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Chapter 10

Chapter 10 - Instructors Please do not post raw PowerPoint...

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Click to edit Master subtitle style Chapter 10 Forecasting Performance: Continuing Value Instructors: Please do not post raw PowerPoint files on public website. Thank you! 11

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22 To estimate a company’s value, we separate a company’s expected cash flow into two periods and define the company’s value as follows: The second term is the continuing value: the value of the company’s expected cash flow beyond the explicit forecast period . Present Value of Cash Flow during Explicit Forecast Period Present Value of Cash Flow after Explicit Forecast Period + Value = Explicit Forecast Period Continuing Value Continuing Value Home Depot: Estimated Free Cash Flow 0 2, 0 0 0 4, 0 0 0 6, 0 0 0 8, 0 0 0 10, 00 0 12, 00 0 2 0 0 4 2 0 0 5 2 0 0 6 2 0 0 7 2 0 0 8 2 0 0 9 2 0 1 0 2 0 1 1 2 0 1 2 2 0 1 3 2 0 1 4 2 0 1 5 2 0 1 6 2 0 1 7 2 0 1 8 2 0 1 9 \$ milli on
33 Session Overview In this session, we will… 1. Introduce alternative approaches and specific formulas for estimating continuing value. Although many continuing-value models exist, we prefer the key value driver (KVD) model, which explicitly ties cash flow to ROIC and growth. 2. Examine the subtleties of continuing value. There are many misconceptions about continuing value. For instance, a large continuing value does not necessarily imply aggressive assumptions about long-run performance. 3. Discuss potential implementation pitfalls. The most common error associated with continuing value is naive base-year extrapolation. Always check that the base-year cash flow is estimated consistently with long-term projections about growth.

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LAN-ZWB887- 44 Approaches to Continuing Value Recommended Approaches: 1. Key value driver (KVD) formula. The key value driver formula is superior to alternative methodologies because it is cash flow based and links cash flow to growth and ROIC. 2. Economic-profit model. The economic-profit model leads to results consistent with the KVD formula, but explicitly highlights expected value creation in the continuing-value (CV) period. Other Methods: •. Liquidation value and replacement cost. Liquidation values and replacement costs are usually far different from the value of the company as a going concern. In a growing, profitable industry, a company’s liquidation value is probably well below the going-concern value. •. Exit multiples (such as P/E and EV/EBITA). A multiples approach assumes that a company will be worth some multiple of future earnings or book value in the continuing period. But multiples from today’s industry can be misleading. Industry economics will change over time and so will their multiples!
55 1. Key Value Driver Formula The continuing value is measured at time t (not today), and thus will need to be discounted back t years to compute its present value. Although many continuing-value models exist, we prefer the key value driver (KVD) model . The key value driver formula is superior to alternative methodologies because it is cash flow based and links cash flow to growth and ROIC .

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Chapter 10 - Instructors Please do not post raw PowerPoint...

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