A few weeks ago in BVWire, Raymond J. ("RJ") Dragon (Rotenberg Meril Solomon) presented two views of the power of time in financial economics: , as he compared the two, “Einstein’s rumored fascination with BV compared to Keynes’ believe that ‘in the long run, we are all dead’.”
More seriously, Dragon performed an experiment which looked at the present value of a cash flow in perpetuity, “assuming it was a reasonable proxy for the cash flow from a business.” Dragon used the inverse of the future value formula, where PV(CFn) =CFn * 1/(1+r)^n, - taking a $1 cash flow in period n to determine its present value. The results?
The use of a 3% or 6% long term growth rate in a small, privately-held company valuation model, if appropriate to the individual circumstances of the company, does not seem to present business valuation experts with an extraordinarily long time horizon for the business to exist to realize most of the value. It can, however, have a significant impact on value. On the other hand, the use of a 10% long-term growth rate, selected because the industry is a “high tech growth industry”, may present issues of whether it is realistic to assume a small, privately-held business will exist the 30 or more years needed to realize most of its value. However, it may be appropriate for valuing certain types of venture capital investments using appropriately high venture capital discount rates.
For Dragon’s complete article and analysis click here.
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