revenues in that year. For instance, a firm with expected
revenues of $6 billion 10 years from now will have an
estimated terminal value in that year of $12 billion if a
value-to-salesmultipleof 2 isused.Ifvaluingequity,weuse
equitymultiplessuchasprice-earningsratiostoarriveatthe
terminal value.
Although this approach has the virtue of simplicity, the
multiplehasahugeeffectonthefinalvalue,andwhereitis
obtained canbe critical. If,as is common,the multiple is
estimatedbylookingathowcomparablefirmsinthebusiness
today are priced by the market, the valuation becomes a
relative valuation rather than a discounted cash flow
valuation.Ifthemultipleisestimatedusingfundamentals,it
convergesonthestablegrowthmodelthatwillbedescribed
in the next section.
Allin all,usingmultiplesto estimateterminalvalue,when
thosemultiplesareestimatedfromcomparablefirms,results
in a dangerous mix of relative and discounted cash flow
valuation.While thereareadvantages to relativevaluation,
andwewillconsidertheseinChapter7,adiscountedcash
flow valuation should provide you with an estimate of
intrinsic value, not relative value. Consequently, the only
consistentwayofestimatingterminalvalueina discounted
cashflowmodelistouseeitheraliquidationvalueorastable
growth model.
Stable Growth Model
Intheliquidationvalueapproach,weareassumingthatyour
firmhasafinitelifeandthatitwillbeliquidatedattheendof
that life. Firms, however, can reinvest some of their cash