SSE/EFI Working Paper Series in Business Administration
No 2011:5:
Value Driver Formulas for Continuing Value in the Discounted Cash Flow Model
L. Peter Jennergren ()
Abstract: The influential valuation book by an author team from
McKinsey recommends the socalled value driver formula rather than the
Gordon formula for the continuing value in the posthorizon period in the
discounted cash flow model for firm valuation. This recommendation has had
considerable impact on valuation practice. This paper points out two
weaknesses of the original value driver formula. The first weakness is that
it is not a significant extension of the Gordon formula. The only case
where it is applicable is where the requirement for working capital is not
the same for the future growth projects (that are started in the successive
years of the posthorizon period) as for the existing operations that are
in place already at the end of the explicit forecast period, a fairly
uninteresting case. In that case, the Gordon formula gives the same
valuation result, implying that the original value driver formula is not
necessary. The second weakness is that the split into existing operations
and growth projects that underlies the original value driver formula
implies that the existing operations are valued under the assumption of
zero inflation, which is unreasonable if inflation is actually positive.
This paper then derives a revised value driver formula that is a more
significant alternative to the Gordon formula. In the revised formula,
gross margins can differ between the existing operations and the growth
projects. The valuation of the existing operations takes into account
positive inflation. Continuing value is a sum of two separate value driver
formulas, one for the existing operations and one for the growth projects.
This means that most of the steadystate character of the posthorizon
period is retained. A comparison with the original value driver formula in
a representative setting indicates that the difference in resulting
continuing values can be nonnegligible.
Keywords: Valuation; free cash flow; discounting; continuing value; value driver formula; inflation; (follow links to similar papers)
14 pages, November 23, 2011, Revised May 30, 2012
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 This paper is published as:

Jennergren, L. Peter, (2013), 'Technical Note: Value Driver Formulas for Continuing Value in Firm Valuation by the Discounted Cash Flow Model', The Engineering Economist, Vol. 58, No. 1, pages 5970
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