Universitt zu Kln

Corporate Finance III

Corporate Valuation Theory
I. Company Valuation
1.
2.
3.
3
4.
5.
6
6.

Overview
Multiples Approach
Discounted
scou ted Cas
Cash Flow
o Models
ode s
Residual Income Model
Relation between different models and Applicability
Application

II. Mergers & Acquisitions

7.
8.
9.
10
10.

M&A Activities
M&A-Activities
Explanations for M&A-Activities
Defense tactics against hostile takeovers
Value driver models

Seminar fr ABWL und

Unternehmensfinanzen
Prof Dr.
Prof.
Dr Dieter Hess

Introduction

Course material:

www.ilias.uni-koeln.de
(Corporate Valuation Theory)

Password:

Content:

Lecture Slides
Tutorials + Solutions
Previous Exams

Schedule (1/2)

Lectures ((Prof. Dr. Hess))

Tuesday, 12:00-13:30 & 14:00-15:30, Room XXIII

02 12 14 | 09
02.12.14
09.12.14
12 14 | 16
16.12.14
12 14 | 13
13.01.15
01 15 | 20
20.01.15
01 15 | 27
27.01.15
01 15

Tutorials (Niklas Blmke)

Thursday, 14:00-15:30 & 16:00-17:30, Room XXV

11.12.14 | 18.12.14 | 15.01.15 | 22.01.15 | 29.01.15 | 05.02.15

Note that there will be no lecture and no tutorial in the week after the winter
break. Moreover, the last lecture (03.02.15) is cancelled.

Schedule (2/2)

Roland Berger
g

TBA

Final Exam

The final will take place on the 23.02.15 (Monday), 14:00-15:00

Literature

Copeland,
p
Thomas E./Weston, John Fr./Shastri, Kuldeep:
p Financial Theory
y and
Corporate Policy, 4th Edt., New York, 2005.

Ross, Stephan A./Westerfield, Randolph W./Jaffe, Jeffrey F.: Corporate Finance,

7th Edt.,
Edt New
N
Y
York,
k 2005
2005.

Hess, Dieter/Homburg, Carsten/Lorenz, Michael/Sievers, Soenke: Extended

Dividend Cash Flow and Residual Income Valuation Models - Accounting for
Dividend,
Deviations from Ideal Conditions, forthcoming: Contemporary Accounting Research
2011, http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1145201

Koller, Tim/Goedhart, Marc/Wessels, David: Valuation: Measuring

and Managing the Value of Companies, 4th Edt., New York, 2005.

Damodaran, Aswath: Domodaran on Valuation, 2nd Edt., New Jersey, 2006.

1. Overview

I. Corporate Valuation
1. Overview
2.
3
3.
4.
5.
6
6.

Multiples
Discounted Cash Flow Models
Residual Income Model
Relation between different model versions and Applicability
A li ti
Application

Literature:

Copeland/Weston/Shastri (2005),
(2005) Ch
Ch. 14
Ross/Westerfield/Jaffe (2005), Ch. 17
6

1. Overview

Single Valuation Method

Total Valuation Method

Total value equals the value

of the individual parts

Enterprise value is only

based on ability to generate
Cash Flows

Tradeoff between Single

Valuation Method and Total
Valuation Method

Determination of the
enterprise value based on
expected (or current) profits

Valuation based on the

information gathered from
Single Valuation Method and
Total Valuation process

Determination of the
enterprise value based on
the individual assets of the
enterprise

Normally based on
performanceor Cash Flow measures

Net Asset Value Method

Under assumption of
going concern
Under assumption of
liquidation

Mixed Methods

Multiples

Stuttgart
Stuttgart Method

Dividend Discount Model

Economic Value Added

DCF-Models

Residual Income Valuation

Entity:
Entit
WACC,
WACC APV,
APV TCF
Equity: FTE
7

1. Overview
Multiples

Basic idea: A target

g company
p y is valued based on the current p
pricing
g of companies
p
with
similar characteristics (comparable company approach)

Example:

Price Earnings Ratio

P/E

stock market price (per share)

earnings (per share)

What is the fair enterprise value according the P/E ratio of the
peer group?
Net Income

Theory:

P/E

Company A

190 Mio.

2,166 Mrd.

