Estimating Terminal Values with Inflation: The Inputs Matter—It Is Not a Formulaic Exercise

Estimation of the terminal value of a business enterprise is a critical aspect of any corporate valuation. In a path-breaking article, Bradley and Jarrell showed that traditional constant growth methods for estimating the terminal value typically failed to deal properly with inflation. The premise underlying the Bradley-Jarrell analysis, namely, that inflation applies to a firm's capital stock in the same manner that it applies to other financial metrics, is straightforward. Unfortunately, the Bradley-Jarrell analysis is often misunderstood because of accounting issues that arise in its application and because of its apparent deviation from traditional formulas for plowback and growth. This article addresses those details. In doing so, we demonstrate how to handle the issues that arise when applying the Bradley-Jarrell model to GAAP-based financial statements or forecasts and we show how the Bradley-Jarrell approach can be reconciled with the traditional models.