SSE/EFI Working Paper Series in Business Administration
No 2000:7:
Terminal Value Techniques in Equity Valuation - Implications of the Steady State Assumption
Joakim Levin and Per M. Olsson ()
Abstract: This paper examines the conditions necessary for
calculating steady state terminal values in equity (company) valuation
models. We make explicit use of the fact that a company's income statements
and balance sheets can be modeled as a system of difference equations. From
these difference equations, we derive conditions for steady state. The
conditions ensure that the company remains qualitatively similar year by
year after the valuation horizon and that it has a stable development of
earnings, free cash flows, dividends and residual income. We show how
steady state condition violations cause internal inconsistencies in
valuation models and how this can have a substantial impact on the value
estimates. Steady state is further a necessary condition for a free cash
flow valuation, a dividend valuation and a residual income valuation to
yield identical results when terminal values are used. The parameters of
the model are common accounting and control concepts, and the derived
conditions have accounting meaning, linking stock variables in the balance
sheet with the flow variables in (and related to) the income statement.
Keywords: equity valuation; terminal value; financial statement analysis; (follow links to similar papers)
JEL-Codes: G12; G31; M49; (follow links to similar papers)
26 pages, June 30, 2000
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