Continuation value, also known as terminal value, is a crucial concept in financial valuation, particularly in discounted cash flow (DCF) analysis. It represents the present value of all future cash flows of a business beyond the explicit forecast period. In simpler terms, it’s the value of a company’s business when you stop explicitly projecting its performance year-by-year.
Why is continuation value so important? Typically, the explicit forecast period in a DCF model only spans 5-10 years. While these years are crucial for capturing near-term growth and changes, the value of a company is ultimately determined by its long-term prospects. For stable, mature businesses, the continuation value often comprises a significant portion – sometimes over half – of the total enterprise value. This highlights the need for a careful and well-reasoned calculation.
There are two primary methods for calculating continuation value:
- Gordon Growth Model (GGM): This is the most widely used approach. It assumes that the company’s cash flows will grow at a constant rate indefinitely. The formula is:
Continuation Value = (Cash Flow in the Last Year of the Forecast Period * (1 + Growth Rate)) / (Discount Rate – Growth Rate)
Here, the ‘Growth Rate’ should be a sustainable rate, often tied to long-term GDP growth or inflation. The ‘Discount Rate’ is the company’s weighted average cost of capital (WACC), reflecting the required rate of return for investors. The GGM is best suited for stable, mature businesses with predictable growth patterns. - Exit Multiple Method: This method values the business based on a multiple of a key financial metric, such as revenue, EBITDA, or earnings, observed in comparable companies. The formula is:
Continuation Value = Financial Metric in the Last Year of the Forecast Period * Exit Multiple
Choosing the appropriate multiple is critical. It should be based on publicly traded companies operating in the same industry, with similar risk profiles, and at a comparable stage of maturity. This method is more suitable for companies where finding a stable growth rate is difficult, or where comparable companies exist that provide a reliable benchmark.
Regardless of the method used, several factors significantly influence the continuation value. The growth rate assumption is paramount; a slightly higher growth rate can dramatically increase the terminal value. Similarly, the discount rate plays a critical role. Higher discount rates reflect higher risk, leading to lower continuation values. The chosen exit multiple, in the exit multiple method, also directly impacts the final value.
It’s important to remember that continuation value is an estimate, not a precise calculation. Sensitivity analysis is crucial. Analysts should test the impact of different growth rates, discount rates, and multiples on the overall valuation to understand the range of potential outcomes and the key drivers of value. Furthermore, analysts need to consider if the company will actually exist and continue to operate into the indefinite future, a valid concern considering technological disruption and evolving market dynamics. Due diligence and rigorous analysis are essential to ensure a realistic and reliable continuation value, ultimately leading to a more accurate and robust valuation.
850×320 calculation continuation scientific diagram from www.researchgate.net 
800×488 business continuation business valuation key person from store.planlab.us :max_bytes(150000):strip_icc()/continuationpatternexamples-b172a4918c5b4191a12fd56fbed288cb.jpg)
1813×833 continuation pattern definition from www.investopedia.com 
525×259 navigating nuances continuation funds publications from www.debevoise.com 
842×546 financial bubble chart template from online.visual-paradigm.com