period (usually specified to be an extraordinary growth
period)andaterminalvalueattheendoftheperiod.While
wewilllook atalternativeapproaches, themost consistent
wayofestimatingterminalvalueina discountedcash flow
model is to assume thatcash flowswill grow ata stable
growthratethatcanbesustainedforeveraftertheterminal
year.In general terms,thevalue ofa firmthat expectsto
sustain extraordinary growth fornyears can be written as:
Inkeepingwith thedistinctionbetweenvaluingequityand
valuingthebusinessthatwemadeinthepreviouschapters,
wecanvalueequityinafirmbydiscountingexpectedcash
flowstoequityandtheterminalvalueofequityatthecostof
equity or we can value the entire firm by discounting
expectedcashflowstothefirmandtheterminalvalueofthe
firm at the cost of capital.
Therearethree componentsto forecastingcash flows.The
first istodetermine thelength oftheextraordinarygrowth
period;differentfirms,dependingonwheretheystandintheir
lifecyclesandthecompetitiontheyface,willhavedifferent
growth periods. The second is estimating the cash flows
during thehigh-growth period, usingthe measuresofcash
flowswederivedin thepreceding chapter.Thethirdisthe
terminal value calculation, which should be based on the
expected path of cash flows after the terminal year.
LENGTH OF EXTRAORDINARY GROWTH PERIOD