Chapter 7: Business Valuation Decisions

How much is my company worth?

The valuation of a business is based on its expected future cash flows. It is affected by the financial relationships found in the most recent period of activity, which can be used to extrapolate results into the future (since the best predictor of tomorrow is what happened today). In developing a valuation model, forecast assumptions are made for sales growth and a cost relating to the source of financing – typically for a 5 to 10-year period.

Business valuation models are like capital budgeting exercises in that they use discounted net cash flows to arrive at a present value. However, because it is assumed that an enterprise is a going concern, it is not expected that the forecast assumptions will hold into the future and for this reason a terminal value – which occurs at the end of the forecast period – is required. The terminal value represents the present value of an annuity which is paid forever (i.e., in perpetuity). This annual amount is based on the cash flow in the final year of the forecast period, adjusted for an assumed growth rate.