Damodaran on Valuation

4.4. TERMINAL VALUE

Since we cannot estimate cash flows forever, we generally impose closure in discounted cash flow valuation by stopping our estimation of cash flows sometime in the future and then computing a terminal value that reflects the value of the firm at that point.

We can find the terminal value in one of three ways. One is to assume a liquidation of the firm's assets in the terminal year and estimate what others would pay for the assets that the firm has accumulated at that point. The other two approaches value the firm as a going concern at the time of the terminal value estimation. One applies a multiple to earnings, revenues, or book value to estimate the value in the terminal year. The other assumes that the cash flows of the firm will grow at a constant rate forever—a stable growth rate. With stable growth, the terminal value can be estimated using a perpetual growth model.

4.4.1. Liquidation Value

In some valuations, we can assume that the firm will cease operations at a point in time in the future and sell the assets it has accumulated to the highest bidders. The estimate that emerges is called a liquidation value. There are two ways in which the liquidation value can be estimated. One is to base it on the book value of the assets, adjusted for any inflation during the period. Thus, if the book value of assets 10 years from now is expected to be $2 billion, ...