11,4

Company B

860 Mio.

6,536 Mrd.

7,6

Target Company C

50 Mio.

----

Enterprise value based on P/E:

Market Cap.

A
Average:9,5
95

---

50 Mio. 9,5 = 475 Mio.

Justification based on DDM (under certain conditions)

8

1. Overview
Dividend Discount Model (DDM)

Basic model in financial theory

y

DDM can be interpreted as capitalized earnings method (Total Valuation)

The Dividend Discount Model states that the value of an enterprise is given by the
present value of all expected future dividends

E Dt
=
t
(1
+
k
)
t =1

V0

Discount rate: risk-adjusted

j
interest rate for expected
p
future Cash Flows = cost of equity
q y
considering the relevant risk ( rate of return equity holders require in the CAPM)

Common simplification: Expected dividend growth is constant

E D t D 0 (1 g) t

t
D

(1

g)
1 g
EQ 0M 0

D
0
t
(1

k)
kg
t 1

1. Overview
Discounted Cash Flow (DCF) models

Discounted Cash Flow ((DCF)) models are widely

y applied
pp
in p
practice

DCF models belong to the group of Total Valuation Methods: The enterprise value is
given by the present value of all expected future cash flows discounted by the
appropriate
app
op ate risk-adjusted
s adjusted interest
te est rate
ate

E CFt
=
t
t =1 (1 + k )

V0

The DCF models..

are similar to the DDM and focus on expected payoffs
use in contrast to the DDM different payoff definitions, i.e. (free/total/) cash flows

Equity approach:

Flow to Equity (FTE)

Entity approach:

Weighted Cost of Capital (WACC)

Adjusted
djusted Present
ese t Value
a ue ((APV))
Total Cash Flow (TCF)
10

1. Overview
The most important DCF models:

E CFt
=
t
t =1 (1 + k )

In general:

V0

V0

CFt

EQM

FTE

cost of equity (levered)

Weighted Average
Cost of Capital (WACC)

TCM

FCF

WACC (levered)

Adjusted
Present Value (APV)

TCM

FCF
tax shield

cost of equity (unlevered)

risk free rate

Equity approach
Flow to Equity (FTE)
Entity approaches:

11

1. Overview
Residual Income Valuation

Interesting
g theoretical model which is based on the idea of capital
p
value; a simplified
p
version in form of the EVA analysis is widely applied in practice

Idea:
Market price consists of:

current book value of assets

capitalized excess returns

EQ0

BV0

E (RI t )
(1 + k )t
t =1

with

RI t = NI t - k BVt -1

12

1. Overview
Diverse definitions of the enterprise value
Enterprise value
aggregated market
price of equity and
debt

VL

Market price of
debt

Market price of
debt

Enterprise value

Debt

Debt

Market price of
equity

Market price of
equity

assuming partial
debt financing

excluding present
value of tax savings

VE

Present value of
tax savings

Present value of
tax savings

TS

TS

Assuming a fictive
pure equity
financing

EQ

13

2. Multiples

I. Corporate Valuation
1. Fundamentals
2. Multiples
2 1 Overview
2.1.
O
i
2.2. Valuation based on multiples
2.3. Theoretical foundation
3.
4.
5.
6.

