Terminal Value

Question 1

Long term growth rate

Answer 1

expected real interest rate = LT bond yield

Question 2

Retention ratio

Answer 2

Expected growth rate/Return on equity

Therefore:Expected Growth Rate=Retention RatioX ROE

Question 3

Equity reinvestment rate(FCFE)

Answer 3

Expected growth rate/Return on equity

Therefore:Expected growth Rate=Equity Reinvestment X ROE

Question 4

Reinvestment Rate in stable growth (FCFF)

Answer 4

Stable growth rate/ Stable period Return on capital

Therefore Expected growth rate = Reinvestment Rate X ROC

Question 5

Terminal value_n

Answer 5

Free cash flow to firm _n+1 /(Cost of capital_n+1−g_n)

gn=Reinvestment rate X return on capital

Question 6

TV for FCFE

Answer 6

EBIT (1-t) (1- g/ROE)/ (Cost of equity –g)

g-Expected growth rate

ROE-Return on Equity

Question 7

TV for FCFF

Answer 7

EBIT (1-t) (1- g/ROC)/ (Cost of capital –g)

g-Stable growth rate

ROC-Stable period of ROC

Question 8

Liquidation Value Approach

Answer 8

Book Value of Asset X (1+inflation)^{average life of assets}

Note: BV may not be accurate hence use Cashflow after tax cashflow

Question 9

Terminal Value _ROC=WACC

Answer 9

EBIT _n+1(1-T)Cost of Capital _n

Use this when WACC=ROC means you assume company has no comparable advantage in long run.

Question 10

3 Factors to consider when looking at growth rate

Answer 10

1. Size of the firm
2. Existing Growth Rate
3. Magnitude and sustainability of competitive advantages

Question 11

What factor contribute to excess return over long period?

Answer 11

STRONG BRAND NAME

Think P&G

Question 12

Adjusted Value for Survival (For younger and small firms)

Answer 12

Adjusted value =Discounted cash flow value(1−Probability of distress) +Distressed sale value(Probability of distress)

Question 13

Cash burn ratio(measure of potential cashflow problem)

Answer 13

Cash balance/EBITDA