Is it Time to Terminate the Traditional Terminal Value?

Abstract

All corporate valuation models rely on very long forecasts of free cash flows. The only question is whether those forecasts are accounted for explicitly by using an extended valuation model or implicitly in an estimate of the terminal value after an explicit short-term forecast period of five to ten years. Given current computing technology, there are good reasons to use projections running out multiple decades. Doing so gives a clearer picture of the long-run issues that affect a company's value. Of course, developing very long-term forecasts is difficult and may be considered speculative, but the difficulty and speculation are not removed by assuming that at a horizon of five or ten years the firm enters steady state and applying a constant growth terminal value model. A better approach in many circumstances may be to explicitly take account of the need for very long-term forecasts, raising the question: “Is it time to terminate the traditional terminal value?”