Discounted Cash Flow Models

Residual Income Models
Relation between different model versions and Applicability
Applicability

Literature:

Copeland/Weston/Shastri (2005),
(2005) Ch.
Ch 14

14

2.1. Overview

Idea:
T
Target
t company is
i valued
l db
based
d on th
the currentt pricing
i i off companies
i with
ith similar
i il
characteristics (comparable company approach)
Financial data which is related to the companys future profitability (or data
with a stable relation to profits, Cash Flows) is primarily used

15

2.1. Overview

Comparison approaches

Comparable Company Approach

Other comparison methods

(usually stock market orientation)

(usually no stock market orientation)

Similar Public Company Method

Share price in relation to certain key

financial data of an enterprise

Recent Acquisition Method

Prices of recent public transactions in
relation to certain key data of an
enterprise

Quantitative Orientated Methods

e.g.
e
g valuation of a taxi company
based on the number of taxi licenses

Sales Method
e.g.
e
g determination of the corporate
value based on sales

(Multiples)

16

2.2. Valuation based on multiples

Basic procedure:
1. Selection of a p
peer g
group:
p
Preferably many companies with similar characteristics
(Especially concerning the value generating factors, e.g. profit growth, operative risk,
leverage,
e e age, ))
2. Calculation of certain multiples for the peer group companies:
Multiple

Market value
Comparison value

Calculation of the average multiple for the peer group

(alternative: median, trimmed mean)
3.

Application of average multiple to target company

Market value Average multiple Comparison value
17

2.2. Valuation based on multiples

In practice multiples are based on a lot of various key figures, e.g.

Profit (with different definitions)

C h Fl
Cash
Flows ((with
ith diff
differentt d
definitions)
fi iti
)

Sales figures

Sometimes (especially in hot markets) even economically questionable figures are

used e
e.g.
g

Number of customers, number of sold licenses,

Click rate,

Furthermore, it is important to distinguish whether the applied market value is

an enterprise
t
i value
l (t
(total
t l value
l off enterprise
t
i = EQM + Debt
D btM) or

an equity value (market value of equity = EQM).

18

2.2. Valuation based on multiples

The definition of specific multiples can vary strongly

e.g. def. of earnings for PER:

most recent annual earnings,

expected
t d earnings
i
ffor currentt year,
sum of last four quarterly earnings,
earnings
ea
gs including/excluding
c ud g/e c ud g e
extraordinary
t ao d a y p
profit,
o t,

The first step when discussing a valuation based on a multiple is to ensure

that everyone in the discussion is using the same definition for that multiple.
19

2.2. Valuation based on multiples

Multiples based on entity value

Multiples based on equity value

(Enterprise / Entity(EnterpriseEntity / Asset-Value-Multiples)

Asset Value Multiples)

(E it M lti l )
(Equity-Multiples)

applied market prices:

Applied market values:

Entity value
(aggregated market price of equity and
debt)
non-operating
non operating assets
= Enterprise value
(Market value of operating business
activity)
applied reference value :
should be generated by total capital, e.g.
sales EBIT(DA)
sales,
EBIT(DA), Operating Cash Flow
Flow,
EntV
EBITDA

EntV
EBIT

EntV
OpFCF

EntV
Sales

Equity value
(market capitalization)
applied reference value:
should be related to equity (e.g. earnings,
EBT, equity book value, FTE, )
Price
Equity book value / Share

Price
Earnings / Share

However, also multiples using total capital

based denominator and equity based
numerator, e.g.
Market capitalization
Sales
20

2.2. Valuation based on multiples

Practical problems for the application of multiples:
((1)) Extreme values / negative
g
values
Multiples are not available for companies with negative earnings and not
meaningful for companies with near-zero earnings
Solution approach:
Constraining the peer group
Elimination of companies with extreme / not meaningful multiples by using only values
within a certain range
Problematic,
Problematic because the boundaries of the chosen range is arbitrary
Better: Use of robust statistical techniques (e.g. median, trimmed mean, )
Robust regression ( CF IV)

21

2.2. Valuation based on multiples

(2) Small number of peers
Only a very small number of peers is available ( very small peer group)
Consequently
C
tl th
the calculated
l l t d average multiple
lti l is
i nott very reliable
li bl
(single peers have a big impact on calculated multiple)
Solution approach:
Inclusion of less similar enterprises and subjective adjustment of calculated multiples
Questionable
Questionable, because these adjustments are based on the personal
personal
experience of the analyst
Usage of multiple regression ( CF IV)
established
t bli h d ((approved
d statistical
t ti ti l ttool)
l) which
hi h iis more powerful
f l ((enables
bl
simultaneous correction of several independent variables)

