TABLE OF CONTENTS Given a choice between two theories, take the one which is funnier.
Blore s Razor
Typically, the expected life of the firm or project is longer than the planning (or forecast) period of five to ten years. In fact, we assume unrealistically that the firm will last forever, even though we know that some firms do file for bankruptcy. In practice, on grounds of simplicity and based on the availability of historical data, for valuation purposes we construct the financial statements for only five to ten years. However, we do not want to disregard the value of the free cash flows (FCFs) that occur beyond the planning period. At the end of year N, which is the end of the planning period, we estimate a terminal value (TV) for the FCFs that occur beyond the planning (or forecast) period and add it to the FCF that occurs in year N.
In the previous chapters, we constructed nominal financial statements for five years and stated that we would postpone discussion on the calculation of the TV. In this chapter, we examine the issues that are related to the calculation of the TV.
In appendix D, we present the reconciliation of economic value added (EVA ), residual income (RI) and the discounted cash flow (DCF) methods discussed in Chapter Seven.
The chapter is organized as follows. First, we briefly discuss the TV, the transfer value, and the liquidation value. Second, we present the standard approach for estimating the TV. Third, we...
