Valuation, 7th Edition

14Estimating Continuing Value

A thoughtful estimate of continuing value is essential to any company valuation. It serves as a useful method for simplifying the valuation process while still incorporating solid economic principles. To estimate a company’s value, separate the forecast of expected cash flow into two periods and define the company’s value as follows:

The second term is the continuing value: the value of the company’s expected cash flow beyond an explicit forecast period. By deliberately making some simple assumptions about the company’s performance during this second period—for example, assuming a constant rate of growth and return on capital—you can estimate continuing value by using formulas instead of explicitly forecasting and discounting cash flows over an extended period.

Continuing value often accounts for a large percentage of a company’s total value. Exhibit 14.1 shows continuing value as a percentage of total value for companies in four industries, given an eight-year explicit forecast. In these examples, continuing value accounts for 56 percent to 125 percent of total value. These large percentages do not necessarily mean that most of a company’s value will be created in the continuing-value period. Often, continuing value is large because profits and other inflows in the early years are offset by outflows for capital spending and working-capital investment—investments ...