<abstract xmlns="http://www.w3.org/1999/xhtml"><p>The paper presents an empirical verification of the main assumptions underlying the calculation of terminal value in DCF valuation models. The test results suggest that the volatility of free cash flows and the dynamism of the operating environment do not allow us to make a reliable long-term forecast of value creation potential of the public companies in Poland. Regardless of their organic growth phase, the overwhelming majority of the sampled firms are evidenced to exhibit extreme year-on-year fluctuations of sales, investments and cash flows over the short- and medium-term observation windows. The variability of operating results and the probabilistic nature of company-level fundamentals may preclude the possibility of constructing a reliable cash flow forecast for the purposes of a DCF valuation. This methodological issue appears to pose a particular challenge during the calculation of terminal value, which is heavily dependent on highly subjective and uncertain steady-state fundamentals. Therefore, the predictive power of the deterministic DCF models may be reduced to a snapshot of the current market sentiment regarding a particular stock. The paper postulates that a further discussion on the tenets of terminal value calculation may be necessary in order to overcome the existing flaws and increase the accuracy of valuation models. We contribute to this discussion by outlining the principal methodological and theoretical issues which challenge the practicing valuators at the stage of terminal value calculation. Our conclusions may help to shed light on the problems of market short-termism, and high inconstancy of investment recommendations.</p></abstract>

The paper presents an empirical verification of the main assumptions underlying the calculation of terminal value in DCF valuation models. The test results suggest that the volatility of free cash flows and the dynamism of the operating environment do not allow us to make a reliable long-term forecast of value creation potential of the public companies in Poland. Regardless of their organic growth phase, the overwhelming majority of the sampled firms are evidenced to exhibit extreme year-on-year fluctuations of sales, investments and cash flows over the short- and medium-term observation windows. The variability of operating results and the probabilistic nature of company-level fundamentals may preclude the possibility of constructing a reliable cash flow forecast for the purposes of a DCF valuation. This methodological issue appears to pose a particular challenge during the calculation of terminal value, which is heavily dependent on highly subjective and uncertain steady-state fundamentals. Therefore, the predictive power of the deterministic DCF models may be reduced to a snapshot of the current market sentiment regarding a particular stock. The paper postulates that a further discussion on the tenets of terminal value calculation may be necessary in order to overcome the existing flaws and increase the accuracy of valuation models. We contribute to this discussion by outlining the principal methodological and theoretical issues which challenge the practicing valuators at the stage of terminal value calculation. Our conclusions may help to shed light on the problems of market short-termism, and high inconstancy of investment recommendations.

Terminal Value Calculation in DCF Valuation Models: An Empirical Verification

Financial Internet Quarterly

This work is licensed under the Creative Commons Attribution-NonCommercial-NoDerivatives 3.0 License.

{"article-title":"Terminal Value Calculation in DCF Valuation Models: An Empirical Verification"}

The paper presents an empirical verification of the main assumptions underlying the calculation of terminal value in DCF valuation models. The test results...

Terminal Value Calculation in DCF Valuation Models: An Empirical Verification

Published Online: Feb 14, 2019

Page range: 27 - 38

Received: Oct 03, 2016

Accepted: Jan 10, 2018

DOI: https://doi.org/10.2478/fiqf-2018-0003

Keywords
DCF valuation, terminal value, intrinsic value

© 2018 Adam Behr et al., published by Sciendo

This work is licensed under the Creative Commons Attribution-NonCommercial-NoDerivatives 3.0 License.

Terminal Value Calculation in DCF Valuation Models: An Empirical Verification

Published Online: Feb 14, 2019

Page range: 27 - 38

Received: Oct 03, 2016

Accepted: Jan 10, 2018

DOI: https://doi.org/10.2478/fiqf-2018-0003

KeywordsDCF valuation, terminal value, intrinsic value

© 2018 Adam Behr et al., published by Sciendo

This work is licensed under the Creative Commons Attribution-NonCommercial-NoDerivatives 3.0 License.

Keywords
DCF valuation, terminal value, intrinsic value