Valuation: Measuring and Managing the Value of Companies, Fifth Edition

10

Estimating Continuing Value

As described in Chapter 6, continuing value (CV) provides a useful method for simplifying company valuations. To estimate a company’s value, separate a company’s 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 the explicit forecast period. Making simplifying assumptions about the company’s performance during this period (e.g., assuming a constant rate of growth and return on capital) allows you to estimate continuing value by using formulas instead of explicitly forecasting and discounting cash flows over an extended period.

A thoughtful estimate of continuing value is essential to any valuation, because continuing value often accounts for a large percentage of a company’s total value. Exhibit 10.1 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 that should generate ...