Chapter 11Discounting Cash Flows and Terminal Value

The discount of explicit cash flows year by year and of the terminal value is the most popular technique used by analysts in the international financial community.

When using this approach, two common issues should typically be dealt with:

  1. The identification of the time horizon for the explicit projections of cash flow;
  2. The appropriate methods used to estimate the terminal value.

11.1 EXPLICIT PROJECTIONS

The time horizon of cash flow projections should satisfy various requirements, and in particular:

  • Show the cash flow dynamics linked to time periods characterized by financial restructuring of business concerns.
  • Show the cash flow dynamics linked to extraordinary investment cycles.
  • Analyze growth phases because of competitive imbalances.
  • Describe performance dynamics in industries characterized by cyclical trends.

Finally, when the project's duration is tied to the availability of irreplaceable resources, renewals, or concession contracts, the time horizon can correspond to the exhaustion of these resources or the maturity of concession contracts.

We reported that, according to international practice, the length of the explicit projection period varies from 7 to 10 years in low-capital-intensive sectors and extends up to 10 to 15 years in industries whose specific assets tend to have an extremely long economic and technical life (e.g., hydroelectric, petrochemical and steel plants, etc.).

Therefore, analysts usually begin ...

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