26 - and there are a number of ways to estimate this value....

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For what kinds of investments would terminal value account for a substantial fraction of the total project NPV, and for what kinds of investments would terminal value be relatively unimportant? Some investments have a well-defined life span. The life span may be determined by the physical life of a piece of equipment, by the length of time until a patent expires, or by the period of time covered by a leasing or licensing agreement. Often, however, investments have an indefinite life. When managers invest in an asset with a long life span, they typically do not construct cash flow forecast more than 5 to 10 years into the future. One reason they give for this behavior is that forecasts more than 5 to 10 years in the future have so much error that the fine detail entailed in an item-by-item cash flow projection is not very meaningful. Instead, managers project detailed cash flow estimates for 5 to 10 years, then calculate a project’s terminal value as of some future date. The terminal value is a number intended to reflect the value of a project at a given future point in time,
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Unformatted text preview: and there are a number of ways to estimate this value. The terminal value can represent a large portion of the valuation. The terminal value of a piece of manufacturing equipment at the end of its useful life is its salvage value, typically less than 10% of the present value. In contrast, the terminal value associated with a business often is more than 50% of the total present value. For this reason, the terminal value calculation often is critical in performing a valuation. The terminal value can be calculated either based on the value if liquidated or based on the value of the firm as an ongoing concern. A high-quality estimate of terminal value is critical because it often accounts for a large percentage of the total value of the company in a discounted cash flow valuation. The higher the growth rate of cash flows, the higher is the terminal value of the project. A project where cash flows level off in time will have a much smaller terminal value....
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This note was uploaded on 10/15/2011 for the course FIN 550 taught by Professor Smith during the Spring '11 term at Berklee.

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