22

2.3. Theoretical foundation of multiples

The value of an enterprise is regardless of the selected valuation method especially

influenced by

its ability to generate Cash Flows

the growth rate and risk of these Cash Flows

Therefore, the selection of a certain multiple should be based on a model:

-

Price Earnings Ratio

DDM, DCF

Price to Cash Flow Ratio

DDM DCF
DDM,

Price to Sales Ratio

DDM, DCF

Life-time-Customer-Value
(Price to customer Ratio)

???

The application of innovative multiples is not in general recommended

23

2.3. Theoretical foundation of multiples

Theoretical foundation of P/E ratio

P/E ratio:

P
PERt t
NIt

with Pt
NIt

market price per share

net income per share

DDM:

Dt
pt NIt
P0

L t
L t
t 1 (1 k )
t 1 (1 k )

with Dt

dividend per share

pt

payout
p
y
ratio

growth rate of earnings

kL

risk adjusted interest rate

24

2.3. Theoretical foundation of multiples

Assuming that both dt and g are constant, we get

P0 p NI0

1 g
kL g

P0
1 g
PER0 p L
NI0
k g

Hence, the P/E ratio depends on

the (expected) growth rate of earnings

the (expected) company risk (kL , L respectively)

the (expected) payout ratio

25

2.3. Theoretical foundation of multiples

Example P/E ratio

The P/E ratio represents

p
the relationship
p between the current p
price p
per share and the
current earnings per share:

PER t

P0
NI0

Assuming that the company maintains a certain dividend payout ratio pt (i.e. Dt = pt NIt)
gives the connection to the DDM:
profits
with constant p

1
P0 p t NI0 L ,
k

or at constant
profit growth

P0 p t NI0

1 g
,
L
k g

1
PER p t L
k

PER p t

1 g
kL g

26

2.3. Theoretical foundation of multiples

Hence, the P/E ratio primarily depends on

PER

P0
1 g
pt L
NI0
k g

The growth rate of the net dividend stream (~ Cash Flow to Equity, FTE), more
specifically the growth of profits in conjunction with the payout ratio, and the riskadjusted return requirement (in consideration of operational and debt risk)

A company
p y valuation based on this multiple
p only
y makes sense if the p
peer g
group
p has
very similar growth and risk characteristics
Caution: Even when applying an industry P/E ratio it is questionable whether the
company is actually comparable to the industry with respect to all value-determining
factors (especially: growth, distribution, operational risk, debt).

27

2.3. Theoretical foundation of multiples

Theoretical foundation of multiples (contd.)

P/E ratio:

PER0

P0
1 g

p L
NI0
k g

Price to sales ratio:

S b tit ti
Substituting
NI0 PM0 S0 into
i t P/E ratio
ti
P0
P0
1 g

p L
NI0
pm0 S0
k g
yields
P0
1 g
pm0 p L
S0
k g

with NIt

net income per share

pmt profit margin on sales

St

sales per share

28

2.3. Theoretical foundation of multiples

Theoretical Foundation of multiples (contd.)

