Valuation of a Firm

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Posted by Bob on October 30, 1999 at 08:45:17:

The proper figure for applying a multiple to determine the terminal value depends on the model and the entity being evaluated. The models are quite flexible in the items to which they can be applied as long as all input items are consistent. In the case of a model of FCFF, however defined, the consistent method is to apply a multiple to that FCFF as defined in each case. Thus FCFF would be combined with a multiple called Price-to-FCFF, FCFE with a multiple called Price-to-FCFE, etc.

If a model with an infinite investment time horizon is used, then there is no terminal value because a perpetuity has no terminus. Therefore, the issue of a multiple to be applied to a terminal value is moot.

When using a model of finite holding period, the terminal value would be discounted back to the present.

To be consistent in the case of the valuation of a firm, as opposed to the valuation of only the equity in a firm, the discount rate could be equal to the firm's historical weighted average cost of capital. This is a valuation from the firm's perspective.

A valuation from the investor's perspective is different. If the company offers the better investment opportunity set (future capital expenditure projects), then the investor could use the firm's expected cost of equity. Alternatively, if the investor has access to a superior investment opportunity set for the amount of funds to be invested, then the investor's opportunity cost of capital or hurdle rate of return could be used as the appropriate discount rate.

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