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Corporate and Project Finance Modeling
book

Corporate and Project Finance Modeling

by Edward Bodmer
November 2014
Intermediate to advanced content levelIntermediate to advanced
624 pages
17h 11m
English
Wiley
Content preview from Corporate and Project Finance Modeling

Chapter 28Terminal Value and PhilosophyCompany Growth Rates and Overall Economic Growth

The necessity of computing terminal value in corporate models comes from the idea that corporations, unlike humans, are assumed to last indefinitely. This notion means that long-term forecasts of items such as earnings before interest, taxes, depreciation, and amortization growth, rate of return, and cost of capital cannot be avoided when valuing a company. Winston Churchill's commented: “It is always wise to look ahead, but difficult to look further than you can see” summarizes the fundamental problem when thinking about growth in a financial model. In forecasting cash flow, you cannot really see more than a few years into the future at the absolute furthest, which begs the question of how you can possibly make a reasonable forecast of growth, return on capital, and risk on an infinite basis.

Given this problem, the convention in valuation is to resort to a rather vague philosophical concept rather than to attempt to make a detailed forecast. Since valuation of a corporation requires some explicit or implicit assumption with respect to growth, you can begin by eliminating unreasonable assumptions. It does not make sense to assume that high growth rates can occur for long periods above the overall nominal growth rate in the economy. You can easily demonstrate that if a company grows by 10 percent above the growth rate in the economy, it will, in the not-too-distant future, take over the economy. ...

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Publisher Resources

ISBN: 9781118854365Purchase book