Price to book ratio:

Substitute NI0 RoE0 BV0 into P/E ratio

P0
P0
1 g

p L
NI0
RoE0 BV0
k g
Assume RoE1 (1 g )RoE0

P0
1 g
RoE0 p L
BV0
k g
P0
RoE
p L 1
BV0
k g

Recall g (1 p ) RoE1 and rearrange this to RoE1 p RoE1 g

Price book ratio:

P0
RoE
R
E1 g

BV0
kL g

with BVt book value of equity

RoEt return on equity
29

2.4. Summary
Valuation based on multiples is widely applied in practice
Advantages:

Multiples are easy to apply and deliver quick results

Multiples require only few and easily available data (market prices and company
data are usually easy to find), the calculation is less complex compared to other
valuation methods

Easy to understand and to communicate

Concept is (seemingly) easy to understand for clients, press
and by comparison easy to communicate

Close to market valuation

Valuation based on current market prices reflecting how the market prices similar
assets

30

2.4. Summary
Disadvantages / error sources:

It is important
p
to have a p
precise definition of the multiple
p
Multiples with identical names can be defined differently

Multiples represent rudimentary application of statistical procedures

Procedure
P
d
comparable
bl tto simple
i l lilinear regression
i ((sometimes
ti
questionable
ti
bl sample
l
selection); consistent application of regression analysis is advantageous

Difficult to select appropriate peers, i.e. truly comparable firms

especially if peers differ regarding value generating factors (growth, risk)

One-dimensionally comparison
Valuation is based on one single corporate key financial
(e.g. EBIT or sales)

Relative valuation with multiples is problematically if the market or peer group is

overvalued
l d as a whole
h l
Self-reinforcing effect in hot markets

31

3. Discounted Cash Flow Models

I. Corporate Valuation
1. Fundamentals
2. Multiples
3 Di
3.
Discounted
t dC
Cash
h Fl
Flow M
Models
d l
3.1. Key elements of valuation
3.1.1. Determination of the relevant Cash Flow
3.1.2. Determination of the cost of capital
3.2. DCF-versions
3.3. Circularity problem
4. Residual Income Model
5. Relation between different model versions and Applicability
6 Applicability
6.

Literature:

Copeland/Weston/Shastri (2005),
(2005) Ch
Ch. 15
Ross/Westerfield/Jaffe, (2005), Ch. 17
Damodaran (2002), Ch. 17, 18, 19

32

3.1. Key elements of Valuation

The basic form for all valuation models is the present value:
Present value:

V0 =

E ( Xt )

((1 + k )t
t =1

Inputs:
1.

Estimating the expected, uncertain "payment flow" (or a different income figure) of a
company Xt

2.

Determination of the relevant risk-adjusted

j
rate of return k the investors require
q

Caution: The numbers in numerator and denominator have to fit together

33

3.1.1. Determination of the relevant Cash Flow

Cash Flow forecasts

To forecast future Cash Flows ((for DCF models),

) earnings,
g different methods are
used

(long-term) financial planning models

Bilanz 20X0

Planbilanz 20X1

...

Planbilanz 20X2

Anlagevermgen
Gebude
XX
Anlagen
XXXX
Umlaufvermgen
Vorrte
XXX
Liquide Mittel
XX

Eigenkapital
Grundkapital XXX
Rcklagen
XXX
Fremdkapital
Verb. L&L
XXX
Langfr. Verb. XXXX

Anlagevermgen
Gebude
XX
Anlagen
XXXX
Umlaufvermgen
Vorrte
XXX
Liquide Mittel
XX

Eigenkapital
Grundkapital XXX
Rcklagen
XXX
Fremdkapital
Verb. L&L
XXX
Langfr. Verb. XXXX

Anlagevermgen
Gebude
XX
Anlagen
XXXX
Umlaufvermgen
Vorrte
XXX
Liquide Mittel
XX

Eigenkapital
Grundkapital XXX
Rcklagen
XXX
Fremdkapital
Verb. L&L
XXX
Langfr. Verb. XXXX

XXXX

XXXX

XXXX

XXXX

XXXX

XXXX

GuV 20X0
Material
Lhne
Abschreibungen
J

Plan-GuV 20X2

Plan-GuV 20X1

XX
XX
XXX
XX

Umsatz
XXXX
Sonst. Ertrge
X

XXXX

XXXX

Cash Flow 20X0

Material
Lhne
Abschreibungen
J

XX
XX
XXX
XX
XXXX

Umsatz
Sonst. Ertrge

XXXX
X

XXXX

erwart. Cash Flow 20X1

Value driver models

Econometric models(e.g. time series analysis)

Material
Lhne
Abschreibungen
J

XX
XX
XXX
XX

Umsatz
XXXX
Sonst. Ertrge
X

XXXX

XXXX

erw. Cash Flow 20X2

...

