rate = Stable growth rate/ Stable period Return on capital   A key issue in valuation is whether it okay to assume that firms can earn more than their cost of capital in perpetuity. There are some (McKinsey, for instance) who argue that the return on capital = cost of capital in stable growth…