How do you decide which approach to use to estimate terminal value?



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How do you decide which approach to use to estimate terminal value?


2 Answer(s)


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Of the three approaches, the one that is least defensible is the use of a multiple to estimate terminal value. Since this multiple comes from looking at how comparable companies trade in the market, it effectively converts the discounted cashflow valuation into a relative valuation. Liquidation value, which in practice often becomes equated with book value, and terminal value, which comes from assuming a stable growth rate forever, will converge if we assume that the firm makes no excess returns in perpetuity. If you do assume that a firm can make excess returns in perpetuity, liquidation value will generally yield a more conservative estimate of value than the stable growth model.

If you are valuing a private company where you are uncomfortable assuming that the firm will be a going concern forever, liquidation value is the more sensible choice. If you are valuing a publicly traded company with significant competitive advantages and potential excess returns, it is best to stick with a going concern assumption and value the firm assuming a constant growth rate forever.

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I think the best approach to estimating Terminal Value is to assume a liquidation of the Firm's assets in the terminal year and estimate what others would pay for the assets that the firm has accumulated at that point.