...

34

3.1.1. Determination of the relevant Cash Flow

Deposits and payments can be forecasted using time series analysis models
Ongoing
g g deposits
p
in p
period t
ongoing payments in period t
= Cash Flow of period t
alternatively their single components can be forecasted separately
(e.g. sales, personnel-, material cost, , tax payments, )

Problem: Common components/ trends in single time series

35

3.1.1. Determination of the relevant Cash Flow

Common developments of single time series are being captured ideally by financial
planning models; that is, by considering relations resulting from financial reporting

Consistent Cash Flow forecasts can be derived based on projected balance sheets and
projected income statements

To do so, Cash Flow schemes are used. A simplified scheme for indirect Cash Flow
calculation can be found on the next slide:

36

3.1.1. Determination of the relevant Cash Flow

Indirect Cash Flow scheme (simplified)
Net Income
+ actually paid interest
+ actually paid taxes
= Earnings before interest and taxes (EBIT)

(a)

tax on EBIT (theoretical tax at 100% equity-financing)

+ depreciation and other non
non-cash
cash expenditures
(b)
Investments in tangible/intangible assets and WC
(c),(d)
= Free Cash Flow (FCF)

Gross Cash Flow

((theoretical 100% equity-financing)
q y
g)

+ tax savings due to debt-deductible interest

= Total Cash Flow (TCF)

Gross Cash Flow

(considers actual debt financing)

interest and debt repurchases/debt issuance

= Flow to Equity (FTE)

Net Cash Flow

(considers actual debt financing)

37

3.1.1. Determination of the relevant Cash Flow

Comments on selected items of the Cash Flow scheme
((a)) Cost of Debt:

only explicit interest; it is sometimes proposed to take implicit interest into account

(b) non-cash expenditures:

D
Depreciation
i ti (income
(i
statement)
t t
t)

Additions to provisions (change in balance sheet, explanation of inc. statement)

non-cash income:

Attributions (income statement)

Release of provisions (change in balance sheet, explanation of inc. statement)

(c) Investment payouts:

Investments in financial and fixed assets

Investments in intangible assets

(d) Decrease/increase in working capital [including cash]

Inventories + accounts receivables + securities [+ cash] + advance payments payments

t received
i d - accounts
t payables
bl
38

3.1.1. Determination of the relevant Cash Flow

Annotation on the term Investment in the context of cash flow determination

Net investment exclusivelyy includes expansionp

or new investments

Gross investment include

R l
Replacement
t iinvestments
t
t (according
(
di tto th
the depreciation
d
i ti amounts)
t ) and
d

Expansion- or new investments (=net investment)

Definition: Gross investment = net investment + depreciation

By using perpetual annuities it is assumed that net investment = 0. Therefore,

replacement investment equals depreciation

39

3.1.1. Determination of the relevant Cash Flow

Detailed indirect Cash Flow scheme (DRS 2)
Result of the period (including earnings share of minority interests) before extraordinary items (
Net income +/- extraordinary expenses/income)

1.
2.

+/-

Depreciation and amortization of fixed assets

3.

+/-

Increase / decrease in provisions

4.

+/-

Other non-cash expenses / income (e.g. depreciation on an activated discount)

5.

-/+

Profit/loss on disposal of fixed assets

6.

-/+

Increase / decrease in inventories, accounts receivables and other assets not assignable to
investing or financing activities

7.

+/-

Increase / decrease in accounts payables and other liabilities not attributable to investing or
g activities
financing

8.

+/-

Payments from extraordinary items

9.

Cash Flow from operating activities

40

3.1.1. Determination of the relevant Cash Flow

Detailed indirect Cash Flow scheme (continued)
10.,12.,14.

