A Life Cycle Model of Firm Value

Abstract

Most business valuation formulas are designed for profitable firms experiencing constant growth, even though in practice firms tend to transition from loss-making, high-growth startups to mature, stable enterprises. This paper introduces a life-cycle valuation model that accommodates this evolution in growth and profitability by treating investment expenditures and revenues as a function of firm age. The model’s predictions regarding the time dynamics of common valuation multiples and financial ratios align well with observed financial data. The life cycle model can be estimated at the firm level from a few basic accounting variables and delivers estimates both of firm value and of the firm’s cost of capital. Firm value estimates show a log-correlation with observed stock market values of more than 90 percent.