Estimating Continuing Value
There are two parts to the estimated value of a company based on future cash flows: (1) a portion of the value based on the initial, explicit forecast period, and (2) a portion of the value based on continuing performance beginning at the end of the explicit forecast period. The continuing value (CV) often exceeds half of the total estimated operating value, and when early years have negative cash flows, the continuing value can exceed the total estimated operating value. There are two formulas for estimating continuing value: (1) the discounted cash flow (DCF) formula and (2) the economic-profit formula. The DCF formula is:
Special considerations in estimating the inputs are that (1) NOPLAT should reflect an average level associated with the midpoint of the business cycle, (2) return on new invested capital (RONIC) should reflect realistic assumptions concerning the level of competition, (3) WACC should be based on a sustainable capital structure, and (4) g should be based on a long-term measure such as the consumption growth for the industry's products.
The economic-profit formula for continuing value is:
The length of the explicit forecast period does not affect the value of the company. There can be a difference between the return on new invested ...