Proceeds from disposal of tangible fixed assets, intangible assets, financial assets

11.,13.,15
.

Payments for investments in tangible fixed assets, intangible assets, financial assets

16.

Proceeds from the sale of consolidated companies and other business units

17.

Payments for the acquisition of consolidated companies and other business units

18.

Proceeds from financial assets as part of short-term financial planning

19
19.

Payments for financial investments as part of short-term

short term financial planning

20.

Cash Flow from investing activities

21.

Proceeds from allocations to equity (capital increases, sale of treasury shares, etc.)

22.

Payments to company owners and minority shareholders (dividends, purchase of treasury

shares, equity repayments, other payouts)

23.

Proceeds from issuance of bonds and of (financial) loans

24.

Payments of loans and (financial) loans

25.

Cash Flow from financing acticities

26.

Change in cash funds from cash-relevant transactions (sum of figures 9, 20, 25)

41

3.1.1. Determination of the relevant Cash Flow

Determination of FCF, FTE on basis of DRS 2 Cash Flow calculation
Cash Flow from operating activities

DRS 2,, Pos. 9

+ paid interest (to the extent shown in the operating activites)

+ paid taxes
= Operating cash flow before interest and taxes
+ Cash Flow from investing activities

DRS 2, Pos. 20

- theoretical tax charge at 100% equity-financing (EBIT sK)

+/ decrease/increase liquid funds
+/-

DRS 2
2, Pos
Pos. 26

= Free Cash Flow (FCFt)

+ tax savings of pro rata debt
= Total Cash Flow (TCFt)
- paid interest
+ Proceeds from issuance of bonds and of (financial) loans

DRS 2
2, Pos
Pos. 23

- Payments of loans and (financial) loans

DRS 2, Pos. 24

= Flow to Equity (FTEt) = Net Cash Flow (NCFt)

42

3.1.1. Determination of the relevant Cash Flow

Phase models

Keyy q
question: How to p
predict cash flows for an infinite p
planning
g horizon?

Simplification: Breakdown of the forecast horizon in 2 (or more) periods (phases)

Phase 1: Detailed phase

Phase 2: Terminal Value phase

Expected
p
Cash Flows for seperate
p
periods
p

Expectation:
p
sustainable Cash Flow g
growth

...
1

Individual forecasts of cash flows

for the next n periods (e
(e.g.
g financial
planning)

Estimation of a balanced (sustainable)

growth rate of the Cash Flows (eternally
growing or constant perpetual
annuity)

43

3.1.1. Determination of the relevant Cash Flow

Value contribution of the different phases:

V0

CFt

(1 + k )t

t =1
T

CFt

(1 + k )t

CFt

(1 + k )t

t =T +1

t =1
T

CFT (1 + g )t -T

t =1

Value
a ue co
contribution
bu o o
of the
e
detailed planning phase

1
(1 + k )T
CFT

(1 + k )t

t =1

CFT (1 + g )t
(1 + k )t

1+g
1
k - g (1 + k )T

Value contribution of the

Terminal Value phase

44

3.1.1. Determination of the relevant Cash Flow

"Terminal Value problem:

The length
g of the detailed p
phase determines the relative value contribution of the
individual phases

The shorter the first phase:

the smaller the contribution of the detailed planning phase to the corporate value
the higher the contribution of the terminal value phase which is based on imprecise
growth assumptions

Detailed phase
phase, usually 3
3-5
5 years;
most of the companys value is based on the Terminal Value (often 80-90%, depending
on g and k)

45

3.1.1. Determination of the relevant Cash Flow

Terminal Value is very sensitive with respect to the growth assumption

E
Example:
l

CFT = 1,
1 k = 10%

g sshould
ou d reflect
e ect tthe
e long-term
o g te growth
g o t rate
ate o
of tthe
e eco
economy
o y (o
(or industry
dust y secto
sector))

46