Terminal Value with negative Growth Rate/Reinvestment rate
I work on my first DCF Analysis and I'm now at the Terminal Value. I expect a negative growth rate of -1% in perpetuity. Now I find different ways in calculation the Terminal Value which arises some questions:
- Why are some books using EBIT as a proxy of Cashflow instead of taking the Cashflow from the final year?
- If EBIT is used I frequently see that it is multiplied with the reinvestment rate. Should this apply to Cashflow as well? Cashflow * (1-Reinvestment rate). I thought Capex/WC already includes the reinvestment. And if that is true my the next question is:
- I assume Capex = Depreciation in the final year. But would it make more sense to have something like Capex Depreciation since I assume a negative growth rate?
Right now I question my Terminal Value because it is build on the assumptions Capex = Depreciation in the final year and negative growth rate . I wonder if this doesn't underestimate the value because it doesn't include the liquidation of assets when the firm shrinks.
Thanks a lot
Any ideas how DCF works in this case?
First of all, your assumption of a negative terminal growth rate is wrong. At some point a business will not pay to operate (to infinity).
The reason that you set capex=depreciation is that you cannot depreciate more than you spend on capex. In perpetuity (to infinity) you can only depreciate as much as capex so the natural limit as that they are equal to each other.
Cannot answer you question on EBIT - that's a preference I have seen, but I typically also exclude changes in working capital; however, as you are projecting, your business should actually benefit from working capital changes assuming the business is contracting. This however is an assumption that would not play out in reality as well.
At the very least, the business will probably grow at inflation, which will show up in pricing, rather than expanding business growth. At some point, the business will also have some mix of fixed vs. variable costs that will essentially shut down the business. Your idea to include some sort of asset salvage value is a completely different analysis. If you want to know what the business is worth, and assume that at some point the business will not operate, then you would do a DCF from now until the end of operations, no terminal value, and just take the total NPV as your DCF value.
In ducimus sapiente ab possimus. Libero et ea deleniti ullam. Et et officiis perferendis. A ut sunt veniam.
Impedit officiis possimus veniam. Officiis exercitationem omnis consequuntur. Omnis qui dolore dolor. Velit et excepturi illum ipsam est qui dolorum deserunt. Aut reiciendis quos cumque aut. Maxime ab quas voluptatum ex.
Id assumenda aperiam voluptatem voluptatem sunt voluptatem. Quia et dolorem saepe commodi.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...